SNW Asset Management | A Minute in the Market

CPI Rises in January

Galen True, Portfolio Manager — Tue, 21 Feb 2012 18:09:19 +0000

The headline Consumer Price Index (CPI) rose 0.2% in January as did the CPI “core” index, which strips out the more volatile changes in food and energy prices. The increase is a 2.9% rise year-over-year for the headline CPI measurement and a 2.3% rise year-over-year for the “core” measurement. This is above the Federal Reserve’s projection for the year of 1.4% to 1.8%. Initial Jobless Claims, considered by some to be a leading indicator of hiring, came in on February 16th at 348,000, which is the lowest print since 2008. According to Deutsche Bank, a sustained level below 350,000 is also a leading indicator of the Fed raising short-term rates. Hiring has been strengthening, as indicated by the Non-farm Payrolls number, with the most recent print at +243,000. Greater employment coupled with higher consumer prices could easily prevent the Federal Reserve from further easing, if not begin to force some tightening in monetary policy. We will continue to monitor the economic data carefully for signs of further strength in our domestic economy and possible changes in the Federal Reserve’s stance on rates.

Tentative Agreement Avoids Default for Greece

Anthony Baruffi, CFA, Sr. Portfolio Manager — Tue, 21 Feb 2012 18:08:39 +0000

European finance ministers agreed today to a new bailout for Greece that will provide 130 billion Euros and avoid a default by the country next month. The agreement calls for private Greek bondholders to take a 53.5% loss on the face value of their bonds, which equates to an overall loss of approximately 75%. The European Central Bank (ECB) also agreed to give up profits from Greek bonds bought at a discount, and pass the gains back to the Greek government. The bailout required members of the Greek government to agree to tough austerity measures, which many believe will cripple the already weak economy and make it difficult for Greece to meet its targeted debt-to-GDP ratio of 120% by 2020. A leaked report by the European Commission, the ECB, and the IMF suggested that Greece could need an additional bailout of $66 billion after 2015. The report stated that “given the risks [of Greece reneging on agreed-to austerity measures], the Greek program may thus remain accident-prone, with questions about sustainability hanging over it”. So as much as we would like to think that this Greek tragedy is behind us, we would expect to see further market volatility related to Greece in the months ahead.

Securitized Loans Back in Vogue

Tim Benzel, CFA, Portfolio Manager — Tue, 21 Feb 2012 18:08:03 +0000

According to the Financial Times, the securitized loan market in the United States is off to its fastest start since the 2008 financial crisis, with over $20 billion in issuance of car-related, credit card, student, and other loans. This is a 23% increase from the same period last year. Driven by strong demand from consumers, investors are welcoming the issuance as it provides an opportunity to pick up yield versus historically low Treasury rates. It also signals that the domestic credit markets are functioning smoothly, despite the ongoing European financial crisis. A functioning credit market is key to sustainable economic growth, as it enables entities such as corporations and municipalities to fund projects and expand. The fact that consumers are willing to borrow for education and to purchase new cars points to increased consumer spending and an improving economic outlook.

California Revenues Fall Short

Galen True, Portfolio Manager — Mon, 06 Feb 2012 19:09:48 +0000

Last week the State of California’s controller, John Chiang, announced that the state would run out of money by March if it did not borrow more or delay payments. Revenues have come in $2.6 billion lower than expected for the six months ended 12/31. During the same period, the state has spent more than budgeted by the same amount, which has caused a cash squeeze. In response, the governor has signed a bill that will allow the state to borrow additional money from special funds, and has accepted loans from the two state university systems. More concerning is the effect that this revenue shortfall will have on K-12 school districts. If the Governor’s newest tax-hike proposal does not pass, districts face cuts of roughly 5% in funding statewide. We will be watching this issue closely as well as monitoring the financial condition of school districts in the state for the ill effects of these adverse operating circumstances.

Corporate Bond Market Benefits From Fed’s Operation Twist

Anthony Baruffi, CFA, Sr. Portfolio Manager — Mon, 06 Feb 2012 19:09:06 +0000

Bloomberg news reports today that the Central Bank’s plan to extend the average maturity of debt in its portfolio by selling short-term bonds and buying longer-term ones is helping corporate borrowers cut their borrowing costs to record lows. Yields on long-term Treasuries have been falling relative to short-term Treasuries since the Fed’s announcement that it would buy $400 billion of bonds with maturities of six to 30 years through June, while selling an equal amount of debt maturing in three years or less. Borrowing costs for companies have also been driven lower, as improving employment and business confidence numbers have outweighed concerns that Europe’s sovereign debt crisis could disrupt credit markets. Last week P&G, the consumer products maker, issued $1 billion of 10-year debt, paying a record low 2.3% annual yield. Many of the corporate securities we own in our clients’ accounts have also benefited from the improving market sentiment. We have benefited from yields falling on bonds issued by American Express, AT&T, JP Morgan, and others that we hold. While we are happy that the market has rewarded us for our credit work, we will continue to monitor all of the securities in these accounts to ensure that our clients are being adequately compensated for the credit risk of holding each security.

