HJ Sims Market Commentary: Dose and Delivery

by Gayl Mileszko

Dose and Delivery

There are plenty of nasty substances in the world and they are found pretty much everywhere. Consider everything from nicotine, lead, and carbon monoxide to asbestos, ethanol, and snake venom. A number of poisons and toxins found on earth or synthetically derived, when administered in a certain dose, cause swift and deadly harm. Among the deadliest found in nature is botulinum toxin, a neurotoxic protein produced by bacteria. A crystal the size of a grain of sand would be enough to kill roughly ninety-six hundred people. Yet, millions around the world willingly subject themselves to injections of botox in properly dosed amounts to paralyze facial muscles that cause wrinkles, prevent excessive sweating or alleviate migraine headaches. Digoxin is a purified extract of the foxglove plant used to treat heart failure, but more than 10 milligrams is almost always fatal. Amatoxin, derived from the death cap family of mushrooms, is thirty times deadlier than strychnine. Sarin, a synthetic compound 500-times more toxic than cyanide, is considered a weapon of mass destruction and was outlawed by the Chemical Weapons Convention of 1993. Ricin is a carbohydrate binding protein obtained from the beans of the castor oil plant; like polonium-210 it has no antidote. Fortunately, anthrax does.  The lethality of poisons is given on a scale called the LD50 which is the lethal dose for 50% of the population. Technically, anything can be a poison. It is just a matter of dose and delivery.

Antidotes to the Pandemic

Financial analysts have been assessing the scale of Washington’s response to the toxic impacts of COVID-19 on the economy. The Federal Reserve’s balance sheet now exceeds $8.09 trillion as a result of its lending to households, consumers, employers, banks, businesses, markets, non-profit organizations, and governments. As an antidote to the pandemic, the central bank cut its target for the federal funds rate to near zero, purchased massive amounts of securities, backstopped money market funds and municipal bond liquidity, expanded its repurchase agreement operations, offered steady forward guidance, and relaxed regulatory requirements. The Fed has arguably gone farther than any other central bank in history, using every tool ever imagined or afforded it by Congress, and then the Congress delivered its own unprecedented $5.3+ trillion fiscal response. There are still more monetary and fiscal approaches under consideration, and debates on their use will ensue for many years. But many have begun to wonder if the size of Washington’s dosage is way too much, and worry about what happens when delivery ends.

Policy Wins or Errors?

Stock, bond, commodity, derivative and money markets have mostly all flourished due to the federal stimuli. The rescue and recovery efforts of the Fed, the Congress and the White House have virtually guaranteed rallies and returns for sixteen months now. Some argue that the guarantees actually date back to the Great Recession. But not much investor attention has been given to how markets will behave as stimulus is gradually reduced or quickly withdrawn. Some thinkers like John Mauldin, a noted financial expert and New York Times best-selling author, ask if the Fed’s dual mandate of price stability and maximum sustainable employment has actually expanded to include keeping stock prices high and monetizing the federal debt. Have central bankers made the greatest policy errors in history by using prolonged rate suppression and quantitative easing to distort the economy, repress savers and exacerbate the wealth and income divide?

This Week: Eye on Washington

The Federal Open Market Committee meets this week and may further consider the timing of tapering bond purchases, mortgage backed securities in particular. No new policy is expected but investors, whether on summer vacation or not, will be listening carefully. Awash in cash, investors here and abroad added more than $900 billion into U.S. mutual and exchange-traded funds during the first six months of 2021, a new record. Corporate earnings are coming in above estimates but not all economic data are reflecting a robust recovery. The National Bureau of Economic Research, the Massachusetts private non-profit accepted as the official measurer of recessions, reported last week that the U.S. emerged from recession in May 2020 after only two months, the shortest period on record. But there remain significant concerns about rampant inflation and the alarming growth of COVID hotspots. Infrastructure legislation has had some setbacks and pretty much all major activity on Capitol Hill looks stalled until September when a number of deadlines loom. Municipal industry advocates fear their priorities for the restoration of tax-exempt refundings and the relaunch of taxable direct pay infrastructure bonds may be lost in the coming melee, so lobbying and educational campaigns are being urged.

