Market Commentary: When Nothing Goes Right

by Gayl Mileszko

When Nothing Goes Right

Morning texts, bookmarked news sites, and cable TV anchors all deliver information and pictures with spin, blatant or subtle, that inevitably shapes our day. The optimists among us absorb it and rally. We act to make things right or better, at least in our little corner of the world. But our pessimists are easily overwhelmed by the dark focus, the seeming hopelessness, within all these reports of crime, illness, decline, and war. Russia invaded Ukraine 558 days ago and more than 100,000 have died in bloody conflicts that have no foreseeable end. Four days ago, on the 50th anniversary of the Yom Kippur War, Iran-backed Hamas terrorists infiltrated the southern border of Israel and launched barbaric attacks, stunning and horrifying what remains of a civilized world. Scores of hostages have been taken, and the death toll has surpassed 1,200. Fear of escalation is rapidly rising in a region long fraught with tensions, rivalries and war, and efforts at peacemaking appear premature by many months if not years.

Elusive Peace

There is no peace on the northern border of Israel either, and armed conflicts rage in Myanmar, the Maghreb, Ethiopia, Sudan, Yemen, Colombia, and countless other parts of the world. Seemingly irreconcilable differences exist between the U.S. and Iran, North Korea, and Syria, where no diplomatic relations exist, and with China. Global debt amongst developed and developing nations now exceeds $307 trillion and the world’s debt-to-GDP ratio now sits at 336%, a situation that the global financial architecture is not adequately prepared to manage according to the Institute of International Finance. Artificial intelligence is upending job markets everywhere, water scarcities threaten food security for billions of people, and open border immigration policies have created major humanitarian crises, including child trafficking, and highly divisive political issues.

Order in the House

With respect to the divisions within the U.S. House of Representatives that have left the body leaderless for the past week, one financial market titan opines that the ousting of Kevin McCarthy brings our nation “another step away from democracy and toward civil war.”  Ray Dalio, 74, the former founder and manager of the world’s largest hedge fund, Bridgewater Associates, published views last week predicting that within the next three years debt and economic issues will lead the United States into a great political conflict with “irreconcilable differences that may not be settled by rules and law.”  High levels of debt, wealth and values gaps, great power conflicts (most importantly between the US and China and those aligning with them), damaging acts of nature, and new technologies are the major interrelated forces he identifies that are “now driving most everything in ways that have not happened in our lifetimes”. His one wish is for “a very strong bipartisan leader with a strong constituency of people to emerge from the political middle.”

Electing the Right Leader

It is unclear which kind of leader will emerge this week in the balloting for U.S. House Speaker, but the world’s eyes are focused on the outcome. The pressure is on to get 217 House members to unite behind a speaker to unify the majority party, to effectively manage the business of the People’s House, and to stand second in line of succession to the presidency. Several procedural steps are involved, involving secret ballots, questions of candidates, other possible nominations, and one or more open roll call votes.  It is believed that the interim speaker, Patrick McHenry, does not have the power to do much at all, including move legislation, without a clear mandate from the majority. Any rulings that may have been made on this or other matters by the House Parliamentarian, who was appointed by Speaker McCarthy, have not been publicly shared. Given all the differing interests and positions, it is also unclear if any bill, even a simple resolution expressing support for a U.S. ally under attack, could obtain unanimous consent in the House.

A Mess in the U.S.

It seems that nothing is going right. Funding for the federal government expires on November 17 and lack of consensus may preclude an extension or precipitate a shutdown, raising concerns for the third time this year over the erosion of governance in Washington. Inflation still plagues us. Wednesday’s data shows the producer price index up again in September, the most since April, and the consumer price index is expected to reflect another aggravating increase on Thursday. Gasoline prices now average $5.73 in California. There are 14 Federal Reserve speakers on the public circuit this week, each dizzying investors with their personal spin on our economic future. Federal Open Market Committee minutes from the September meeting are expected to show some of the splits between the hawks and doves but highlight the overall expectations for high rates — at least for the next two years. This is very bad news for prospective homebuyers, credit cardholders with $ 1 trillion of debt outstanding at an average interest rate of 21%, corporations looking to refinance debt coming due, municipal and nonprofit borrowers seeking to access the markets with new money and refunding issues. Perhaps no one feels the hit more than the U.S. Treasury, which is paying higher interest on the $103 billion of new paper being auctioned each quarter to finance our $2 trillion deficit.

