HJ Sims Market Commentary: Sinkers and Curves

by Gayl Mileszko

Fans of every stripe will argue until they fall off their barstools, but the greatest sinker ball pitcher of all time may well be Orel Hersheiser, now 63, who played a total of 18 seasons in the majors racking up a win-loss record of 204-150 with 2,014 strikeouts. “Bulldog”, as he was nicknamed by legendary Dodgers manager Tommy Lasorda, was a right hander who threw sinking fastballs that would hop and dive dramatically, causing baffled batters to blink, swing and miss, or ground out. Just as it sounds, the sinker is a type of fastball that has both a horizontal and downward movement. Pitchers grip the ball along the two seams and apply pressure with their fingers on the inside edge, giving it a tilted sidespin, and turn their palms at release. When thrown correctly, the sinker can drop 6 to 9 inches more than a typical four-seam fastball. But it can be tricky: in throwing the sinker there is a greater risk of a wild pitch, and Hersheiser had 121 of them over the course of his career in Los Angeles, Cleveland, San Francisco and New York Mets uniforms.

Sinking Markets

Fears of stagflation among consumers have surged with gas and grocery prices. Eggs are up 32.2% year-over-year, poultry prices are 16.6% higher, milk is up 15.9%. The U.S. average price for a gallon of gas has topped $5. Americans are expected to spend an average of $2,600 per person on summer vacations this year, up 30% from pre-pandemic levels. The median Manhattan apartment rent is now $4,000 and average national rental prices have increased 15% year over year, with some metro areas 50% higher. Mortgage demand has sunk to its lowest level in 22 years. The personal savings rate is at a 14-year low and revolving credit has grown at an annual rate of nearly 20%. Small business expectations for business conditions in the next six months have fallen to a 48 year low. Americans worry that the White House, the Congress and the Federal Reserve have lost their grip on the economy and that we are on the downward path to recession. As a result, stock and bond markets have been sinking this month as they have been for the better part of 2022. Almost all asset prices have seen steep drops. Volatility as measured by the VIX has increased by 30% since the beginning of this month. The spread on the Markit CDX North American Investment Grade Index, which rises as credit risk increases, widened to 100.1 on Tuesday, the highest level since April 8, 2020. Oil prices are up 5.5% to $120.93 a barrel.

A Yield Curve Walks into a Bar

The S&P 500 closed in bear market territory on Monday; at 3,749 it was down 9.3% in the first 9 trading days of June. For the first time ever, the Dow closed down 600+ points three sessions in a row; the index stands at 39,516 at this writing, down 7.5%. The Nasdaq at 10,809 is off by 10.5%. The Russell 2000 at 1,714 has lost 8%. Gold prices at $1,828 an ounce are down about one percent. And Bitcoin, at $23,699 has fallen more than 26% as crypto lending company Celsius paused withdrawals for its customers, fueling fears of contagion. The value of the crypto market has fallen below $1 trillion, down from its peak of $2.9 trillion in November 2021. On the bond side, the 2-year yield reportedly rose to its highest level since 2007 and it flatlined directly alongside the 10-year and 30-year Treasury yields at 3.35%, a highly unusual situation. Traders looking at the selloff amid the lineup of auctions this week reverted, as they often do like ballplayers, to humor. “A yield curve walks into a bar,” they begin. “The bartender asks, ‘Why so down?”

Bonds in the Same Dugout

It is baffling to many why Treasuries have not been the safe haven trade this year, so divorced from the dollar rally. The selloff in this sector has been one of the worst in four decades; returns on U.S. Treasuries are down 11%, this year, the lowest recorded in Bloomberg data going back to 1973. The 2-year has risen by 80 basis points this month alone, the 10-year is up 51 basis points, and the 30-year is 30 basis points higher. The 10-year Baa rated corporate bond yield at 5.66% is up 40 basis points. Despite all the favorable technical conditions in the tax-exempt market, including strong credit fundamentals, low supply, and heavy reinvestment cash, munis yields have spiked alongside those of taxables. They were observed playing under different traditional correlations to governments last year but are in the same dugout in 2022. The 2-year AAA rated muni general obligation bond yield at 2.00% is up 17 basis points this month. The 10-year at 2.83% is up 36 basis points. And the 30-year benchmark at 3.32% is 51 basis points higher in June, up 183 basis points (123%) so far this year.

The Reliever

The Federal Open Market Committee met on Tuesday and Wednesday this week to raise the federal funds rate and share their outlooks. The pressure on voting members ahead of the gathering had been enormous. Since 2008, investors and non-investors alike have come to look upon the central bank as our relief pitcher, the Cy Young winner who comes in and saves us all from major league losses. This year, for several months, they did their best to set market expectations. In much the same way as catchers and pitchers communicate with hand signals, the Fed has been telegraphing plans for raising rates in an orderly manner, 25 or 50 basis points at a time, in order to fight inflation. They also made announcements well in advance of their quantitative tightening efforts (i.e., not reinvesting maturing Treasury and mortgage securities).

But Fed practice is to stay silent during the blackout period which generally begins 10 days before they meet. During this most recent quiet period, consumer price index data were released, showing inflation coming at us like a rising fastball. Consumer sentiment sank to the lowest level ever recorded in the 70-year history of the index published monthly by the University of Michigan. And the New York Fed reported that consumer expectations for inflation rose to a record high in May alongside their pessimism about the stock market. Speculation is that Fed officials started leaking the prospect of a 75 basis point hike to some of their favorite traders and reporters in an effort to either gauge or re-shape market expectations; some may have hinted at 100 basis points as a possibility. Historians had to go back to November 1994 to find another recent rate increase of such proportion. But investors worry about a wild pitch and are skeptical that any Fed action can put a stop the kind of inflation we face now — even with a massive two point hike to 19-20 percent that they approved in December of 1980. We are losing faith in the reliever. We ask: “How relevant is historical precedent in these unprecedented conditions?” We do not know and so, in less time than it takes to call a ball or strike, markets led by retail fears and algorithmic trades have experienced a broad selloff.

