HJ Sims Market Commentary: When Things Go Wrong

by Gayl Mileszko

In an all too familiar scenario for writers, one persistent author suffered through 30 rejection slips before his book was finally accepted for publication. Canadian sociologist Laurence Peter had asked aloud: “Why do things always go wrong?” His answers, when circulated in print, created something of a phenomenon. Within 18 months, his book, co-authored by Raymond Hull, became a number one best seller for 33 weeks and was translated into 38 languages. Readers from around the world quickly embraced his hilarious and all-too-true treatise on business and life. The Peter Principle took a close look at the maddening incompetence that seems to greet us all at every turn. The bestselling authors intended to satirize the business world but folks from every quarter found themselves nodding their heads and chuckling at the examples of people who become increasingly incompetent the higher they rise through the ranks not only in their office but in their school, their church, their team, their government. In time, the theory goes, every job tends to be occupied by someone who is incompetent to carry out his or her duties — and the only work actually accomplished is by those who have not yet reached their level of incompetence.

The Peter Principle

Fifty-three years later as we survey the global landscape, as well as settings closer to home, we still see the Peter Principle in action. Military maneuvers. International public health policies. Olympic rules. Social media moguls and fact-checkers. Dog-themed cryptocurrencies. Investors watching the wild swings in stock and bond markets are concerned with the goings-on behind algorithmic trading strategies and how the flow patterns involving trillions in mutual and exchange traded funds will impact their accounts and the future of their families. The U.S. legal community again scrambles to ensure that the Principle does not apply in the case of the next Supreme Court justice. The financial markets are similarly scrutinizing the backgrounds and bents of the President’s nominees to three Federal Reserve Board vacancies, and assessing whether the 10 or 12 voting members of the Open Market Committee are truly well-suited to guiding us along the rocky path to normalization. 

Normalcy in Financial Markets

January was a textbook illustration of the rocky path. The leading measure of volatility, the VIX, rose by as much as 86%, but settled down a bit and closed 44% higher at 24.83.  All the major stock indices lost ground, with at least one experiencing the worst decline since 2008. The Russell 2000 at 2,028 closed down 9.7%, the Nasdaq at 14,239 finished down 9%, the S&P 500 at 4,515 lost 5.3%, and the Dow at 35,131 lost 3.3%.  Bitcoin at $38,509 plummeted 18% and even silver at $22.41 and gold at $1,797 ended the month down 3.8% and 1.8%, respectively, while oil prices at $88.15 a barrel rose 17.2%. 

Facing the Dreaded Rate-Hikes

Fast rising bond yields caused much of the disruption for stocks as traders started to figure in not only two rate hikes of 25 basis points this year, but as many as seven, beginning on March 16, and how they could hurt technology firms as well as others still looking to keep liquid amid continuing supply chain disruptions, inflation at a 40-year high, competitive threats, and countless black swan possibilities. The 2-year Treasury yield jumped 60% since the start of the year, rising from 0.73% to 1.17%. The 10-year benchmark at 1.77% added 26 basis points, and the 30-year yield at 2.10% gained 20 basis points. Ten-year Baa-rated corporate bond yields rose 13% from 3.20% to 3.63% in January. Just about every fixed income sector except leveraged loans was crushed. But the greatest hurt was felt in the tax-exempt market, one of the stars of 2021. Although muni borrowers continued to enjoy extraordinarily low rates, muni bondholders suffered through the worst January in 30 years.  The 2-year AAA general obligation bond yield rose from 0.24% to 0.90%, the 10-year yield climbed 52 basis points to 1.55%, and the 30-year benchmark yield increased 46 basis points from 1.49% to 1.95%.  Many dealers, with heavy exposure as they planned for the traditional “January effect” of high demand, took losses. The year-long threat of higher taxes disappeared with the hopes some had for another big federal stimulus package.

The Fed Still In Charge of Our “Free Markets”

Change is afoot after 13 years of suppressed interest rates and some (but not all) negative real yields. The two-year sovereign yields of France, Germany, Italy, Spain, Japan and many other nations are still negative even before inflation is factored in. Markets have had plenty of forewarning that the Fed will stop adding to its balance sheet by March, but many have doubted that the Fed can raise rates more than a tad given the impact on the cost of our annual federal interest payments and corporations in stressed sectors with ongoing liquidity needs. Questions remain about the timing and extent of liftoff amid all this inflation, the ongoing pandemic, and worries over slowing economic growth, consumer spending trends, and empty store shelves. The process of ending more than a decade of quantitative easing and money printing can in no way be painless. But the markets have been accustomed to having the Fed take on an unofficial third role in support of the economy and guardian against market crashes — perhaps now even ahead of its two key responsibilities: promoting maximum employment (the box is checked), and preventing runaway inflation (no end yet in sight).

Tax-Exempts Issues in the Municipal Market

The municipal market saw only $24 billion of issuance in January, down from $28.2 billion in 2021. Borrowers came to market and still achieved relatively low historic rates, but volume fell with the drop in taxable and refunding deals. Refinancing transaction par fell by 57% and taxable issuance was down 54%. Buyers had plenty of cash but not many offerings appealed; almost 26% of coupons in 2021 were under 3 percent. In the last sale week of the year, high investment grade issues dominated. Non-rated bonds yielding 5.00% remain extremely rare. The Wisconsin Public Finance Authority had $97.9 million of non-rated subordinate municipal social certificates due in 2044 priced at par to yield 4.00%, and the latest in a series of non-rated California essential housing revenue bonds sold with a 2043 term bond with a 3.25% coupon yielding 4.05%.

This Week in the Markets

February brings another $8 billion municipal bond calendar with nine charter school deals, three senior living financings, two series of green bonds, three social bond deals, one sustainability-linked issue, a forward settlement and one higher education transaction with a corporate CUSIP. Buyers are awash in cash as February 1 saw $24 billion of principal and interest payments hit municipal bondholder accounts. This comes on the heels of $33.8 billion in January, a good portion of which is still uninvested. Investment grade corporate bond volume this week may reach $20 billion with the slowing pace of earnings blackouts; high yield corporate issuance was $7 billion last week and is announced with much less notice. The market for initial public equity offerings, which totaled only $26.7 billion in January, has shrunk 60% from last year.

Investor Concern

Major investor concerns have shifted from the COVID variants to inflation. Ukraine, Taiwan, North Korea are all in focus. Most are closely watching fund and ETF assets and adjusting buy/sell orders in response to outflows and higher new issue yields. Corporate earnings so far are not as rosy as projected, and the White House is already downplaying some of the next rounds of key US economic indicators.

Contact Your HJ Sims Representative

We have proudly guided our clients through all the market cycles since 1935. While we offer no crystal ball, we do have seasoned veterans on our sales, trading, analytic, operations, and banking teams that have been promoted not only into their jobs but into the HJ Sims family. We are committed to helping you make things go right: meeting your goals this month, this quarter, this year, and throughout your strategic and investment horizon. If you are an individual investor, institution, foundation, or non-profit borrower with questions or concerns about your portfolios or strategies, we welcome your call.

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