by Gayl Mileszko
With seven percent annualized inflation and supply chain woes carrying over from 2021, with our central bank clearly telegraphing the reversal of its decade-long loss insulation efforts, with uncertainty over the next path of a pandemic going into its fourth calendar year, and with increasing angst over everything from Russia-Ukraine border tensions to the possible impact of the 5G rollout on U.S. aviation, it is no wonder that most financial markets are upside down this month. It is still very early in the year and investors are trying to adjust to a slightly more normalized environment with rates higher by a notch and a Federal Reserve gently reducing its pace of bond purchases. In the grand scheme of things, no dramatic changes are underway. The economy is still booming; even though recent retail sales and consumer sentiment reports were disappointing, unemployment has fallen to 3.9% and forecasters still expect growth in the range of 3.5% in 2022. Target rates are still near historic lows, far from the 6.62% level we had in July of 2000. But Fed Fund futures contract prices currently reflect market expectations for four increases by the end of the year. The last time the Federal Open Market Committee voted to raise or lower the target rate to a range of 1.00%-1.25% was March 3, 2020; before that it was June 14, 2017 and October 29, 2008. Some skeptics believe that markets will come unglued before we even get close to 1.00% and predict that a newly dovish Fed will again act to stabilize the markets they have effectively anesthetized by lowering rates once again down to near zero in the fall.
The Great Unwinding
We all knew that the process of unwinding from all the unprecedented stimulus would not be pain-free. But some market analysts categorize current conditions as a temporary overreaction by equity and bond markets. Instead of the typical “January Effect” – the seasonal anomaly in which securities prices increase higher in the first month of the year than they do in any other month as investors reinvest cash from positions sold at year-end or put year-end bonus money to work – we seem to have a “January Defect”. With exceptions only in commodities, returns are in the red across the board and selloffs are underway as the likelihood of a Fed rate hike of 25 or even 50 basis points in less than two months increases. Just 10 trading days into 2022, the Nasdaq at 14,893 was down 4.8%, the Russell 2000 at 2,162 was 3.69% lower, the S&P 500 at 4,662 was off 2.17%. Even Bitcoin at $42,923 has plummeted 8.7%. At the close on Friday, investment grade corporate bond indices were down 2.11%, Treasuries were 1.79% lower, and investment grade tax-exempt bonds lost 0.93%. Even the fixed income superstars of 2021, high yield corporate and high yield municipal bonds, were down 0.82% and 0.54%, respectively. And none of these losses factor in inflation, which would bring real returns far deeper into negative territory.
The Hunt for Inflation Insulation
It is much too early to gauge trends, given all the uncertainty, but metals and energy have generally been the best performers in these early days. Thermal coal closed Friday at $186 per ton. Natural gas was at $4.26 per metric million British Thermal Unit , up 14%, WTI crude oil was at $84 per barrel (42 US gallons), 11% higher. Iron ore at $129 a ton was up 9%, nickel at $10.07 a pound was 7% higher, and aluminum at $1.35 a pound rose 6%. Investors unfamiliar with these markets have turned to commodity exchange traded funds, volatility and inflation hedge ETFs, non-domestic equity funds, dividend-paying real estate investment trusts, leveraged loans, Treasury Inflation-Protected Securities, inverse Treasury funds, and other so-called inflation havens. In the last two months, smaller savers have scooped up $3.8 billion of the Treasury’s Series I bonds, which pay a fixed interest rate plus inflation. Others have searched high and low for floating rate preferreds, corporate inflation protected securities, and monthly paying variable rate bonds.
Inflation expectations are a major component of bond yields and the rising yields – especially the closely watch 10-year benchmark — have had a big effect on technology stocks so far this year. The 2-year Treasury yield rose by 23 basis points in the first two trading weeks of the year, from 0.73% to 0.96%, and is now over 1.00% for the first time since late February 2020. The 10-year yield broke through the 1.75% barrier and, having gained more than 27 basis points, is now at the highest levels in two years. The 10-year Baa rated corporate benchmark has risen from 3.20% to 3.47%. The 30-year Treasury at 2.12% has risen 22 basis points, as has the 2-year tax exempt muni benchmark which started the year at 0.24% and now stands at 0.46%. The 10-year AAA rated general obligation muni yield at 1.18% is 15 basis points higher as is the 30-year which stands at 1.64%. Technicians are following the difference between the 5-year and 10-year muni yields which has narrowed to a point not seen in two years. The five-year ratio of municipal to Treasury yields stood at 52% on Friday; it was 67% in 10 years and 78% in 30 years.
