Market Review and Outlook: 1st Quarter 2014
The first quarter of 2014 was good for many fixed-income investors. Bonds across the yield curve delivered positive returns, with longer dated bonds outperforming shorter ones. Economic data, such as job creation and GDP growth, came in below expectations; interest rates declined and the yield curve flattened. Investors were particularly disappointed by the economy’s inability to build momentum, although growth remains positive. The difficult winter in many parts of the country caused many to wonder if the subdued growth might be weather related. In any case, the result was a stall in the equity market rally and we believe that bonds of all maturities, once again, became an attractive investment alternative.
Apart from the lackluster economic news, other events, both domestic and international, also had an impact on interest rates during the quarter. On the domestic front, the chairmanship of the Federal Reserve transitioned smoothly from Ben Bernanke to Janet Yellen. Ms. Yellen chaired her first Federal Reserve Board meeting and, in the press conference which followed, gave the market the impression that the Fed would begin tightening short-term rates sooner than investors had anticipated. Rates rose modestly, and Fed Fund futures continue to price in a 2015 Fed tightening. Additionally, the Fed felt sufficiently confident about the economy’s stability to extend its “tapering” program, which was first announced in December 2013.
Abroad, a forceful, if mostly non-violent, attempt to redraw the borders of Russia and the Ukraine raised global concerns and precipitated a flight to quality, especially to US dollar denominated assets. While this has raised palpable geo-political tension, the absence of armed confrontation has allowed the market’s reaction to remain muted, if still cautious. Growth in China, the world’s second largest economy, also remains below par and its traction uncertain. In Europe, a decelerating rate of inflation – which was already unusually low – is still a concern.
It appears that the municipal market was a major beneficiary of the bond market rally. New municipal bond issuance for the quarter was among the lowest quarterly issuance on record. Mutual funds and others saw new inflows of cash, which helped drive demand. While demand for the rest of the year is difficult to forecast, it is likely that supply will remain low and continue to support municipal market performance. Even so, late in the quarter some shorter maturity bonds were so richly valued that we began to “crossover” into Treasury and agency bonds which may perform better should relationships normalize. As with the taxable bond market, longer maturities materially outperformed shorter ones, and lower rated bonds outperformed higher rated ones as spreads compressed.
The biggest stories on the municipal credit front remain Puerto Rico and Detroit. Detroit continues to work its way through the bankruptcy process. Despite the city’s severe financial difficulties, holders of their general obligation bonds seem positioned for a better-than-expected outcome. There have been recent news reports that the insurers for Detroit’s GOs may receive 74 cents on the dollar, versus the 15 to 20 cents originally proposed. Bondholders will receive 100 cents on the dollar because insurance will pay the balance. The details of the plan are still evolving, but the indications are that the general obligation bonds will be categorized as secured by the bankruptcy court if approved by the judge. While the plan remains fluid as the city negotiates with creditors, it is nearly certain that all unsecured creditors will see a more material impairment of their claims. These are critical issues for bond investors that we continue to monitor. Puerto Rico was downgraded in February to non-investment grade, also known as “junk,” by the three largest rating agencies. This action had been widely anticipated by the market and spreads in fact narrowed somewhat following the downgrade. The Commonwealth remains a highly speculative issuer with severe financial troubles. In early April, Puerto Rico hired a law firm specializing in debt restructuring. This may be an indication that the Commonwealth is researching options that it previously had not considered.
Going forward, the performance of both the bond and stock markets will be dependent on clearer economic data. Another quarter of corporate earnings announcements is about to begin. It remains to be seen if the first quarter’s softness was truly weather related, and if the positive, but lackluster growth that we have been experiencing over that past few years can pick up some momentum.
The first quarter’s bond rally notwithstanding, interest rates are meaningfully higher than they were at this time last year. Given continued uncertainties about the pace of economic growth, restrained inflation levels, and a few remaining geo-political stress points, bonds remain an attractive asset class.
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.