Market Review and Outlook 1st Quarter 2013
The first quarter of 2013 might best be described as one of cautious optimism for U.S. investors as the U.S. consumer took more tentative steps towards increased confidence. This stance was reinforced by slow and steady job creation and some positive news from the housing market, although the potential for housing headwinds remains in the form of shadow inventories and the legacy of foreclosures. Notes of caution came both at home and abroad. The U.S. Congress postponed battles on sequestration and the debt ceiling, and Europe continued to struggle with ongoing banking and economic problems. The US bond and stock markets, meanwhile, took it all in stride. Bond yields vacillated over the quarter, peaking in mid-March before ending the period only slightly above where they started. The 10 Year US Treasury was at 1.76% on January 2, and ended March 29 at 1.85% and the 10 Year AAA Municipal opened at 1.72% and closed at 1.91%.
For municipals, the news was more positive than negative. The credit quality in many municipal sectors has continued to slowly improve; state and local governments have now seen 13 consecutive quarters of positive year over year growth: the result of economic recovery, increased tax rates, and firmer property values. There are still many concerns, including pensions and health care, but the trend is on the mend. The state of California was upgraded to A+ in January, reflecting an improved fiscal and cash position, in part due to the income tax increase approved by the state’s voters. There continue to be problem issuers, most of whose struggles have been well known for years. The Governor of Michigan appointed an emergency manager to oversee Detroit’s troubled finances, which we believe was viewed as a positive step by the market. Puerto Rico was downgraded by S&P to BBB- in March, following Moody’s December 2012 downgrade to Baa3, making the Commonwealth one step from non-investment grade. The Governor has proposed reforms to its severely underfunded pension system in an attempt to begin to address one of the island’s many financial problems, but the final outcome is not clear. We at Samson have recognized the problems with Puerto Rico and Detroit for years and our clients do not own bonds from these issuers.
According to data complied by Lipper, new issuance of municipal bond supply increased over that of Q1 2012, but a large portion continued to be refunding of previous years’ higher cost bonds; ultimately, net new supply was far less. Demand for municipals remained firm and flows into mutual funds were positive for all but a few weeks in the quarter.
The Fed continues to argue for its very accommodative, results-oriented policies, targeting an unemployment rate of 6.5%, assuming inflation remains relatively benign. While there has been some press about dissent within the Fed’s ranks, notably from the Richmond and Dallas branches, it has emerged that Bernanke has considerable backing within the organization for his targets and policies.
The Outlook for Bonds in 2013.
The popular press continues to make much of current low yields and the effect that rising rates can have on a portfolio’s market value. In point of fact, however, the Federal Reserve has repeatedly made clear its intention to keep rates low, even after the economy begins to pick up. Even the hint of an end to its current Quantitative Easing program causes the markets to react and threatens to undo all that the Fed has accomplished to date. We believe a time will come when growth will be resilient enough that the markets demand that the Fed begin to tighten. Our analysis suggests that this occurrence appears likely to be sometime beyond 2013.
As noted above, the US economic outlook is slowly improving. However, we remain attentive to possible headwinds. The tax increases of 2013 have yet to have a meaningful impact on consumer spending. The effects of sequestration and a decline in government spending may materially offset some of the rebound in the private sector, as we were beginning to see at the end of 2012. According to US Census Bureau data, job creation, while steady, is at levels which are historically low for a post-recession period.
Even in a low rate environment, we believe that municipals continue to offer good after-tax relative value. As the quarter ended, AAA bonds offered higher yields than comparable-maturity Treasury bonds across the maturity spectrum. This is a far more advantageous relationship than has historically been the case, even more so since municipals continue to offer a tax advantage. Furthermore, it is important to consider the potential of capital appreciation that occurs over time when there is a steep yield curve. Given these advantages, we are staying fully invested and are maintaining the durations of portfolios in line with their benchmark targets.
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.