march 2016 market commentary
COMMENTARY
MARCH 2016 MARKET COMMENTARY KEY TAKEAWAYS • Fixed income markets continued to
bounce back after weak performance in January and early February.
• Higher oil prices and dovish Central
Bank posturing helped turn investors to risk-on sentiment.
• We expect to see more decoupling and a higher level of idiosyncratic risks in both muni and corporate credit markets.
• We continue to expect bear flattening of the yield curve, but we are closely monitoring inflation.
MARKET REVIEW Many basketball teams have zoomed into the winner’s circle by making pivotal rebounds to gain possession of the basketball and turn those possessions into scores. Of course, the “rebound” can be just as important to financial markets as it is to the outcome of a basketball tournament. In March, fixed income markets bounced back further from weak performance in January and early February. Corporate bond spreads continued to rebound from their wides in mid-February, ending March nearly in line with levels at the start of the year. The turnaround occurred largely because of a rise in oil prices that helped boost sentiment and move investors into risk-on positioning. Additionally, investors became more optimistic due to a potential Organization of the Petroleum Exporting Countries (OPEC) agreement to freeze oil production in some major regions, more remarks from Chinese policymakers seeking to maintain stability in the yuan, continued strong employment data in the U.S. and dovish posturing from the U.S. Federal Reserve and the European Central Bank (ECB) (Figure 1). These positive trends helped curb the odds of recession for many broker/ dealers, although many market participants have lowered estimates for the first quarter of 2016, following the lead of Federal Reserve governors. The Federal Reserve Bank of Atlanta now shows projections of 0.1 percent gross domestic product (GDP) growth for the first quarter versus projections of more than 2.5 percent earlier in the year, as weak global economic prospects are tilting GDP estimates to the downside. The Fed has now added global economic stability as a “third mandate” to its goals of maximum employment and stable prices, prompting it to hold rates steady and make dovish comments in the March meeting. Lackluster data on U.S. industrial production and manufacturing also offset strong elements of the U.S. economy, such as labor. In our view, a sudden increase in inflation that pushes the Fed into a more hawkish stance would pose risks to fixed income markets.
TAX-EXEMPT MARKET REVIEW New Money Supply Dribbles In Municipal bond yields fell in the first quarter of 2016 due primarily to strong performance in January and the last two weeks of March. Munis benefited from the flight to quality trade occurring at the start of the year. However, muni yield declines failed to keep up with the sharp drops in Treasury yield during 1
MARCH 2016 MARKET COMMENTARY
Figure 1: Many Investors Poised for “Lower for Longer” U.S. Yields
Figure 1: Many Investors Poised for “Lower for Longer” U.S. Yields
10-year Sovereign Debt (%)
6 5 4 3 2 1 0 -1 Jan-13
Jan-14 U.S.
Jan-15
Jan-16
Germany Japan Source: Bloomberg, as of March 31, 2016.
