Market Commentary: Special Sauce

by Gayl Mileszko

Special Sauce

To incentivize customers to use its mobile app and contactless payment system, McDonald’s is offering a “Free Fries Friday” deal. You can get a bag of medium fries every Friday for the rest of the year – there are only nine lefts by the way — with the following “strings”: spend at least $1 on other items and opt into the company’s rewards program which now boats of 57 million members. If you have been to one of the 40,000-plus golden arches locations in the past year, you have seen prices increase by an average of 10%. You will see them increase another 10% in the coming months.  The price tag for a Big Mac combo meal has in fact risen to $18 in at least one Connecticut drive-thru location.  So, families are being priced out of the enterprise that Ray Kroc built into the most successful fast-food company in the world with market cap of $193 billion and 2.1 million employees. With a long history as a place to get cheap burgers, the worldwide chain is now catering to the middle- and higher-income crowd who are trading down from $$$$ rated restaurants. 

Your Kind of Place

Business has recently slowed in the fast-food industry as higher for longer rates sink in and food inflation persists. There has been a drop in traffic at restaurants like McDonald’s, Taco Bell, and KFC for three consecutive months. Menu prices in the restaurant industry are up 6% on average, year over year, much higher than the headline inflation rate. Some of the increase comes in response to the higher costs of labor, food, and fuel. But it also comes from new menu enhancements and the simple fact that customers insist on dining out and will pay more even when they cannot afford to. McDonald’s has one of the strongest brands in the world, and there is a perception that its meals are cheaper; several $1 specials are still featured, while other offerings have higher prices and smaller portion sizes.  There are more than 1,000 franchisees with freedom to set prices, and some are making what they term “strategic” price hikes.  The strategies are not disappointing stockholders. With 75 burgers sold every second, McDonald’s third quarter revenue totaled $6.69 billion, net income was $2.32 billion, and dividends increased 10%, beating analyst estimates. 

You Want it, Need it, Gotta Have it

Roughly half of the S&P 500 companies have reported results thus far, and many reflect the resilience of consumers, their willingness to continue buying whether with cash or cards permitting them to pay later. Household credit card debt now exceeds $1 trillion, jumping $70 billion since the start of the pandemic. Consumer discretionary companies know firsthand that higher prices are not fazing their customers.  As a result, have on average exceeded earnings-per-share estimates by 19% in the third quarter. A 4.9% reported rise in U.S. gross domestic product in the third quarter further highlights the stubbornness of consumers who get what they want when they want it, at least for now.

Food, Folks and Fun

We have roughly 76 million school-aged children in the U.S.  and they have long been a key target of fast-food chains with draws like play areas and features like Happy Meals. But birth rates have declined by 23% since 2007 and companies will need to redirect their marketing to the larger prospective pool of seniors, numbering 56 million and rising. Some McDonald’s franchises offer discounts on coffee or other menu items to attract those living on fixed incomes who do not otherwise dine out. Others benefit from celebrity partnerships with the likes of Michael Jordan, Heidi Klum, Justin Timberlake, and Cardi B. President Biden favors Egg McMuffins. Former President Trump is known to be a fan of Big Macs, Filet of Fish, and vanilla shakes.             

The Closest Thing to Home

Catering to seniors is what life plan communities are all about. There are more than 1,900 in the U.S., each offering its unique combination of hospitality, entertainment, social engagement, assistance with daily living, and medical care. Their products and services are evolving along with the preferences and needs of the 10,000 Americans turning 65 every day. Building, repositioning, expanding and renovating the 75% of those communities that have non-profit sponsors is often done through the municipal bond market. This year so far, we have seen about 22 of such financings with combined par value of $1.1 billon. Due to the higher rate environment, inflation, and other factors, this falls well below the $2.6 billion of senior living transactions we saw in the first 10 months of 2022 and the $5.2 million that came in 2021. Given demographic changes in the population, demand projections indicate that our country needs to step up the production of senior housing. The National Investment Center for Senior Housing & Care estimated that as of June 30, 2023, we have a total of 1.91 million units of independent living, assisted living, memory care and skilled nursing in the major market areas that it tracks. They projected that meeting the needs of seniors going forward would require about 54,000 additional units of inventory per year from 2020-2025 and a total of 881,000 additional units by 2030.

Happy Deals

Last week, the California Municipal Finance Authority came to market with a $10.9 million transaction for the Ararat Home of Los Angeles life plan communities. The deal was rated “AA- “on the basis of the state mortgage insurance program.  It was structured with 20 years of serial bonds with a final maturity in 2043 priced at 5.00% to yield 5.03%. This week, the Lancaster County Hospital Authority is bringing a $26.2 million “A” rated financing for Masonic Villages in Pennsylvania.

