Market Commentary
NOVEMBER 2015
MARKET COMMENTARY Market Review November opened with an upbeat U.S. payroll report that handily beat expectations. Per that report, October non-farm payrolls rose by 271,000 jobs versus 190,000 consensus and the unemployment rate held steady at 5 percent. Even the stubbornly low wage growth in the U.S. showed signs of life, with average hourly earnings ticking 9 cents higher to $25.20. Meanwhile, the purchasing managers index (PMI) and retail sales numbers were much less rosy. The October PMI fell to its lowest reading since May 2013, and cheap prices at the gas pump did not translate into a boom in consumer retail spending. Additionally, inflation has remained low, with the consumer price index (CPI) up a paltry 0.2 percent for October.1 Nonetheless, October’s encouraging labor report served as a herald to markets that the U.S. Federal Reserve (the Fed) would have enough positive economic momentum to raise rates at its December meeting. By month end, the futures markets had largely priced in a December rate hike, although the schedule for hiking remains less clear. In our view, the Fed will raise rates at a measured pace, and the low-rate environment will continue in upcoming months (Figure 1).
Divergent policy trends remain in place in the global economy, as the U.S. is poised to tighten policy while the European Central Bank may enact even more accommodation after its latest action. (The ECB cut the deposit facility interest rate by 10 basis points on December 3). The ECB’s announcement underwhelmed markets, as many expected a greater deposit rate cut and more drastic accommodative measures.
Tax-Exempt Review Municipal bonds (munis) told a tale of two markets in November, with a sluggish start to the month followed by a better finish. However, munis were less volatile than Treasury bonds. The 10year Treasury yield increased at the beginning of November but then dropped later, as investors shifted into safe haven trading on heightened geopolitical concerns. The 10-year Treasury bond finished the month up about 7 basis points at 2.22 percent. Muni ratios remained very low due to stark outperformance of munis versus Treasuries. For maturities seven years and higher, ratios have plummeted to the lows of the year. During November, munis outperformed Treasuries and most other fixed income assets, with the best muni performance at the long end of the curve. The 30-year AAA general obligation (GO) ratio ended the month at 99 percent. BBB munis were the best performers during the month (Figure 2).
Figure 1: Fed Chair Janet Yellen Expects Inflation to Meet 2 Percent Target in the Medium Term 4.0
Year Over Year Growth (%)
“staggering adverse conditions” for commodity credits and the large volume of oil/gas and metals/mining bonds outstanding.
3.5 3.0 2.5 2.0
Figure 2: Munis Outperformed Treasuries in November Especially at the Long End
1.5 1.0
20 5 No v15
4 l-1
ar -1 M
Ju
3 No v13
2
ar -1
l-1
M
Ju
1 No v11
0 l-1
ar -1 M
Employment Cost Index
15
U.S. Average Hourly Earnings
Source: Bloomberg, as of December 1, 2015.
Commodity prices fell sharply in November. Brent crude fell 10 percent during the month, and copper hit a 6.5-year low due to continued slow growth in China and a strong dollar that stifled demand from foreign buyers.2 The weakness in commodities continues to ripple through credit markets. In high yield (HY), energy was the worst performing sector in November, with independent oil and gas companies posting the most severe declines. Moody’s Investors Service expects the speculative-grade default rate to rise in 2016 from the current trailing 12-month rate of 2.7 percent due to
10
Yield (bps)
U.S. Core PCE Price Index
Ju
9 No v09
8 l-0
ar -0 M
Ju
M
ar -0
7 No v07
0.5
5 0 -5 -10 -15 -20 1 YR
2 YR
3 YR
Treasury
5 YR
7 YR
10 YR
20 YR
30 YR
Municipal AAA GO
Source: Thomson Reuters, U.S. Treasury, U.S. Federal Reserve, as of November 30, 2015.