the quarter. By the end of March, shorter maturity ratios were at the highest levels since October 2015. Munis underperformed notably in the five-year, potentially attributable to richness in the belly of the curve that caused retail muni demand to wane modestly. As the five-year muni underperformed, this created a better entry point in terms of relative value. For the quarter, returns were positive, with the highest returns in the long end. No one sector stood out from a return perspective, but A and BBB bonds fared best. Supply and demand trends remained generally favorable for munis during the quarter. Supply lulled versus robust issuance in 1Q15; overall, supply declined 12 percent in 1Q16 versus 1Q15 due to the ongoing trend in lower refunding volume. However, new issue volume increased during the quarter, which could signal a start to funding for delayed infrastructure projects that need to be completed. In addition, refunding patterns suggest an uptick in supply. The second quarter of 2016 marks the close of the 10-year non-call period for bonds
Italy
issued in 2Q06. Supply dipped in the first quarter of 2006 but came back strong in the second quarter of that year, per Barclays. On the demand side, investors continue to favor the asset class on a positive muni credit story and lower
volatility in the sector versus equities and high-yield bonds. Most new issues were oversubscribed and saw pricing lowered through the primary market sales process. Seasonal weakness on tax payments did not appear to hurt demand during March. Overall, more than $14 billion has poured into retail muni mutual funds year to date. For 2015, Fed flow-of -funds data shows that the largest proportion of muni buyers was mutual funds, and U.S. bank holdings increased $47.4 billion. Households continue to reduce their holdings (Figure 2). While credit fundamentals in munis have plateaued, muni credit benefits from higher tax revenues and oildependent states that have mostly been able to manage plummeting oil prices. We do, however, continue to watch many of the headline stories in the muni bond sector, such as those in Pennsylvania, Chicago, Illinois and
Figure 2: Mutual Funds and U.S. Banks are Increasing Muni Holdings, While Households and Nonprofits are Reducing 2015 Net Change in Municipal Holdings
4Q15 Ending Balance
U.S. $ Billions Households and Nonprofit Organizations*
-25.6
1514.8
Mutual Funds
47.7
705.4
Banks
47.4
498.9
1.7 -13.5
323.4 268.2
2.4 4.2
143.4 84.6
Property and Casualty Companies Money Market Mutual Funds Life Insurance Companies (General Accounts) Investors Outside the U.S. Closed-End Funds ETFs State and Local Governments Security Broker Dealers
-0.8
84
3.9
18.5
1.1
14.8
-4.9
14
Non-Financial Corporate Businesses
0.8
13.5
Life Insurance Companies (Separate Accounts)
1.7
8.5
Non-Financial Non-Corporate Businesses
0.3
4.9
-1.4
3.3
Private and Public Pension Funds
*Sector includes domestic hedge funds, private equity funds, and personal trusts. Source: U.S. Federal Reserve, as of March 10, 2016.
2
MARCH 2016 MARKET COMMENTARY
A more-detailed review and our outlook on the corporate bond market can be found in our Quarterly Corporate Bond Commentary.
Figure 3: Financial Spreads Gapped Wider During 1Q16
Figure 3: Financial Spreads Gapped Wider During 1Q16 250 200 150 100 50
6
6
ar -1 M
-1 Fe b
5
5
16 Ja n-
c1 De
5
-1 ov N
t1 Oc
15 pSe
15 gAu
15 Ju l-
15 nJu
ay -1
5
0
5
However, in mid-February, the sector began a large rebound that was sustained through March. Energy and Metals credits led the bounce. Higher oil prices in the first quarter caused Energy spreads to tighten. Additionally, low oil prices helped the consumer and lowered input costs for certain sectors. For the week ending March 11, the price of
Overall, high-grade spreads ended the quarter 4bps tighter. One of the most salient trends of the quarter was lagging performance in Banks, partly due to hefty supply; high-grade Banks are now one of the worst performers year to date (Figure 3). Financials dominated new issuance at 45 percent of the primary market by volume, based partly on expected TLAC requirements and refinancing activity.
U.S. investment grade supply held firm during the quarter, soaring to $356 billion in 1Q16, in line with 1Q15. Credit fundamentals remain challenged by high debt and weak earnings, although we believe we are coming closer to a point in the credit
M
In the investment grade corporate market, the year started weak in sympathy with higher-beta asset classes. As Treasury yields fell, spreads widened, as investors flew into quality. Investors worried about poor data in the Eurozone and Japan along with some weak signals in the U.S. economy, such as a January loan officer survey showing tightening credit conditions. These concerns were only partially offset by strength in wages and household balance sheets. In corporates, ongoing disappointment in profit reports and high corporate leverage helped push spreads wider. Excess return through February 12 was -216 basis points (bps), one of the worst starts to any year in the highgrade corporate market.
cycle where fundamentals are nearing a trough, as companies are receiving fewer plaudits from shareholders on buybacks and as weaker growth expectations are prompting management teams to take better care of balance sheets. Year to date, issuance of A and AA rated bonds has increased significantly versus the first quarter of 2015, while BBB issuance is down 21 percent. However, in March, BBB issuance returned strong, as nearly 45 percent of March supply was BBB rated within the quarter.
