Market Commentary: The Certainty Trap

by Gayl Mileszko

The Certainty Trap

Many of us, perhaps too many, have a tendency to treat our beliefs, our principles, our values as unassailable. It is of course normal to have certainty about things that are universally known to be true: the sun rises in the East, two follows one, there are no round squares. But sociology professor Ilana Redstone points out that there are other areas we can easily fall into a “Certainty Trap.”  This is where we get a satisfying sense of righteousness when we condemn, harshly judge, or flatly dismiss people and positions with which we disagree. These days, almost any political, ethical, or moral issue presents such a trap.  It is a particularly sad moment in American history when there is almost no constructive dialogue being held, for example, on the rectitude of either the current or former president of the United States, on the 8-plus million illegal crossings over our northern and southern borders in the past two years, on our national debt at $32.8 trillion or our federal deficit at $1.6 trillion, and on the projected insolvency of Social Security by 2033.  For some reason, we have an oversupply of certainty about these and other matters that is blinding.

Mental Maps Askew

Millions of us are entrenched in points of view that have never been critically examined. This raises the question about how we can ever respectfully engage with others, persuade anyone to see things the way we do, or find common or middle ground.  Without questioning, without study, we somehow stubbornly cling to all sorts of mistaken beliefs. National Geographic recently pointed out, for instance, how askew our “mental maps” are. We picture facts differently, but the truth is that virtually all of the South American continent lies to the east of Florida.  Paris is further north than Montreal.  Rome has the same latitude as Chicago.  Alaska is actually a little smaller than Libya.  Two third of Africa is north of the equator. Brazil is bigger than the entire contiguous United States.  And the most direct flight route between Washington, D.C. and Shanghai takes us over the North Pole. 

No Certain Bets on Rate Cuts

In the financial markets, many of us believed – or rather fervently wished and hoped – that the Federal Reserve would start lowering rates this year. Lots of money behind these views has been won or lost in futures trading these past 18 months. Bondbuyers have celebrated yields that have not been seen since 2010, but these yields have not quite kept up with the inflationary prices in many essential goods. Inflation has indeed come down from 40-year highs, but the costs of borrowing have bankrupted smaller companies in need of capital. Several prominent banks have failed, credit card debt has hit an all-time high, first-time homebuyers cannot afford current mortgage costs and home prices, new drivers are underwater on many auto loans. Key speeches at the Jackson Hole Symposium last week signaled that we on the path to another rate increase with little hope of cuts for quite a while and almost no chance that we will return to the golden years of near-zero rates.

Taxable Bond Yields

Those who have traded through multiple market cycles know that the average 10-year Treasury yield over the past 50 years is 5.97%, well above where it currently stands at 4.23%. But those who began investing 10 years ago only know an average yield of 2.25% and have seen the all-time 10-year low at 0.50% in 2020. At the close on Friday, with four trading days left in the month, the 2-year Treasury at 5.07% had risen 20 basis points in August. The 10-year yield increased 28 basis points, and the 30-year yield at 4.26% was up 27 basis points. The peak of the upside-down yield curve was at 6 months, where it stood at 5.52%, 6 basis points higher than where it ended in July. Right in line with Treasuries, the 10-year BAA corporate bond index yield at 6.58% jumped 30 basis points in less than a month. These increasing yields led to a lot of volatility in the equity markets. The VIX index is 17.6% higher in August. As of last Friday, the Dow has fallen 3.1% to 34,346. The S&P 500 at 4,405 has dropped 3.9%. The Nasdaq at 13,590 has lost 5.1%, and the Russell 2000 has decreased by 6.5% to 1,853. Oil, gold, silver and Bitcoin prices have also all fallen this month.

Tax-Exempt Market Certainly Attractive

The tax-exempt markets have also weakened, not primarily due to elevated credit risks but the rate risks still being flagged by the Fed.  The first 13 years of the municipal yield curve are inverted, an unprecedented situation for bonds that normally price to the call date. The one-year AAA general obligation bond yield at 3.27% is only 64 basis points below the 30-year at 3.91%. The 7-day SIFMA municipal swap index yield has climbed to 4.47%, 55 basis points higher than the top-rated long bond. The 10-year muni benchmark yield at 2.95% is 38 basis points higher in August, but we remind both borrowers and investors that the average 10-year yield since 1964 is 4.51%. The 2-year yield has increased 19 basis points this month to 3.19% and the 30-year is up 40 basis points.  In the $8 billion primary market last week, we saw tenders, floating rate notes, eight ESG certified bonds, a rare Triple-A transaction for Deerfield Academy yielding 3.04% in ten years, and even a $126 million refinancing for the American of Motion Picture Arts and Sciences in the midst of the 100+ day Hollywood strike. In the charter school sector, Founders Academy of Las Vegas brought a $14.8 million BB-minus rated financing structured with a 2058 maturity priced at 6.75% to yield 6.77%. Loveland Classical Schools in Colorado sold $5.8 million of A+ rated state moral obligation bonds featuring a 30-year maturity priced with a coupon of 5.00% to yield 5.08%. And Global Academy of South Carolina placed $30.3 million of non-rated bonds that included a 10-year term bond priced at par to yield 7.50%.

August Adjustments and Year-to-Date Performance

Market adjustments to the reality of higher rates for longer have been as painful as they have been on Main Street. In the first three weeks of August, mutual fund investors have pulled $520 million from municipal bond funds and ETFs, $3.18 billion from taxable bond funds, and $21.8 billion from equity funds. Money market funds, on the other hand, have taken in $50.9 billion, and it is no wonder. The annualized 7-day current yield of the Crane 100 Money Fund Index stands at 5.15%. Year-to-date returns on August 25 are strong overall for stock indices: the S&P 500 is up 16%, the Dow is +5.08%, and the Nasdaq takes the cake at +30.59%. Treasuries have reversed all of 2023’s gains and the sector index now register a negative 0.21% return. A major mortgage market index is down 0.12%. Investment grade munis are up 1.31%, high grade corporate bonds are up 1.96%, taxable munis are returning 2.15%, high yield munis are up 2.29%, and high yield corporate bonds have a 6.14% return.

Certain Market Movers

The summer is winding down and activity slows ahead of the holiday weekend. Nevertheless, there are plenty of market movers to keep an eye on this week. U.S. economic data on housing, jobs and job openings, GDP, inflation, and consumer confidence will draw attention all the way through Friday’s releases. There are nine Treasury auctions, six Federal Reserve officials on the speaking circuit, corporate earnings results coming out for Best Buy, UBS, and others. Hurricane Idalia is threatening major damage on its path between Florida’s Gulf Coast and North Carolina’s Outer Banks. There are daily developments on the four trials involving the former president and reports from House Republicans who appear to be moving forward with an impeachment inquiry of the incumbent president. Analysts are examining the ramifications of the recent six nation BRICS membership expansion. Poland has placed 10,000 troops on its border with Belarus. There is renewed Chinese military activity in the Taiwan Strait. The Congress soon returns to tackle a heavy year-end agenda and the 2024 presidential campaign is heating up.

Labor Day

We at HJ Sims wish you and your family a safe and happy Labor Day. Markets will be closed on Monday as America takes the long weekend celebrate the many contributions to the strength and prosperity of our nation made by our civilian workforce of 167.1 million and our active-duty military and reserve forces numbering 2.1 million. We are also very mindful of the 5.2 million who are actively seeking work, the employers who are actively looking to fill 8.8 million job openings, and those whose work and home lives are currently being upended by weather and other unexpected events. Please reach out to your HJ Sims representative if we may be of assistance this week or in any of the weeks ahead and, as always, be certain of our care and attention.