On the high yield side, Puerto Rico’s headline risk continued to grip market participants in November, as high yield investors worried about the Commonwealth’s ability to meet its December Breckinridge Capital Advisors | Market Commentary p 1
MARKET COMMENTARY, NOVEMBER 2015
Municipal bond fund inflows have been positive for nine straight weeks as of December 2nd, with aggregate flows of about $9.4 billion year-to-date.4 Many issues were oversubscribed during the month of November. For example, a California school district priced a new general obligation bond 10 to 15 basis points tight to talk5 given strong demand and limited supply Thanksgiving week. In specific credit news, Pennsylvania continues to struggle with its budget. The state released a (tentative) new budget that didn’t pass; it included an increase in state sales taxes by 1.25 percent, changes to state-owned liquor stores, reform of state pension systems and an increase in support to school districts in the form of a property tax reduction.6
IG saw another month of massive supply, after surpassing $1 trillion for the year in October.9 For November’s $96.7 billion of fixed-rate issuance,10 supply flourished in all weeks except for the last week of the month when geopolitical flare-ups and the holiday prompted a slowdown. IG supply has now reached historical highs, as opposed to HY, where supply is tracking to have its lowest annual issuance since 2011. The copious HG issuance is largely driven by mergers and acquisitions (M&A) in North America, which has also swelled to an annual record (Figure 3). The announced $160 billion pharmaceutical merger of Pfizer Inc. and Allergan plc—the largest deal this year— lifted North American M&A volume to $3.3 trillion year-to-date. Other deals in the pipeline are primarily to back share buybacks or to fund free cash flow deficits for exploration & production (E&P) firms. Figure 3: M&A Has Skyrocketed, Elevating Event-Driven High-Grade Issuance 700
70
600
60
500
50
400
40
300
30
200
20
100
10
0
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov 2014 2015
0
Percent of Global M&A Sized $10Bln+
Puerto Rico’s woes did not permeate the positive sentiment on the municipal sector as a whole, as demand for new issues remained robust in the face of heavy supply. Municipalities issued $23.2 billion in November, as issuers raced to market before the December Fed meeting and the upcoming holidays. Additionally, over the last three months, we’ve seen new issue supply down versus year-ago levels as refunding volume has slowed. November 2015 supply came in 21 percent lower than the same month a year ago, which likely accounts for some of the strong muni performance.3 Potentially a boost to 2016 supply, both houses of Congress passed a new multiyear highway bill that provides $305 billion worth of transportation funding through 2020.
Bank outperformance was helped by a lower level of supply in the banking/finance sector versus industrials. Further supporting banks, the Financial Stability Board released its final Total Loss-Absorbing Capacity (TLAC) standard for global systemically important banks in November,8 and it was seen as less stringent than expected.
Monthly Global M&A Volume
debt obligations. Puerto Rico sold off during the month, but that underperformance was offset by strong performance in other sectors including tobacco. The Commonwealth’s bonds generally improved after it made all principal and interest payments for its December 1st due date and announced a clawback provision of certain funding sources, with positive implications for GO bonds.
Source: Dealogic, taken from http://www.dealogic.com/media/market-insights/ma-statshot/, as of December 1, 2015.
In early November, the U.S. House of Representatives approved a bill treating munis as high-quality liquid assets (HQLA). The bill is not yet law, and as a Citi report noted, the bill may have a muted impact given that muni demand has remained robust—even when excluded from HQLA treatment.
Taxable Market Review Investment grade (IG) corporate bonds held up well in November, with the Barclays Credit Index coming 3 basis points tighter and outperforming duration-matched Treasuries. Broadly, IG performance was impacted by a broader risk-off stance in markets versus October. Single-A credits performed best, while crossover credits fared worst. This is flipped from October, when crossover credits did best and high quality underperformed. During November, IG dramatically outperformed HY, which saw spreads widen 50 basis points on energy weakness.7 Foreign local government, bank and telecom credits led IG performance in November. Metals and midstream names had the worst showing. The outperformance of banks versus industrials is one of the most salient trends in today’s market.
With the rampant M&A, along with the general lackluster U.S. earnings reports the last two quarters, the credit profile of investment grade names continues to deteriorate. We remain concerned about increasing leverage, particularly given the nowcommonplace reports of shareholder shakeups across high-grade names. For example, in November, Alcoa, Yahoo and Xerox were impacted by shareholder activism. HG continues to see strong demand; the new issue concession for November hit its lowest level since June 2014, according to Bank of America Merrill Lynch. Inflows were solid throughout the month, especially relative to substantial outflows in HY in the latter part of the month. Yields remain low versus historical levels. However, with year-to-date widening and Treasury weakness in November, U.S. IG long-maturity yields exceeded 5 percent during the month11—the threshold level for some pension fund investors. The pickup in yield potentially bodes well for institutional inflows.
Breckinridge Capital Advisors | Market Commentary p 2
MARKET COMMENTARY, NOVEMBER 2015
Figure 4: Passage of the FAST Act May Boost Public Transportation Spending 35000 30000 25000 20000 15000
U.S. Bureau of Labor Statistics, as of November 6, 2015.
