Market Commentary - Amazon Simple Storage Service (S3)
AUGUST 2015
MARKET COMMENTARY Market Review Global Weakness Clouds Outlook for Fed Rate Hike Market volatility returned in August, triggered in large part by concerns over a lackluster global economy. The Chinese government, likely struggling to meet its 7-percent target for GDP growth, unexpectedly devalued its currency early in the month. China is the largest single contributor to world GDP growth, as shown in the following chart. Even moderate declines in China’s economy reverberate around the world, as was evident in August in both the global equity and commodity markets. Figure 1: Contribution to World GDP Growth* 6% 4%
2%
0%
-2%
1980
1985
1990
United States
China
1995
Other BRICs
2000
2005
2010
Other emerging countries
2015†
Other rich countries
Source: International Monetary Fund, The Economist
*Purchasing-power parity †Forecast
Commodity prices continued to slump with oil prices temporarily dipping below $40 per barrel late in the month. The Dow Jones Industrial Average (DJIA), S&P 500 Index and Nasdaq fell by more than 6 percent in August, with the DJIA experiencing its largest monthly decline since May 2010. At times during the month, both the DJIA and the S&P 500 dropped 10 percent, entering correction territory. Figure 2: Asset Class Returns (YTD)
Treasury bonds also experienced dramatic price swings. Yields on the 10-year Treasury bond fell from just over 2.25 percent at the beginning of the month to below 2 percent during the peak of the equity sell-off, only to retrace most of those gains during the last week of the month and close at a yield of 2.21 percent. As Figure 2 illustrates, fixed income was the best performer for the month and year-to-date. The Federal Open Market Committee (FOMC) faces a difficult decision when it meets on September 17, as it weighs whether to raise rates for the first time in nearly 10 years. While U.S. GDP growth continues to be steady and the labor market is rapidly approaching full employment, inflation remains below the Fed’s stated target of 2 percent. Weakness in commodity prices and a strong U.S. dollar are likely to keep inflation contained. Persistently low inflation, a slowing global economy and increased volatility all combined in August to lower market expectations for a September rate hike. If the Fed does not raise rates at its next meeting, it would have two opportunities to take action on rates before the end of the year—at FOMC meetings on October 28 and December 16.
Tax-Exempt Review An Oasis of Calm and Modest Returns Municipal bonds outperformed Treasuries during the month. As illustrated in Figure 3 below, the outperformance was most prominent in the short to intermediate part of the curve. Municipals were an oasis of calm compared to other asset classes during the month and produced modestly positive returns. Barclays Municipal Bond Index gained 20 basis points (bps) during the month compared to 4 bps for Treasuries. In contrast to the wide trading range of the 10-year Treasury bond over the course of the month, the 10-year AAA-rated municipal yield stayed within a 15 bps trading range and held onto most of its gains at month-end.
2% 1%
Figure 3: Change in Yield (August 2015)
0%
Total Returns (%)
-1%
10
-2% -3%
8
-4%
6
Yield (bps)
-5% -6% -7%
lB pa ici
0
S AB
d on
BS un M
U. S.
y M
su r
q sd a Na
2
-2 -4 -6 1 YR
Do w
YTD Total Returns
U. S.
de x
Tr ea
In e sit
po
Co rp or at e Co m
HY
50 0 P
Co rp or at e IG
S&
de x In 00 0
l2 ss el Ru
Jo ne
sI
nd u
st ria
lA ve ra ge
-8%
4
August Total Returns
Source: Bloomberg, Barclays
2 YR
3 YR
Treasury
5 YR
7 YR
10 YR
20 YR
30 YR
Municipal AAA GO
Source: Thomson Reuters, Treasury, Federal Reserve
Breckinridge Capital Advisors | Market Commentary p 1
MARKET COMMENTARY, AUGUST 2015
While quality spreads in corporate bonds, particularly high-yield bonds, widened during the month, municipal quality spreads were largely unaffected by the turmoil, providing investors with much needed stability. Adding to the low price volatility of municipal bonds has been a marked decline in secondary trading volume throughout the summer despite continued strong new issuance. For the sixth consecutive month, new issue supply in August totaled just over $30 billion. Full-year new issuance is on track to reach more than $400 billion, an aggregate amount not seen since 2010. Despite the relative calm in the municipal market, there were several important developments related to Puerto Rico. Puerto Rico Public Finance Commission, one of the smaller Puerto Rico issuers, defaulted on a payment that was due on August 1 and the electric authority was close to an agreement with bondholders on a reduction in the principal amount of their debt outstanding. As we write this letter, a working group in Puerto Rico is presenting their proposal to the governor on an economic recovery and debt adjustment plan, raising the likelihood of a default on the GO credit. However, despite the likely restructuring, travails in Puerto Rico have had little impact on the broader municipal market.
