Market Review and Outlook 2nd Quarter 2012
Demand for high-quality municipal bonds remained steady throughout the 2nd quarter, despite a significant increase in supply. While total new issuance is up sharply from last year, net supply is actually lower given that refinancings accounted for a significant portion of these new deals as issuers took advantage of historically low yields and strong demand. Municipal bond funds had experienced 11 consecutive weeks of positive flows as of quarter-end. The Barclay’s Three Year and Five Year Municipal Indices returned 1.3% and 1.8% respectively, year to date.
Fiscal austerity continues to be the focus at the state and local levels as most municipalities have been cutting expenses and issuing less debt for public works projects. Furthermore, state tax revenues have increased for 9 consecutive quarters. These factors, combined with attractive municipal-to-Treasury yield ratios, should continue to support tax exempt yields over the next quarter.
If this sounds familiar, it is because the same pattern that we witnessed during the first halves of 2010 and 2011 has emerged again in 2012. The year began with widespread optimism over an improving U.S. economy; the S&P 500 Index returned 12.6% during the 1st quarter. Investor psyche was shaken in the 2nd quarter as weaker economic indicators started to point to a slower U.S. recovery and geopolitical concerns returned to the forefront. As a result, the S&P 500 Index declined 2.8% in the 2nd quarter. One notable headwind was the unexpected weakness in employment numbers, casting doubt on the vigor of the labor market. In addition, persistent issues relating to the Eurozone debt crisis increased the markets’ volatility this past quarter. Increased demand for safe haven highlighted this reversal in investor sentiment, with the 10-year U.S. Treasury returning 5.8% for the quarter.
Uncertainty surrounding the following factors will serve as the underlying theme facing the financial marketplace over the next six months:
- Year-End Fiscal Cliff: As we are writing this letter, the debate is beginning regarding the Bush tax cuts and whether they should be extended. The issue is further complicated by the automatic spending reductions that are scheduled to go into effect at the start of 2013. The public may demand that both the administrative and legislative branches of the government respond prudently with tax and spending policies that will not weaken the U.S. economic recovery.
- Presidential Election: Given the unsteadiness of the economy and concerns about fiscal and monetary policies, we would expect market volatility to continue in the months prior to the elections. Of almost equal importance to the presidential election are the legislative elections. The public is asking the government to adopt strategies that deal with some of our country’s issues, which range from high unemployment to infrastructure issues to looming deficits.
- Eurozone Debt Crisis/Emerging Markets: The continued inability of the 17 nation Eurozone to come to any consensus over a two-year period punctuated with over 20 summits has significantly added to market turbulence (and a sustained flight to quality). Resolution of this issue, if possible, may take several months. Of equal concern, but with less press coverage, are relatively slower growth expectations for some of the emerging economies in China and India.
We continue to believe that yields will remain at relatively low, range-bound levels throughout the remainder of the year. The Fed’s commitment to maintain a low rate environment, further supported by its decision in July to extend Operation Twist through the end of the year, has contributed to this assertion. In addition, demand for municipal bonds should continue to outpace supply as we approach an environment of increasing tax rates and lower economic growth.
As we manage portfolios in the current interest rate environment, we are well aware of the perils of being too short or too long. The latter strategy is more dangerous in today’s lower interest rate environment as small (e.g. 20 – 30 basis points) increases in yields in the ten-year area of the market could result in a 2-3% negative return. For this reason, we are modestly shorter than the comparable indices and fairly concentrated in the 3 – 7 year part of the curve. We believe this defensive positioning will best fulfill our preservation of capital mandate.
The opinions expressed herein are solely attributable to Samson and should not be construed as an offer to buy or a solicitation to sell any securities. Inherent in any investment is the risk of loss. All factual information and statistical data in this document were obtained or derived from public sources. Samson makes no representations that such information or statistical data is accurate or complete. No person to whom a copy of this document has been delivered should rely on any such factual information or statistical data as being accurate or complete and should not undertake any investment program based on such information contained in this document. Any statements regarding future events constitute only subjective views or beliefs, are not guarantees or projections of performance, should not be relied on, are subject to change due to a variety of factors, including fluctuating market conditions, and involve inherent risks and uncertainties, both general and specific, many of which cannot be predicted or quantified and are beyond our control. Past performance is not indicative of future results. All estimates, opinions and analysis in this document constitute judgments made by Samson as of the date of this document and are subject to change without notice. Samson has no obligation or duty to inform any person to whom a copy of this document has been delivered of any change in any estimate, opinion or analysis in this document or to update the document on a going forward basis.