7.
Based on the Bank of America Merrill Lynch U.S. High Yield Index (H0A0), MTD change, as of November 30, 2015.
2.
Bloomberg, ICE Brent Futures contract, Copper (Comex) Futures data, as of December 1, 2015.
8.
Financial Stability Board, as of November 9, 2015.
3. Bond Buyer, as of December 4, 2015.
9. Thomson Reuters, as of October, 2015.
4.
10. Barclays, as of December 1, 2015.
5. Bloomberg, as of November 2015; Breckinridge Capital Advisors, as of November 2015.
11. Based on the Barclays U.S. Long Corporate Index, U.S. Yield-to-Worst.
6.
12. Thomson Reuters, The Municipal Market Monitor (TM3), as of November 30, 2015
Pennsylvania Budget and Policy Center, November 18, 2015; Commonwealth of Pennsylvania, Office of the Governor, March
t-1 5
Source: U.S. Census Bureau, as of October 2015.
1.
Bond Buyer, as of December 4, 2015.
Oc
t-1 4 Oc
t-1 3 Oc
t-1 2 Oc
t-1 1 Oc
t-1 0 Oc
t-0 9 Oc
t-0 8 Oc
Oc
The passage of the FAST Act is unquestionably credit positive for GARVEE bonds. As we highlighted in our February 2014 commentary,
t-0 7
10000
t-0 5
In December, President Obama signed the Fixing America’s Surface Transportation (FAST) Act reauthorizing the Federal Highway Trust Fund (HTF). The HTF is funded by federal gas tax revenues, which are transferred to states in the form of grants for transportation projects. Many states use these grant revenues to secure “Grant Anticipation Revenue Vehicles” or GARVEE bonds. The FAST Act is not perfect, in that it relies on a patchwork of non-recurring funding sources to plug the shortfall between revenues derived from gas taxes, and total HTF expenditures. However, the fully-funded, five-year tenure of the legislation marks the longest authorization period for the HTF since 1998—demonstrating that bipartisan support for federal surface transportation grant programs has not abated. The support is particularly notable given the commonplace congressional gridlock occurring over the last several years.
Oc
Credit Market Spotlight
We suspect that the passage of the FAST Act may spark an uptick in GARVEE bond issuance. Also, public spending on transportation infrastructure in general may rise (Figure 4). The bill provides a 15% total increase in federal highway grants for each state over the next five years. The multi-year length of the legislation provides funding certainty for states to move forward with large transportation projects, even those that have not securitized their federal transportation grants via GARVEE issuance. As this chart demonstrates, state and local transportation construction spending has been increasing since 2012. We believe this trend may accelerate as state and local governments look to address aging infrastructure and deferred capital needs.
t-0 6
For our tax-efficient strategies, we see the most pricing risk in the middle of the curve. Municipal bonds have outperformed and ratios have richened significantly, particularly in the 5-year area. The 5-year ratio ended the month at 76.2 percent, close to the average for the period of 1990 to 2006, but well below the average for 2006 to 2015 (89.6 percent)12. As a result, we have pared back exposure to the 5-year area across some strategies. Given the high valuations of taxable munis, we reduced the muni weighting in our government credit strategies a little and shifted into more Treasuries. Our exposure to IG corporates in government credit is unchanged, as we think that the declining credit profile in that asset class is a near-term risk. We would need to see the management of IG companies increase their focus on balance sheet strength before becoming more constructive on the sector.
we believe GARVEE bonds are solid credits, particularly those that finance state highway projects. GARVEEs are an important financing mechanism for essential transportation infrastructure, and Congress is likely to protect this financing source for the foreseeable future. In our view, the biggest risk for GARVEE bonds is not reauthorization of the HTF upon expiration of the FAST Act in 2020, but the possible “rightsizing” of the program to a level where gas taxes cover 100% of the cost. This risk is mitigated by the fact that most GARVEE bonds are modestly leveraged. Any GARVEE funding reductions are unlikely to have meaningful impact on debt-service coverage levels for highway GARVEE bonds.
Oc
We are confident that the Fed will begin to normalize interest rates in December, although we are watching the November jobs report and ongoing geopolitical risks closely. We continue to expect a bear flattening as short-end Treasury rates inch up.
State and Local Government Transportation Construction Spending ($Mlns)
Breckinridge Strategy and Outlook
3, 2015.