Taxable Market Review Spreads Widen in Risk-Off Market Investment-grade (IG) corporate spreads widened significantly again in August and underperformed duration-matched Treasuries by -60 bps. While the new issue calendar slowed dramatically, concerns about China and commodity prices caused risk assets to sell off globally and kept IG credit spreads under pressure. The Barclays Corporate Index ended the month 9 bps wider and, at 30 bps wider year to date, is back to levels last seen in September 2012. Similar to last month, high quality outperformed with AA-rated bonds generating -18 bps of return compared to -106 bps for BBB-rated bonds. While IG corporates reported total returns of -.59 percent, they held up much better than high-yield corporate bonds, which returned -1.74 percent in August. Figure 4: Investment Grade OAS Performance (YTD) Metals & Mining Cable Satellite Media Entertainment Independent Energy Aerospace & Defense Telecom REITs Technology Railroads Chemicals Paper Health Insurance Healthcare P&C Insurance Utilities Retailers Life Insurance Food & Beverage Banking Finance Refining Integrated Energy Supermarkets
-20
0
20 40 60 Year-to-date OAS change (bps)
80
100
120
As illustrated in Figure 4 above, the IG metals and energy sectors were again the big underperformers. After widening 50 bps last month, most metals credits widened another 20 to 30 bps in August. Even with oil prices bouncing back strongly by monthend, most energy credits widened 20 to 30 bps. Highly rated integrated energy credits were the exception, widening 10 to 15 bps in August. The media sector came under pressure after Disney reported disappointing earnings, raising concerns over long-term sector growth. Financials outperformed, widening 3 to 5 bps, led by insurance credits. The food/beverage and homebuilders sectors also performed well. After setting a record in July, new issuance dropped off in August with $52 billion pricing. While August is a seasonally slow month for supply, elevated volatility in the capital markets also impacted deal flows. Per Barclays, year-to-date new issuance is $957 billion, up 25 percent versus the same period last year.
Credit Spotlight Sizing Up the EPA’s Clean Power Plan In early August, the U.S. Environmental Protection Agency (EPA) released its final rule for the regulation of utility-generated carbon emissions, the Clean Power Plan. The plan is a modest credit negative for coal-reliant utilities and may hamper economic growth in Kentucky and West Virginia. However, most power plants are likely to withstand its near- and medium-term impacts. The Clean Power Plan is designed to reduce utility-based carbon emissions roughly 11 percent by 2030 compared to presentday levels. Under the plan, the federal government establishes carbon-reduction targets, but states have broad authority to determine how utilities will reach federal targets. The rule aims to substantially reduce reliance on coal, which was responsible for 39 percent of U.S. electricity generation in 2014, according to the Energy Information Administration. The plan strongly incents utilities to include more renewable and low-carbon energy in their supply mix. For this reason, carbon-intensive energy producers, like coal-reliant utilities, are most threatened by the new rule. We expect most utilities to weather the immediate impact of the Clean Power Plan for three primary reasons. First, with the availability of abundant and cheap natural gas, utilities throughout the country are slowly transitioning away from coal. Second, several states already incent utilities to reduce carbon emissions. For example, California passed a carbon emission control law in 2005 and nine states in the northeast region of the U.S. have established the Regional Greenhouse Gas Initiative, which caps carbon emissions across state lines. Third, several states have sued to halt the implementation of the new rule, which is likely to slow implementation. It is unclear whether the EPA has authority under the Clean Air Act to regulate carbon emissions as promulgated by the Clean Power Plan.
Source: Barclays
Breckinridge Capital Advisors | Market Commentary p 2
MARKET COMMENTARY, AUGUST 2015
To the extent the plan moves forward, states like Kentucky and West Virginia may be negatively affected. Coal mining jobs remain a source of employment in Appalachian communities
in both of these states. Diminished demand for coal is likely to weaken job growth, increase demands on social services, and may reduce personal income and sales tax collections.