Another major tailwind for U.S. high corporates came from across the pond, when the European Central Bank (ECB) increased its pace of quantitative easing by 20 billion euros per month—expanding its balance sheet more than expected— and added investment grade nonfinancial corporate bonds to the mix of securities it would purchase. After the market digested the news, highgrade corporate bond spreads fell. The ECB purchases of corporates should provide a positive technical for IG credit spreads, as it will lead to potentially less supply in the U.S. In addition, U.S. high-grade spreads could become more attractive on a yield basis if European bond spreads contract significantly.
r1
GOVERNMENT CREDIT MARKET REVIEW Central Banks Assist
Brent Crude breached $40 for the first time since December.
Ap
Puerto Rico. Moody’s Investors Service placed 11 Texas oil and gas-reliant local government issuers on review for possible downgrade on March 4 due to low oil prices. Hefty Pension and Other Postemployment Benefits (OPEB) liabilities of several states continue to loom. As the credit cycle enters its later stage, we expect to see more decoupling and a higher level of idiosyncratic risks in both muni and corporate credit markets.
IG Industrial Intermediate OAS IG Financial Institutions Intermediate OAS Source: Barclays, as of March 31, 2016.
3
MARCH 2016 MARKET COMMENTARY
BRECKINRIDGE STRATEGY Watching the Shot Clock on Inflation In rates markets, Fed expectations continue to drive Treasury yield dynamics. We continue to expect the Fed to raise rates three times in 2016, and a bear flattening of the yield curve remains the most likely scenario.
quick spike in inflation could lead to a steeper yield curve. Additionally, a more hawkish Fed could spawn a negative feedback loop of an increasing dollar, which could hurt U.S. manufacturing and emerging markets (as dollar-based debt gets harder to pay off).
M&A transactions. We remain agile to take advantage of subtle shifts to individual names that are at attractive levels.
However, we are closely watching inflation. If oil has bottomed and oil prices turn increasingly higher, a
In corporate credit, earnings remain weak and leverage is elevated. We are encouraged by some slack in the pace of M&A and more equity funding for
For municipal bonds, the credit environment remains good and revenue growth is positive. While there is uncertainty around several upcoming court decisions that are likely to generate headlines, marketwide impact is likely to be minimal.
FOOTNOTES:
4. Thomson Reuters, as of April 11, 2016.
9. Bloomberg, as of March 6, 2016.
1. Broker/dealer reports, Breckinridge Capital
5. Barclays, 2016.
10. Thomson Reuters, as of March 2016.
6. The Bond Buyer, as of April 11, 2016.
11. Barclays, as of April 8, 2016.
7. Lipper, 2016.
12. Barclays, U.S. Intermediate Corporate Index,
Advisors, as of April 11, 2016. 2. Federal Reserve Bank of Atlanta, as of April 8, 2016.
GDP Projections are Seasonally Adjusted Annual Rate. 3. U.S. Federal Reserve, as of March 16, 2016.
8. Barclays, U.S. Intermediate Corporate Index,
Option Adjusted Spread, as of March 31, 2016.
Excess Return YTD as of February 12, 2016.
DISCLAIMER: This material has been prepared for our clients and other interested parties and contains the opinions of Breckinridge Capital Advisors, Inc. Information and opinions are current as of the date(s) indicated and are subject to change without notice. Any specific securities or portfolio characteristics are for illustrative purposes and example only. They may not reflect historical, current or future investments in any client portfolio. Nothing in this document should be construed or relied upon as tax, legal or financial advice. All investments involve risk – including loss of principal. An investor should consult with an investment professional before making any investment decisions. Breckinridge can make no assurances, warranties or representations that any strategies described will meet their investment objectives or incur any profits.This document may include projections or other forward-looking statements, which are based on Breckinridge’s research, analysis, and assumptions. There can be no assurances that such projections will occur and the actual results may differ materially. Other events that were not taken into account in formulating such projections may occur and may significantly affect the returns or performance of any account. Past performance is not indicative of future results. This document includes information from companies not affiliated with Breckinridge (“third party content”). Breckinridge reasonably believes the third party content is reliable but cannot guarantee its accuracy or completeness.