Even The Fed is Operating at a Loss

Up until August of 2022, the Treasury could at least count on the Fed to kick back its operating profits. In 2014, such remittances totaled $101.9 billion.  It was never imagined that the Federal Reserve System could actually lose money, never mind more than $100 billion in one single year. But the Fed’s mark-to-market losses currently exceed $1 trillion and its operating losses (operating expense plus net interest expense) are accumulating at $2.5 billion a week. Cash losses totaled $110 billion in the fiscal year just ended on September 30. How is this possible? The Fed is paying more than 5 percent interest on money it borrows and is only earning about 2 percent interest on the $7.86 trillion of Treasury and mortgage-backed securities it owns. The mismatch receives very little attention and losses do not show up in many government reports; they are not counted as federal government expenditures, and borrowings are not counted in U.S. Treasury statistics.  Congressional Budget Office projections exclude the Fed in its estimates of spending and interest expense.

Uncharted Waters

The magnitude of debt and central bank problems is not limited to the U.S., but it certainly presents unprecedented challenges for our elected and appointed officials. Fiscal and monetary policies adopted since the Great Recession and again during the pandemic have disrupted all the standard economic cycles and leave us as investors and taxpayers in uncharted waters. In the financial markets, we have seen tremendous volatility since the Fed started raising rates in March of 2022. The 2-year Treasury yield at 5.08% has risen 317 basis points, the 10-year at 4.80% is up 263 basis points and the 30-year has increased 250 basis points to 4.96%. In the municipal market, triple-A benchmark yields have risen as well, but to a lesser degree. The 2-year yield at 3.70% is 231 basis points higher, the 10-year yield at 3.56% is up 163 basis points, and the 30-year at 4.45% has increased by 212 basis points. In the equity markets, the Nasdaq at 13,431 has declined 1.3%, the S&P 500 at 4,308 is down 2.3%, the Dow at 33,407 has lost 3.1%  and the Russell 2000 has fallen 15.5%. Gold prices at $1,833 an ounce are down 5.6% and Bitcoin at $27,890 has dropped 31.7%. One can argue that the markets have not fully absorbed the impact of all the rate hikes and stimulus, as well as the inflation they have brought about and the recession that has been looming.

Third Quarter Ends with Very Few Winners

Volatility in the third quarter of the year, just ended on September 30, reflected the significant uncertainty over the direction of the economy and the next likely Fed rate move. In the stock market, the major indices were hit by losses in August or September but maintained solid gains on the year: the Dow closed September up 2.743% year-to-date, the S&P 500 up 13% and the Nasdaq higher by more than 27%.  Treasury yields increased across the inverted curve by 15 basis points for the 2-year and 83 basis points for the 30-year. The peak of the government curve remained at 6 months, where yields closed out September at 5.54%, up 14 basis points from June 30 and 79 basis points since the start of the year. Treasury index returns erased all gains for the year and finished the quarter at -1.76% High yield corporate bonds were among the top fixed income performers with returns of +5.97%. Leveraged loans at +10.23%, convertibles at +7.02% and preferreds at +3.36% also posted positive YTD results. Municipal benchmark yields increased by 73-85 basis points across a curve that was inverted in the first 12 maturities.. Investment grade municipal bond indices posted negative year-to-date returns at -1.04%, while non-rated munis remained positive at +1.21%. 

Heavy Muni Trading with Higher Yields

Prior to the flight to quality in the immediate aftermath of the declaration of war by Israel, higher bond yields attracted considerable retail interest. Trading in the municipal market during the first week of October hit a high for the year, with households electing to take losses on the sale of lower coupon bonds and swap into higher yielding money market funds and individual bonds coming into the market from 10 straight weeks of mutual fund redemptions. The month of October is typically a weak one for tax-exempts as issuance typically increases ahead of year-end while investors see only about $32.7 billion of principal and interest hit accounts for reinvestment.

HJ Sims In the Market for Renaissance Charter Schools

HJ Sims is in the market this week with a $44.1 million non-rated financing for projects at two Renaissance Charter Schools in Broward County serving 2,500 students and managed by Charter Schools USA.  Bonds are being issued through the Florida Development Finance Corporation and are structured with tax-exempt term bonds in 2033, 2038, 2043 and 2053 in $250,000 denominations for qualified purchasers and institutional buyers. The $5 billion calendar also includes a $10.1 million non-rated transaction for Athenian eAcademy in Utah and a $15.2 million deal for White Pine Charter School in Ammon, Idaho coming under the state’s Aa2 rated moral obligation program. Last week’s slate included an $11.8 million non-rated Colorado Skies Academy financing that priced at par with a 7.00% coupon in 2030.

Where to Go When Nothing Seems to Go Right

The old adage says, “When nothing goes right, go left.” We at HJ Sims choose to go forward. We work to find the right forward-looking approach to every challenge – whether it is with the economy in general, an investment portfolio, or a borrower’s unique financing needs.  Reach out to your HJ Sims representative this week for guidance in moving forward to meet your goals for year-end and for 2024.