DISCLAIMER: The material in this document is prepared for our clients and other interested parties and contains the opinions of Breckinridge Capital Advisors. Nothing in this document should be construed or relied upon as legal or financial advice. Any specific securities or portfolio characteristics listed above are for illustrative purposes and example only. They may not reflect actual investments in a client portfolio. All investments involve risk – including loss of principal. An investor should consult with an investment professional before making any investment decisions. Factual material is believed to be accurate, taken directly from sources believed to be reliable, including but not limited to, Federal and various state & local government documents, official financial reports, academic articles, and other public materials. However, none of the information should be relied on without independent verification. Breckinridge Capital Advisors | Market Commentary p 3
MARKET COMMENTARY Market Review Global Weakness Clouds Outlook for Fed Rate Hike Market volatility returned in August, triggered in large part by concerns over a lackluster global economy. The Chinese government, likely struggling to meet its 7-percent target for GDP growth, unexpectedly devalued its currency early in the month. China is the largest single contributor to world GDP growth, as shown in the following chart. Even moderate declines in China’s economy reverberate around the world, as was evident in August in both the global equity and commodity markets. Figure 1: Contribution to World GDP Growth* 6% 4%
2%
0%
-2%
1980
1985
1990
United States
China
1995
Other BRICs
2000
2005
2010
Other emerging countries
2015†
Other rich countries
Source: International Monetary Fund, The Economist
*Purchasing-power parity †Forecast
Commodity prices continued to slump with oil prices temporarily dipping below $40 per barrel late in the month. The Dow Jones Industrial Average (DJIA), S&P 500 Index and Nasdaq fell by more than 6 percent in August, with the DJIA experiencing its largest monthly decline since May 2010. At times during the month, both the DJIA and the S&P 500 dropped 10 percent, entering correction territory. Figure 2: Asset Class Returns (YTD)
Treasury bonds also experienced dramatic price swings. Yields on the 10-year Treasury bond fell from just over 2.25 percent at the beginning of the month to below 2 percent during the peak of the equity sell-off, only to retrace most of those gains during the last week of the month and close at a yield of 2.21 percent. As Figure 2 illustrates, fixed income was the best performer for the month and year-to-date. The Federal Open Market Committee (FOMC) faces a difficult decision when it meets on September 17, as it weighs whether to raise rates for the first time in nearly 10 years. While U.S. GDP growth continues to be steady and the labor market is rapidly approaching full employment, inflation remains below the Fed’s stated target of 2 percent. Weakness in commodity prices and a strong U.S. dollar are likely to keep inflation contained. Persistently low inflation, a slowing global economy and increased volatility all combined in August to lower market expectations for a September rate hike. If the Fed does not raise rates at its next meeting, it would have two opportunities to take action on rates before the end of the year—at FOMC meetings on October 28 and December 16.
Tax-Exempt Review An Oasis of Calm and Modest Returns Municipal bonds outperformed Treasuries during the month. As illustrated in Figure 3 below, the outperformance was most prominent in the short to intermediate part of the curve. Municipals were an oasis of calm compared to other asset classes during the month and produced modestly positive returns. Barclays Municipal Bond Index gained 20 basis points (bps) during the month compared to 4 bps for Treasuries. In contrast to the wide trading range of the 10-year Treasury bond over the course of the month, the 10-year AAA-rated municipal yield stayed within a 15 bps trading range and held onto most of its gains at month-end.
2% 1%
Figure 3: Change in Yield (August 2015)
0%
Total Returns (%)
-1%
10
-2% -3%
8
-4%
6
Yield (bps)
-5% -6% -7%
lB pa ici
0
S AB
d on
BS un M
U. S.
y M
su r
q sd a Na
2
-2 -4 -6 1 YR
Do w
YTD Total Returns
U. S.
de x
Tr ea
In e sit
po
Co rp or at e Co m
HY
50 0 P
Co rp or at e IG
S&
de x In 00 0
l2 ss el Ru
Jo ne
sI
nd u
st ria
lA ve ra ge
-8%
4
August Total Returns
Source: Bloomberg, Barclays
2 YR
3 YR
Treasury
5 YR
7 YR
10 YR
20 YR
30 YR
Municipal AAA GO
Source: Thomson Reuters, Treasury, Federal Reserve
Breckinridge Capital Advisors | Market Commentary p 1
MARKET COMMENTARY, AUGUST 2015
While quality spreads in corporate bonds, particularly high-yield bonds, widened during the month, municipal quality spreads were largely unaffected by the turmoil, providing investors with much needed stability. Adding to the low price volatility of municipal bonds has been a marked decline in secondary trading volume throughout the summer despite continued strong new issuance. For the sixth consecutive month, new issue supply in August totaled just over $30 billion. Full-year new issuance is on track to reach more than $400 billion, an aggregate amount not seen since 2010. Despite the relative calm in the municipal market, there were several important developments related to Puerto Rico. Puerto Rico Public Finance Commission, one of the smaller Puerto Rico issuers, defaulted on a payment that was due on August 1 and the electric authority was close to an agreement with bondholders on a reduction in the principal amount of their debt outstanding. As we write this letter, a working group in Puerto Rico is presenting their proposal to the governor on an economic recovery and debt adjustment plan, raising the likelihood of a default on the GO credit. However, despite the likely restructuring, travails in Puerto Rico have had little impact on the broader municipal market.