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 November opened with an upbeat U.S. payroll report that handily beat expectations. Per that report, October non-farm payrolls rose by 271,000 jobs versus 190,000 consensus and the unemployment rate held steady at 5 percent. Even the stubbornly low wage growth in the U.S. showed signs of life, with average hourly earnings ticking 9 cents higher to $25.20. Meanwhile, the purchasing managers index (PMI) and retail sales numbers were much less rosy. The October PMI fell to its lowest reading since May 2013, and cheap prices at the gas pump did not translate into a boom in consumer retail spending. Additionally, inflation has remained low, with the consumer price index (CPI) up a paltry 0.2 percent for October.1 Nonetheless, October’s encouraging labor report served as a herald to markets that the U.S. Federal Reserve (the Fed) would have enough positive economic momentum to raise rates at its December meeting. By month end, the futures markets had largely priced in a December rate hike, although the schedule for hiking remains less clear. In our view, the Fed will raise rates at a measured pace, and the low-rate environment will continue in upcoming months (Figure 1).
Divergent policy trends remain in place in the global economy, as the U.S. is poised to tighten policy while the European Central Bank may enact even more accommodation after its latest action. (The ECB cut the deposit facility interest rate by 10 basis points on December 3). The ECB’s announcement underwhelmed markets, as many expected a greater deposit rate cut and more drastic accommodative measures.
Tax-Exempt Review Municipal bonds (munis) told a tale of two markets in November, with a sluggish start to the month followed by a better finish. However, munis were less volatile than Treasury bonds. The 10year Treasury yield increased at the beginning of November but then dropped later, as investors shifted into safe haven trading on heightened geopolitical concerns. The 10-year Treasury bond finished the month up about 7 basis points at 2.22 percent. Muni ratios remained very low due to stark outperformance of munis versus Treasuries. For maturities seven years and higher, ratios have plummeted to the lows of the year. During November, munis outperformed Treasuries and most other fixed income assets, with the best muni performance at the long end of the curve. The 30-year AAA general obligation (GO) ratio ended the month at 99 percent. BBB munis were the best performers during the month (Figure 2).
Figure 1: Fed Chair Janet Yellen Expects Inflation to Meet 2 Percent Target in the Medium Term 4.0
Year Over Year Growth (%)
“staggering adverse conditions” for commodity credits and the large volume of oil/gas and metals/mining bonds outstanding.
3.5 3.0 2.5 2.0
Figure 2: Munis Outperformed Treasuries in November Especially at the Long End
1.5 1.0
20 5 No v15
4 l-1
ar -1 M
Ju
3 No v13
2
ar -1
l-1
M
Ju
1 No v11
0 l-1
ar -1 M
Employment Cost Index
15
U.S. Average Hourly Earnings
Source: Bloomberg, as of December 1, 2015.
Commodity prices fell sharply in November. Brent crude fell 10 percent during the month, and copper hit a 6.5-year low due to continued slow growth in China and a strong dollar that stifled demand from foreign buyers.2 The weakness in commodities continues to ripple through credit markets. In high yield (HY), energy was the worst performing sector in November, with independent oil and gas companies posting the most severe declines. Moody’s Investors Service expects the speculative-grade default rate to rise in 2016 from the current trailing 12-month rate of 2.7 percent due to
10
Yield (bps)
U.S. Core PCE Price Index
Ju
9 No v09
8 l-0
ar -0 M
Ju
M
ar -0
7 No v07
0.5
5 0 -5 -10 -15 -20 1 YR
2 YR
3 YR
Treasury
5 YR
7 YR
10 YR
20 YR
30 YR
Municipal AAA GO
Source: Thomson Reuters, U.S. Treasury, U.S. Federal Reserve, as of November 30, 2015.