A McFlurryTM of Bonds

In the corporate and municipal bond markets, we are seeing the vast bulk of new offerings coming in the investment grade sector. Municipal issuance in October rose 29% over the 2022 level to $37.1 billion as borrowers grew tired of waiting for rates to fall and put current yields in context. Municipal Market Advisors reports that, since 1964, the average municipal 10-year yield is 4.51%. Today it is 3.61%. We are seeing record high retail trading volume and, like the McDonald’s jingle goes, we are lovin’ it. Investors are arranging tax swaps and reaching for more yield than they have seen in over a decade. Muni bids-wanted par on Tuesday totaled $1.8 billion and offering par exceeded $28 billion. Our analysts and traders scouring these lists throughout the day and are finding some great value for our clients.

On the Muni Menu

For most of this year, taxable and tax-exempt money market funds have been big targets in the hunt for quality, income, and liquidity. Tax-exempt MMF assets under management have risen to $120.2 billion this year and muni ETFs grew to $110 billion. Individual bonds with longer maturities, including higher yielding bonds in the charter schools and senior living sectors are very attractively priced as offered in the primary and secondary markets.  Last week, we sold a block of the BB rated 5% bonds due in 2049 issued for Pennsylvania’s Morningstar Senior Living at a tax-exempt yield of 6.91%.  Bloomberg reports that 30-year bonds sold this month by the New York Power Authority are trading at about 5.2% which, on a tax-equivalent basis, would earn about 10.7% for New York investors in the top bracket.  On the corporate side, McDonald’s is a BBB+ credit; its 30-year bonds with a 5.45% coupon are trading in the range of $88 for a taxable yield of 6.30%.

Shaking Up the Markets

November is here and events, global and domestic vie for the attention of traders.  We are shifting our focus back and forth from Washington to Gaza, from our southern border to Ukraine, U.S. courtrooms to China. The Treasury announced its plans to borrow nearly $800 billion by the end of this year and another $816 billion in the first quarter of 2024 to manage our growing debt load in this higher rate environment. The Federal Open Market Committee met this week to discuss the direction of rates, reiterate their focus on inflation, and leave markets confused about whether the Fed thinks it has done enough to combat it. The Congress deliberates on funding for war-torn Ukraine and Israel as well as the protection of our own borders.  The new House speaker cites “mounting evidence” of bribery and pay-to-play schemes involving the President.  The director of the FBI just testified that antisemitism has reached an “historic level” in the U.S and he warns of an increased terrorist threat.   Economic data is being released on housing, consumer confidence, construction spending, job openings, nonfarm payrolls, factory and durable goods orders.  The former President is being called as a witness in a civil fraud trial in New York. Real estate stocks are taking a beating after a federal jury in Kansas City found that the National Association of Realtors and several residential brokerages conspired to artificially inflate commissions for home sales and are liable for $1.78 billion of damages.

Fourth Quarter Pounding

With all these events swirling, October, the first month of the fourth quarter, finished with bond market volatility heightened by nearly 12%, and stock market volatility up 3.5%.  All equity indices finished in the red with the Russell 2000 down 6.9%, the Nasdaq down 2.8% and the S&P 500 down 1.4%.  Oil prices dropped more than 10% to $81.02 a barrel. Gold prices rose over 7% to $1,984 an ounce.  Bitcoin prices soared 28% to $34,392. In the bond markets, the 2-year Treasury yield rose 4 basis points to 5.08%. The 10-year finished at 4.93%, up 36 basis points on the month. The 30-year yield at 5.09% ended 40 basis points higher. Swept alongside Treasuries, the 10-year BAA corporate index at 7.19% closed 42 basis points higher. And municipals also weakened. The 2-year AAA general obligation bond benchmark closed October at 3.67%, higher by 1 basis point. The 10-year muni yield at 3.61% increased by 16 basis points. The 30-year at 4.57% rose 23 basis points. Investment grade returns on the month, as measured by the S&P Municipal Bond Index, were negative 1.13%, bringing year-to-date returns further into the red at negative 2.19%. The High Yield Muni Index lost 2.18%, dragging down year-to-date performance to negative 1.36%

Lovin’ itTM

Your HJ Sims representatives stand ready to help with your investment needs. Amid all the volatility, there is a lot out there to love. Reach out to us today for some of our McNuggets of market insight to enhance your portfolio before year-end.