4
MARCH 2016 MARKET COMMENTARY KEY TAKEAWAYS • Fixed income markets continued to
bounce back after weak performance in January and early February.
• Higher oil prices and dovish Central
Bank posturing helped turn investors to risk-on sentiment.
• We expect to see more decoupling and a higher level of idiosyncratic risks in both muni and corporate credit markets.
• We continue to expect bear flattening of the yield curve, but we are closely monitoring inflation.
MARKET REVIEW Many basketball teams have zoomed into the winner’s circle by making pivotal rebounds to gain possession of the basketball and turn those possessions into scores. Of course, the “rebound” can be just as important to financial markets as it is to the outcome of a basketball tournament. In March, fixed income markets bounced back further from weak performance in January and early February. Corporate bond spreads continued to rebound from their wides in mid-February, ending March nearly in line with levels at the start of the year. The turnaround occurred largely because of a rise in oil prices that helped boost sentiment and move investors into risk-on positioning. Additionally, investors became more optimistic due to a potential Organization of the Petroleum Exporting Countries (OPEC) agreement to freeze oil production in some major regions, more remarks from Chinese policymakers seeking to maintain stability in the yuan, continued strong employment data in the U.S. and dovish posturing from the U.S. Federal Reserve and the European Central Bank (ECB) (Figure 1). These positive trends helped curb the odds of recession for many broker/ dealers, although many market participants have lowered estimates for the first quarter of 2016, following the lead of Federal Reserve governors. The Federal Reserve Bank of Atlanta now shows projections of 0.1 percent gross domestic product (GDP) growth for the first quarter versus projections of more than 2.5 percent earlier in the year, as weak global economic prospects are tilting GDP estimates to the downside. The Fed has now added global economic stability as a “third mandate” to its goals of maximum employment and stable prices, prompting it to hold rates steady and make dovish comments in the March meeting. Lackluster data on U.S. industrial production and manufacturing also offset strong elements of the U.S. economy, such as labor. In our view, a sudden increase in inflation that pushes the Fed into a more hawkish stance would pose risks to fixed income markets.
TAX-EXEMPT MARKET REVIEW New Money Supply Dribbles In Municipal bond yields fell in the first quarter of 2016 due primarily to strong performance in January and the last two weeks of March. Munis benefited from the flight to quality trade occurring at the start of the year. However, muni yield declines failed to keep up with the sharp drops in Treasury yield during 1
MARCH 2016 MARKET COMMENTARY
Figure 1: Many Investors Poised for “Lower for Longer” U.S. Yields
Figure 1: Many Investors Poised for “Lower for Longer” U.S. Yields
10-year Sovereign Debt (%)
6 5 4 3 2 1 0 -1 Jan-13
Jan-14 U.S.
Jan-15
Jan-16
Germany Japan Source: Bloomberg, as of March 31, 2016.