On the high yield side, Puerto Rico’s headline risk continued to grip market participants in November, as high yield investors worried about the Commonwealth’s ability to meet its December Breckinridge Capital Advisors | Market Commentary p 1
MARKET COMMENTARY, NOVEMBER 2015
Municipal bond fund inflows have been positive for nine straight weeks as of December 2nd, with aggregate flows of about $9.4 billion year-to-date.4 Many issues were oversubscribed during the month of November. For example, a California school district priced a new general obligation bond 10 to 15 basis points tight to talk5 given strong demand and limited supply Thanksgiving week. In specific credit news, Pennsylvania continues to struggle with its budget. The state released a (tentative) new budget that didn’t pass; it included an increase in state sales taxes by 1.25 percent, changes to state-owned liquor stores, reform of state pension systems and an increase in support to school districts in the form of a property tax reduction.6
IG saw another month of massive supply, after surpassing $1 trillion for the year in October.9 For November’s $96.7 billion of fixed-rate issuance,10 supply flourished in all weeks except for the last week of the month when geopolitical flare-ups and the holiday prompted a slowdown. IG supply has now reached historical highs, as opposed to HY, where supply is tracking to have its lowest annual issuance since 2011. The copious HG issuance is largely driven by mergers and acquisitions (M&A) in North America, which has also swelled to an annual record (Figure 3). The announced $160 billion pharmaceutical merger of Pfizer Inc. and Allergan plc—the largest deal this year— lifted North American M&A volume to $3.3 trillion year-to-date. Other deals in the pipeline are primarily to back share buybacks or to fund free cash flow deficits for exploration & production (E&P) firms. Figure 3: M&A Has Skyrocketed, Elevating Event-Driven High-Grade Issuance 700
70
600
60
500
50
400
40
300
30
200
20
100
10
0
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov 2014 2015
0
Percent of Global M&A Sized $10Bln+
Puerto Rico’s woes did not permeate the positive sentiment on the municipal sector as a whole, as demand for new issues remained robust in the face of heavy supply. Municipalities issued $23.2 billion in November, as issuers raced to market before the December Fed meeting and the upcoming holidays. Additionally, over the last three months, we’ve seen new issue supply down versus year-ago levels as refunding volume has slowed. November 2015 supply came in 21 percent lower than the same month a year ago, which likely accounts for some of the strong muni performance.3 Potentially a boost to 2016 supply, both houses of Congress passed a new multiyear highway bill that provides $305 billion worth of transportation funding through 2020.
Bank outperformance was helped by a lower level of supply in the banking/finance sector versus industrials. Further supporting banks, the Financial Stability Board released its final Total Loss-Absorbing Capacity (TLAC) standard for global systemically important banks in November,8 and it was seen as less stringent than expected.
Monthly Global M&A Volume
debt obligations. Puerto Rico sold off during the month, but that underperformance was offset by strong performance in other sectors including tobacco. The Commonwealth’s bonds generally improved after it made all principal and interest payments for its December 1st due date and announced a clawback provision of certain funding sources, with positive implications for GO bonds.
Source: Dealogic, taken from http://www.dealogic.com/media/market-insights/ma-statshot/, as of December 1, 2015.
In early November, the U.S. House of Representatives approved a bill treating munis as high-quality liquid assets (HQLA). The bill is not yet law, and as a Citi report noted, the bill may have a muted impact given that muni demand has remained robust—even when excluded from HQLA treatment.
Taxable Market Review Investment grade (IG) corporate bonds held up well in November, with the Barclays Credit Index coming 3 basis points tighter and outperforming duration-matched Treasuries. Broadly, IG performance was impacted by a broader risk-off stance in markets versus October. Single-A credits performed best, while crossover credits fared worst. This is flipped from October, when crossover credits did best and high quality underperformed. During November, IG dramatically outperformed HY, which saw spreads widen 50 basis points on energy weakness.7 Foreign local government, bank and telecom credits led IG performance in November. Metals and midstream names had the worst showing. The outperformance of banks versus industrials is one of the most salient trends in today’s market.
With the rampant M&A, along with the general lackluster U.S. earnings reports the last two quarters, the credit profile of investment grade names continues to deteriorate. We remain concerned about increasing leverage, particularly given the nowcommonplace reports of shareholder shakeups across high-grade names. For example, in November, Alcoa, Yahoo and Xerox were impacted by shareholder activism. HG continues to see strong demand; the new issue concession for November hit its lowest level since June 2014, according to Bank of America Merrill Lynch. Inflows were solid throughout the month, especially relative to substantial outflows in HY in the latter part of the month. Yields remain low versus historical levels. However, with year-to-date widening and Treasury weakness in November, U.S. IG long-maturity yields exceeded 5 percent during the month11—the threshold level for some pension fund investors. The pickup in yield potentially bodes well for institutional inflows.
Breckinridge Capital Advisors | Market Commentary p 2
MARKET COMMENTARY, NOVEMBER 2015
Figure 4: Passage of the FAST Act May Boost Public Transportation Spending 35000 30000 25000 20000 15000
U.S. Bureau of Labor Statistics, as of November 6, 2015.