Inflation in Extra Innings

The Fed is trying to clamp down on demand shortly after Washington just flooded the economy with cash designed to stimulate demand. Former U.S. Treasury Secretary William E. Simon once quipped, “The American people have a love-hate relationship with inflation. They hate inflation but love everything that causes it.” We are now deep in the “hate inflation” mode right now. It is our top concern and most others rank well below it. Those of us in the bleacher seats are watching how Washington responds, but we are not cheering. We see inflation going into extra innings and spot a wave of recession indicators. So, at HJ Sims, we are getting more defensive but, as always, looking for value and continuing to guide our investing and banking clients through this cycle’s market fluctuations.

HJ Sims on the Mound

HJ Sims came to market last week with a $30.3 million non-rated Illinois Finance Authority transaction for Clark-Lindsey Village in Urbana that included a 2057 term bond priced at 5.50% to yield 5.65%. The 40-year old life plan community with 264 units is adjacent to the University of Illinois campus and has a two-phase expansion and repositioning plan with construction completion estimated for early in 2024. Among other recent high yield sales in the primary market were four non-rated charter school financings. The Allegheny County Industrial Development Authority issued $14.4 million of revenue bonds for Westinghouse Arts Academy Charter School in Wilmerding, Pennsylvania with a single maturity in 2032 priced at par to yield 5.75%. The Indiana Finance Authority sold $12.9 million of revenue bonds for the Indiana Math and Science Academy in North Indianapolis that featured a 2032 term bond priced at par to yield 5.375%. The Wisconsin Public Finance Authority brought a $6.9 million non-rated revenue bond deal for American Renaissance School in Statesville, North Carolina priced at par to yield 6.125% in 2051; there was also a $6.2 million adjustable rate series. And the City of Bethel, Minnesota had a $2.6 million sale for Partnership Academy that had a single 2057 maturity priced at par to yield 6.00%. In other high yield sectors, the Brazoria County Industrial Development Corporation sold $75 million of non-rated solid waste disposal facilities revenue bonds for Aleon Renewable Metals due in 20 years, subject to the alternative minimum tax, and priced at 10% to yield 10.25%. The Virginia Small Business Finance Authority had a $35 million non-rated solid waste deal for the Total Fiber Recovery Chesapeake Project also subject to the AMT, due in 20 years and priced at par to yield 8.50%; there was also a $30 million variable rate series with a seven year final maturity.

New American Pastime

America’s pastime has long been baseball with its diamonds and green grass, homeruns and rivalries, box seats and cold beers, all stars and seventh inning stretches. This summer, given the high ticket and hot dog prices, we may go to fewer games and spend more time hunting for bargains in our necessities. Inflation has changed the playing field for many and this week’s producer price, import price, retail sales, home sales and FOMC statement reveal some of the latest levels and impacts. But for those who look at the stats and invest for the long term, this is a great time to pick up good credits with more yield. Borrowers may not see the same kind of refinancing opportunities that they did last year but rates are still historically attractive for those financing start-ups, expansions, renovations and repositionings. For investors, investment grade corporate bond yields are at levels not seen since 2009 and it has been a long time since we have seen new tax-exempt issues priced at par with coupons in the 6% range. Benchmark taxable muni yields just surged by as much as 39 basis points on Monday alone. High grade tax-exempts increased by 25 basis points, high yield by 30 basis points. Our traders noted $2.1 billion of bonds out for bid on the Bloomberg platform. Fund flow data coming out on Thursday will likely show that mutual fund investors pulled assets and moved to cash for a second consecutive week. In the most recent period ended June 8, investors withdrew $1.7 billion from municipal bond mutual funds, $3.2 billion from taxable bond mutual funds and $4.8 billion from conventional equity funds while adding $24.3 billion to money market funds.

This Week’s Lineup

Uncertainty encircles the markets through the Fed Chair’s press conference on Wednesday and then the speculation will either fuel or sap activity until the next FOMC meeting which begins on July 26. But worries between now and then will not abate during the imminent Juneteenth and the Fourth of July holidays. Nor are they exclusively linked to interest rates, Fed balance sheet reductions, and inflation. There is no end to the pandemic yet in sight and the Russia-Ukraine war rages on. There is new attention on global stockpiles of nuclear weapons. Voters in primary states continue to weigh in on issues that are likely to change the political playing field come November. Significant demographic shifts and corporate relocations are underway. Those in charge of the nation’s power grid struggle to avoid blackouts amid the spreading heat waves. The Supreme Court, which has only heard 59 cases this term, has less than three weeks left on its official calendar to decide 29 cases, including 6 major announcements that are likely to upset half the country. There is no time in history that matches this one, but HJ Sims has been operating in the all tumultuous market cycles and unique conditions faced by borrower and investors since 1935. We invite you to support your local baseball teams this summer and to contact your HJ Sims representative for our perspective, portfolio reviews and stress tests, and recommendations suited to your investment and borrowing needs and goals.

For more information on our municipal offerings or questions about current market conditions, please contact your HJ Sims representative.

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