the quarter. By the end of March, shorter maturity ratios were at the highest levels since October 2015. Munis underperformed notably in the five-year, potentially attributable to richness in the belly of the curve that caused retail muni demand to wane modestly. As the five-year muni underperformed, this created a better entry point in terms of relative value. For the quarter, returns were positive, with the highest returns in the long end. No one sector stood out from a return perspective, but A and BBB bonds fared best. Supply and demand trends remained generally favorable for munis during the quarter. Supply lulled versus robust issuance in 1Q15; overall, supply declined 12 percent in 1Q16 versus 1Q15 due to the ongoing trend in lower refunding volume. However, new issue volume increased during the quarter, which could signal a start to funding for delayed infrastructure projects that need to be completed. In addition, refunding patterns suggest an uptick in supply. The second quarter of 2016 marks the close of the 10-year non-call period for bonds
Italy
issued in 2Q06. Supply dipped in the first quarter of 2006 but came back strong in the second quarter of that year, per Barclays. On the demand side, investors continue to favor the asset class on a positive muni credit story and lower
volatility in the sector versus equities and high-yield bonds. Most new issues were oversubscribed and saw pricing lowered through the primary market sales process. Seasonal weakness on tax payments did not appear to hurt demand during March. Overall, more than $14 billion has poured into retail muni mutual funds year to date. For 2015, Fed flow-of -funds data shows that the largest proportion of muni buyers was mutual funds, and U.S. bank holdings increased $47.4 billion. Households continue to reduce their holdings (Figure 2). While credit fundamentals in munis have plateaued, muni credit benefits from higher tax revenues and oildependent states that have mostly been able to manage plummeting oil prices. We do, however, continue to watch many of the headline stories in the muni bond sector, such as those in Pennsylvania, Chicago, Illinois and
Figure 2: Mutual Funds and U.S. Banks are Increasing Muni Holdings, While Households and Nonprofits are Reducing 2015 Net Change in Municipal Holdings
4Q15 Ending Balance
U.S. $ Billions Households and Nonprofit Organizations*
-25.6
1514.8
Mutual Funds
47.7
705.4
Banks
47.4
498.9
1.7 -13.5
323.4 268.2
2.4 4.2
143.4 84.6
Property and Casualty Companies Money Market Mutual Funds Life Insurance Companies (General Accounts) Investors Outside the U.S. Closed-End Funds ETFs State and Local Governments Security Broker Dealers
-0.8
84
3.9
18.5
1.1
14.8
-4.9
14
Non-Financial Corporate Businesses
0.8
13.5
Life Insurance Companies (Separate Accounts)
1.7
8.5
Non-Financial Non-Corporate Businesses
0.3
4.9
-1.4
3.3
Private and Public Pension Funds
*Sector includes domestic hedge funds, private equity funds, and personal trusts. Source: U.S. Federal Reserve, as of March 10, 2016.
2
MARCH 2016 MARKET COMMENTARY
A more-detailed review and our outlook on the corporate bond market can be found in our Quarterly Corporate Bond Commentary.
Figure 3: Financial Spreads Gapped Wider During 1Q16
Figure 3: Financial Spreads Gapped Wider During 1Q16 250 200 150 100 50
6
6
ar -1 M
-1 Fe b
5
5
16 Ja n-
c1 De
5
-1 ov N
t1 Oc
15 pSe
15 gAu
15 Ju l-
15 nJu
ay -1
5
0
5
However, in mid-February, the sector began a large rebound that was sustained through March. Energy and Metals credits led the bounce. Higher oil prices in the first quarter caused Energy spreads to tighten. Additionally, low oil prices helped the consumer and lowered input costs for certain sectors. For the week ending March 11, the price of
Overall, high-grade spreads ended the quarter 4bps tighter. One of the most salient trends of the quarter was lagging performance in Banks, partly due to hefty supply; high-grade Banks are now one of the worst performers year to date (Figure 3). Financials dominated new issuance at 45 percent of the primary market by volume, based partly on expected TLAC requirements and refinancing activity.
U.S. investment grade supply held firm during the quarter, soaring to $356 billion in 1Q16, in line with 1Q15. Credit fundamentals remain challenged by high debt and weak earnings, although we believe we are coming closer to a point in the credit
M
In the investment grade corporate market, the year started weak in sympathy with higher-beta asset classes. As Treasury yields fell, spreads widened, as investors flew into quality. Investors worried about poor data in the Eurozone and Japan along with some weak signals in the U.S. economy, such as a January loan officer survey showing tightening credit conditions. These concerns were only partially offset by strength in wages and household balance sheets. In corporates, ongoing disappointment in profit reports and high corporate leverage helped push spreads wider. Excess return through February 12 was -216 basis points (bps), one of the worst starts to any year in the highgrade corporate market.
cycle where fundamentals are nearing a trough, as companies are receiving fewer plaudits from shareholders on buybacks and as weaker growth expectations are prompting management teams to take better care of balance sheets. Year to date, issuance of A and AA rated bonds has increased significantly versus the first quarter of 2015, while BBB issuance is down 21 percent. However, in March, BBB issuance returned strong, as nearly 45 percent of March supply was BBB rated within the quarter.