The July Finale

July comes to an end this week and markets enter midsummer with sky high prices and not much new product to fight over. As usual, there is a lot of data to analyze. More than 165 S&P 500 companies are reporting this week, and most of them are expected to reference inflation as a growing concern.  Second quarter GDP, housing, consumer confidence, and wholesale and retail inventories are just some of the reports expected. A Chinese stock rout is underway, the Treasury has another $136 billion of auctions after the 10-year real yield hit a record low at minus 1.127%. At this writing, the Russell 2000 is down 6% on the month, while the Dow and S&P are up more than 1% and the Nasdaq is effectively flat. Oil prices are down 2% to $71.91 a barrel, gold is up 1.5% to $1,799 and volatile Bitcoin has gained 14%. Bond yields are down across the board. The 2-year Treasury at 0.19% is down 5 basis points. The 10-year has fallen 18 basis points to 1.28% and the 30-year is down 14 basis points to 1.94%.  Baa corporate yields have dropped 6 basis points to 2.95%.

Municipal Bonds in Their Own Bubble

Municipal bonds have been beneficiaries of the strength of U.S. Treasuries, but they are largely operating in their own bubble this summer. And it has been a happy bubble for those lucky enough to own high yield munis. Whereas Treasuries and investment grade corporate bonds have had negative returns year-to-date, high yield munis are up 6.01%, besting high yield corporates at 4.0% and even convertibles at 5.71% as the top performing fixed income sector. Twenty consecutive weeks of heavy inflows into mutual funds and ETFs have brought assets to a record high $1.02 trillion. New issue calendars of only $7 or $8 billion despite near-perfect borrowing conditions for non-profits reflect net negative supply of about $19 billion. The perceived credit strengths stemming from massive federal aid and reflected in improved ratings have produced very frustrating conditions for investors in tax-exempt and taxable municipals. For example, today, buyers of $100 face value of New York Liberty Development Corporation bonds are paying $146.11, Houston utility system bonds are trading a $133.13, University of Connecticut bonds at $127.84. The par amount of principal set to be returned in August together with coupon payments due exceed $61.3 billion but there will not be much to buy at any price. Dealer inventories have been below $10 billion for 22 of the 28 weeks this year according to Municipal Market Advisors. The 30-day visible supply is under $10.2 billion.

Municipal Sales at Big Premiums

Bond buyers are acutely aware that there is no effective yield in high yield, but borrowers could not be more thrilled with their low rates of borrowing for renovation, expansion or start-up projects. The Mayflower Retirement Community in Winter Park, Florida brought an $80 million BB+ rated deal last week and sold 2055 term bonds with a 4.00% coupon priced to yield 2.51%. The Build NYC Resource Corporation issued $65.6 million of non-rated bonds for Shefa School structured with 2051 term bonds priced at 5.00% to yield 2.90%. The Homewood Maryland Obligated Group came to market with a $50.5 million non-rated financing that included 2042 term bonds priced at 4.00% to yield 3.25%. Trevecca Nazarene University in Nashville, Tennessee sold $42.1 million of BBB-minus rated bonds with maturities out to 2051 that priced with a 4.00% coupon to yield 2.08%. Rocketship Public Charter Schools in California had a forward delivery deal with $14.7 million of non-rated bonds priced at 4.00% to yield 2.58%. One of the highest yielding deals came through the Wisconsin Public Finance Academy for the non-rated Capitol Encore Academy in Fayetteville, North Carolina and the $6.4 million issue sold at a premium to yield 4.00%.

Evaluating Bond Offerings This Week

This week’s high yield corporate calendar totals about $8.79 billion and kicked off with a $1.5 billion sale by aluminum producer Novelis that had a 10-year maturity priced at par to yield 3.875%. The municipal slate is smaller at less than $7 billion. With less than a month to go until most schools resume classes, there are dozens of school district financings as well as higher education sales by MIT, Kentucky State, Long Island University, and The University of the South.  There are airport deals for Salt Lake City and Guam, four social bond issues, and a BB+ rated Illinois Sports Authority refunding. Most of the bonds being sold via negotiation or competition will prove to be sound investments but some investors in desperate search for incremental yield are not thoroughly examining credits or security provisions of offerings in the highest risk sectors.

We encourage you to reach out to your HJ Sims representative for guidance in weighing risks, value, price, and suitability to avoid potential toxins in your portfolio.

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