Taxable Market Review Spreads Widen in Risk-Off Market Investment-grade (IG) corporate spreads widened significantly again in August and underperformed duration-matched Treasuries by -60 bps. While the new issue calendar slowed dramatically, concerns about China and commodity prices caused risk assets to sell off globally and kept IG credit spreads under pressure. The Barclays Corporate Index ended the month 9 bps wider and, at 30 bps wider year to date, is back to levels last seen in September 2012. Similar to last month, high quality outperformed with AA-rated bonds generating -18 bps of return compared to -106 bps for BBB-rated bonds. While IG corporates reported total returns of -.59 percent, they held up much better than high-yield corporate bonds, which returned -1.74 percent in August. Figure 4: Investment Grade OAS Performance (YTD) Metals & Mining Cable Satellite Media Entertainment Independent Energy Aerospace & Defense Telecom REITs Technology Railroads Chemicals Paper Health Insurance Healthcare P&C Insurance Utilities Retailers Life Insurance Food & Beverage Banking Finance Refining Integrated Energy Supermarkets
-20
0
20 40 60 Year-to-date OAS change (bps)
80
100
120
As illustrated in Figure 4 above, the IG metals and energy sectors were again the big underperformers. After widening 50 bps last month, most metals credits widened another 20 to 30 bps in August. Even with oil prices bouncing back strongly by monthend, most energy credits widened 20 to 30 bps. Highly rated integrated energy credits were the exception, widening 10 to 15 bps in August. The media sector came under pressure after Disney reported disappointing earnings, raising concerns over long-term sector growth. Financials outperformed, widening 3 to 5 bps, led by insurance credits. The food/beverage and homebuilders sectors also performed well. After setting a record in July, new issuance dropped off in August with $52 billion pricing. While August is a seasonally slow month for supply, elevated volatility in the capital markets also impacted deal flows. Per Barclays, year-to-date new issuance is $957 billion, up 25 percent versus the same period last year.
Credit Spotlight Sizing Up the EPA’s Clean Power Plan In early August, the U.S. Environmental Protection Agency (EPA) released its final rule for the regulation of utility-generated carbon emissions, the Clean Power Plan. The plan is a modest credit negative for coal-reliant utilities and may hamper economic growth in Kentucky and West Virginia. However, most power plants are likely to withstand its near- and medium-term impacts. The Clean Power Plan is designed to reduce utility-based carbon emissions roughly 11 percent by 2030 compared to presentday levels. Under the plan, the federal government establishes carbon-reduction targets, but states have broad authority to determine how utilities will reach federal targets. The rule aims to substantially reduce reliance on coal, which was responsible for 39 percent of U.S. electricity generation in 2014, according to the Energy Information Administration. The plan strongly incents utilities to include more renewable and low-carbon energy in their supply mix. For this reason, carbon-intensive energy producers, like coal-reliant utilities, are most threatened by the new rule. We expect most utilities to weather the immediate impact of the Clean Power Plan for three primary reasons. First, with the availability of abundant and cheap natural gas, utilities throughout the country are slowly transitioning away from coal. Second, several states already incent utilities to reduce carbon emissions. For example, California passed a carbon emission control law in 2005 and nine states in the northeast region of the U.S. have established the Regional Greenhouse Gas Initiative, which caps carbon emissions across state lines. Third, several states have sued to halt the implementation of the new rule, which is likely to slow implementation. It is unclear whether the EPA has authority under the Clean Air Act to regulate carbon emissions as promulgated by the Clean Power Plan.
Source: Barclays
Breckinridge Capital Advisors | Market Commentary p 2
MARKET COMMENTARY, AUGUST 2015
To the extent the plan moves forward, states like Kentucky and West Virginia may be negatively affected. Coal mining jobs remain a source of employment in Appalachian communities
in both of these states. Diminished demand for coal is likely to weaken job growth, increase demands on social services, and may reduce personal income and sales tax collections.
DISCLAIMER: The material in this document is prepared for our clients and other interested parties and contains the opinions of Breckinridge Capital Advisors. Nothing in this document should be construed or relied upon as legal or financial advice. Any specific securities or portfolio characteristics listed above are for illustrative purposes and example only. They may not reflect actual investments in a client portfolio. All investments involve risk – including loss of principal. An investor should consult with an investment professional before making any investment decisions. Factual material is believed to be accurate, taken directly from sources believed to be reliable, including but not limited to, Federal and various state & local government documents, official financial reports, academic articles, and other public materials. However, none of the information should be relied on without independent verification. Breckinridge Capital Advisors | Market Commentary p 3