Another major tailwind for U.S. high corporates came from across the pond, when the European Central Bank (ECB) increased its pace of quantitative easing by 20 billion euros per month—expanding its balance sheet more than expected— and added investment grade nonfinancial corporate bonds to the mix of securities it would purchase. After the market digested the news, highgrade corporate bond spreads fell. The ECB purchases of corporates should provide a positive technical for IG credit spreads, as it will lead to potentially less supply in the U.S. In addition, U.S. high-grade spreads could become more attractive on a yield basis if European bond spreads contract significantly.
r1
GOVERNMENT CREDIT MARKET REVIEW Central Banks Assist
Brent Crude breached $40 for the first time since December.
Ap
Puerto Rico. Moody’s Investors Service placed 11 Texas oil and gas-reliant local government issuers on review for possible downgrade on March 4 due to low oil prices. Hefty Pension and Other Postemployment Benefits (OPEB) liabilities of several states continue to loom. As the credit cycle enters its later stage, we expect to see more decoupling and a higher level of idiosyncratic risks in both muni and corporate credit markets.
IG Industrial Intermediate OAS IG Financial Institutions Intermediate OAS Source: Barclays, as of March 31, 2016.
3
MARCH 2016 MARKET COMMENTARY
BRECKINRIDGE STRATEGY Watching the Shot Clock on Inflation In rates markets, Fed expectations continue to drive Treasury yield dynamics. We continue to expect the Fed to raise rates three times in 2016, and a bear flattening of the yield curve remains the most likely scenario.
quick spike in inflation could lead to a steeper yield curve. Additionally, a more hawkish Fed could spawn a negative feedback loop of an increasing dollar, which could hurt U.S. manufacturing and emerging markets (as dollar-based debt gets harder to pay off).
M&A transactions. We remain agile to take advantage of subtle shifts to individual names that are at attractive levels.
However, we are closely watching inflation. If oil has bottomed and oil prices turn increasingly higher, a
In corporate credit, earnings remain weak and leverage is elevated. We are encouraged by some slack in the pace of M&A and more equity funding for
For municipal bonds, the credit environment remains good and revenue growth is positive. While there is uncertainty around several upcoming court decisions that are likely to generate headlines, marketwide impact is likely to be minimal.
FOOTNOTES:
4. Thomson Reuters, as of April 11, 2016.
9. Bloomberg, as of March 6, 2016.
1. Broker/dealer reports, Breckinridge Capital
5. Barclays, 2016.
10. Thomson Reuters, as of March 2016.
6. The Bond Buyer, as of April 11, 2016.
11. Barclays, as of April 8, 2016.
7. Lipper, 2016.
12. Barclays, U.S. Intermediate Corporate Index,
Advisors, as of April 11, 2016. 2. Federal Reserve Bank of Atlanta, as of April 8, 2016.
GDP Projections are Seasonally Adjusted Annual Rate. 3. U.S. Federal Reserve, as of March 16, 2016.
8. Barclays, U.S. Intermediate Corporate Index,
Option Adjusted Spread, as of March 31, 2016.
Excess Return YTD as of February 12, 2016.
DISCLAIMER: This material has been prepared for our clients and other interested parties and contains the opinions of Breckinridge Capital Advisors, Inc. Information and opinions are current as of the date(s) indicated and are subject to change without notice. Any specific securities or portfolio characteristics are for illustrative purposes and example only. They may not reflect historical, current or future investments in any client portfolio. Nothing in this document should be construed or relied upon as tax, legal or financial advice. All investments involve risk – including loss of principal. An investor should consult with an investment professional before making any investment decisions. Breckinridge can make no assurances, warranties or representations that any strategies described will meet their investment objectives or incur any profits.This document may include projections or other forward-looking statements, which are based on Breckinridge’s research, analysis, and assumptions. There can be no assurances that such projections will occur and the actual results may differ materially. Other events that were not taken into account in formulating such projections may occur and may significantly affect the returns or performance of any account. Past performance is not indicative of future results. This document includes information from companies not affiliated with Breckinridge (“third party content”). Breckinridge reasonably believes the third party content is reliable but cannot guarantee its accuracy or completeness.
4