7.
Based on the Bank of America Merrill Lynch U.S. High Yield Index (H0A0), MTD change, as of November 30, 2015.
2.
Bloomberg, ICE Brent Futures contract, Copper (Comex) Futures data, as of December 1, 2015.
8.
Financial Stability Board, as of November 9, 2015.
3. Bond Buyer, as of December 4, 2015.
9. Thomson Reuters, as of October, 2015.
4.
10. Barclays, as of December 1, 2015.
5. Bloomberg, as of November 2015; Breckinridge Capital Advisors, as of November 2015.
11. Based on the Barclays U.S. Long Corporate Index, U.S. Yield-to-Worst.
6.
12. Thomson Reuters, The Municipal Market Monitor (TM3), as of November 30, 2015
Pennsylvania Budget and Policy Center, November 18, 2015; Commonwealth of Pennsylvania, Office of the Governor, March
t-1 5
Source: U.S. Census Bureau, as of October 2015.
1.
Bond Buyer, as of December 4, 2015.
Oc
t-1 4 Oc
t-1 3 Oc
t-1 2 Oc
t-1 1 Oc
t-1 0 Oc
t-0 9 Oc
t-0 8 Oc
Oc
The passage of the FAST Act is unquestionably credit positive for GARVEE bonds. As we highlighted in our February 2014 commentary,
t-0 7
10000
t-0 5
In December, President Obama signed the Fixing America’s Surface Transportation (FAST) Act reauthorizing the Federal Highway Trust Fund (HTF). The HTF is funded by federal gas tax revenues, which are transferred to states in the form of grants for transportation projects. Many states use these grant revenues to secure “Grant Anticipation Revenue Vehicles” or GARVEE bonds. The FAST Act is not perfect, in that it relies on a patchwork of non-recurring funding sources to plug the shortfall between revenues derived from gas taxes, and total HTF expenditures. However, the fully-funded, five-year tenure of the legislation marks the longest authorization period for the HTF since 1998—demonstrating that bipartisan support for federal surface transportation grant programs has not abated. The support is particularly notable given the commonplace congressional gridlock occurring over the last several years.
Oc
Credit Market Spotlight
We suspect that the passage of the FAST Act may spark an uptick in GARVEE bond issuance. Also, public spending on transportation infrastructure in general may rise (Figure 4). The bill provides a 15% total increase in federal highway grants for each state over the next five years. The multi-year length of the legislation provides funding certainty for states to move forward with large transportation projects, even those that have not securitized their federal transportation grants via GARVEE issuance. As this chart demonstrates, state and local transportation construction spending has been increasing since 2012. We believe this trend may accelerate as state and local governments look to address aging infrastructure and deferred capital needs.
t-0 6
For our tax-efficient strategies, we see the most pricing risk in the middle of the curve. Municipal bonds have outperformed and ratios have richened significantly, particularly in the 5-year area. The 5-year ratio ended the month at 76.2 percent, close to the average for the period of 1990 to 2006, but well below the average for 2006 to 2015 (89.6 percent)12. As a result, we have pared back exposure to the 5-year area across some strategies. Given the high valuations of taxable munis, we reduced the muni weighting in our government credit strategies a little and shifted into more Treasuries. Our exposure to IG corporates in government credit is unchanged, as we think that the declining credit profile in that asset class is a near-term risk. We would need to see the management of IG companies increase their focus on balance sheet strength before becoming more constructive on the sector.
we believe GARVEE bonds are solid credits, particularly those that finance state highway projects. GARVEEs are an important financing mechanism for essential transportation infrastructure, and Congress is likely to protect this financing source for the foreseeable future. In our view, the biggest risk for GARVEE bonds is not reauthorization of the HTF upon expiration of the FAST Act in 2020, but the possible “rightsizing” of the program to a level where gas taxes cover 100% of the cost. This risk is mitigated by the fact that most GARVEE bonds are modestly leveraged. Any GARVEE funding reductions are unlikely to have meaningful impact on debt-service coverage levels for highway GARVEE bonds.
Oc
We are confident that the Fed will begin to normalize interest rates in December, although we are watching the November jobs report and ongoing geopolitical risks closely. We continue to expect a bear flattening as short-end Treasury rates inch up.
State and Local Government Transportation Construction Spending ($Mlns)
Breckinridge Strategy and Outlook
3, 2015.
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