Weekly Market Update
This week is a corporate analyst’s delight as reporting on fourth quarter earnings picks up. Seventy seven percent of the S&P 500 firms reporting have had bottom-line results that beat analyst expectations, and 2021 could end up in the record books with year-over-year earnings up in the neighborhood of 49%. Markets will also closely watch five Treasury auction results as well as key housing and manufacturing data releases, conflicting reporting on the severity of Omicron, the filibuster debate in the Senate, and reaction to the President’s nominations to fill three Federal Reserve seats. Puerto Rico bondholders are digesting the news of the bankruptcy judge’s approval of certain key restructuring plans. Investors are closely tuned in for Thursday’s weekly fund flow report from Refinitiv Lipper to see if the telltale retail investor is buying or selling. Global bond traders are watching as the last major 10-year sovereign, the German bund, traded with a positive yield for the first time in nearly three years, and China’s10-year benchmark has rallied after its central bank’s surprise 10 bp rate cut on Monday.
Many companies are entering blackout periods ahead of their fourth quarter filings, but there are a number of banks in the market again this week and they may raise corporate primary issuance to $32 billion. Last week saw $39.6 billion of new issue investment grade sales and $6.8 billion of high yield supply. Municipal volume ahead of the long weekend totaled $10 billion and included the $872 million Chicago Board of Education BB rated general obligation bond deal structured with a 25-year maturity that priced with a coupon of 5.00% to yield 2.80%. There were five charter school deals including one for Hayden Canyon Charter School which had a $6.1 million issue due in 40 years priced at par to yield 4.25%, and for Golden View Classical Academy in Golden, Colorado which sold $11.5 million of Baa3 rated refunding bonds at 4.00% to yield 3.10% in 40 years. We also saw some of the highest yields in several years. Among other sales, the Phoenix Industrial Development Authority had a $202.7 million BB rated hotel and event center financing in Colorado Springs with 35 year term bonds priced at par to yield 4.15%, a separate non-rated series of bonds due in 2052 priced at 5.00% to yield 4.75%, and a third non-rated taxable capital appreciation bond series totaling $29.1 million and yielding 13.185%. The Florida Development Finance Corporation came to market with two deals: $39.3 million of non-rated bonds for The Cabana at Jensen Dunes that included two maturities in 2056 priced at 5.00% to yield 5.375% and 5.25% to yield 5.375%, and a $20.8 million non-rated deal due in 35 years for Dreamers Academy in Sarasota priced at par to yield 6.00%. The Florida Capital Trust Agency issued $17.3 million of non-rated 40-year bonds for Imagine Schools of West Melbourne offered with a coupon of 5.875% to yield 6.076%
Current Municipal Bond Sales
The municipal bond calendar is expected to total $8.5 billion in this holiday-shortened week, leaving the market with a negative net supply of $12.9 billion and keeping a big smile on the faces of every borrower coming to market looking for low rates. In senior living, Presbyterian Retirement Communities is bringing a $140.6 million A-minus rated forward refunding through the Orange County Health Facilities Authority in Florida, and Westminster-Canterbury of the Blue Ridge has a $53.4 mil BBB+ rated refunding through the Albemarle County Economic Development Authority in Virginia. In the high yield sector, the Wisconsin Public Finance Authority has a $62.6 million BB rated refunding for Roseman University of Health Sciences in Henderson, Nevada. The Delaware Economic Development Authority is in the market with a $21.8 million BB rated deal for Aspira of Delaware. There are two corporate CUSIP deals, one forward settlement, one social bond, one green bond, and one sustainability-linked bond scheduled for sale.
Volatility is up more than 30% since New Year’s Day and market conditions call for professional guidance. We invite you to reach out to your HJ Sims representative to assess the resilience of your portfolio and strategy and help you weather all the conditions swirling this January.
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