Upside Surprise in January Jobs Report

Tim Benzel, CFA, Portfolio Manager — Mon, 06 Feb 2012 19:08:28 +0000

The employment picture in 2012 got off to an unexpectedly positive start, as the economy added 243k jobs in January and the unemployment rate fell 0.2% to 8.3%. Economists were expecting an increase of 200k workers and a flat unemployment rate of 8.5%. Job gains were widespread across sectors, as business services, manufacturing, and construction added 70k, 50k, and 21k jobs respectively. Unlike recent reports that have beaten expectations, January’s number was very “clean” in that there were few one-offs and special factors to consider. The Treasury market immediately reacted to the news by selling off as interest rates rose across much of the curve, with the long-end particularly hard hit. While rates are higher than prior to the report, they are still not at levels consistent with the positive economic data recently. Likely contributing to this is the continued uncertainty surrounding the European financial crisis. The next few days will be critical for Greece, as the country struggles to reach agreements with private sector creditors on the haircuts they will take on existing debt and with European finance ministers over further austerity measures.

Fed Increases Transparency; Extends Low Rates Expectation

Galen True, Portfolio Manager — Mon, 30 Jan 2012 20:21:52 +0000

Last week, the FOMC announced interest rate forecasts from 17 of its policy makers in an ongoing attempt to increase transparency. The Fed also announced that certain Fed presidents believe economic and employment circumstances will dictate keeping interest rates low through the end of 2014. Interest rates have historically led the Federal Reserve, not the other way around. Currently, interest rates are low mainly because there is strong demand for safe, secure income, and there is a lack of available supply (for multiple reasons) to meet that need. The Federal Reserve has a dual mandate to keep inflation low and foster maximum employment, and is clearly focused on the low percentage of eligible workers who are employed. If there is evidence of a strong recovery, the Fed will have to change its policy in response. The “keeping rates low until late 2014” policy is a response to its staff economists’ expectations of an uneven, weak recovery with low inflation.

The Fed has a poor track record of predicting GDP and inflation. For example, mid-2007 FOMC statements that pointed to strong economic growth and eschewed asset price inflation concerns turned out to be laughably inaccurate. It appears that, with its announcement, the Fed has just pushed Treasury rates to the lower end of the recent range. However, if domestic economic momentum continues or accelerates and is coupled with inflationary pressure, the Fed will be hard pressed to keep its word. At SNW Asset Management, our concern is the unintended consequences this new “transparency” will have on investor behavior. In our opinion, it will push many investors into riskier assets as they search for yield and cash flows at almost any price.

GDP Disappoints; Deflation More of a Risk than Inflation?

Anthony Baruffi, CFA, Sr. Portfolio Manager — Mon, 30 Jan 2012 20:21:20 +0000

On Friday, the Commerce Department reported that fourth quarter GDP rose less than expected, at a 2.8% annual rate. While the gain is the strongest since the second quarter of 2010, the report showed that consumer spending is still weak, growing at only 2.0% in the fourth quarter. The gain follows a GDP increase of 1.8% in the third quarter, and is less than the median 4Q estimate of 3.0%. The growth rate would have been 0.8% if gains in inventories were excluded. Inflation was also weaker than expected, growing 0.7% in the fourth quarter, down from 2.3% in the third quarter and the smallest gain in more than a year. The weak growth and inflation numbers come as an article in the Wall Street Journal reports that, despite an increase in lending in the fourth quarter, demand for bank loans is declining and may hint at deflation. On Monday, the Fed will release its quarterly bank survey, and many fear that it will show business loan demand is weak while many banks are tightening lending standards. Banks tightened lending standards on small businesses last summer, and on large and medium-sized businesses in the fourth quarter, after easing standards for seven consecutive quarters. The article warns that with loan demand weak and lending standards tightening, risks are weighted towards deflation, not inflation. However, mild inflation and sub-3% GDP growth is what most economists are predicting for the US economy in 2012, which means that scenario is unlikely to occur. Welcome to 2012; enjoy the ride!

Subdued Headlines in Europe Lead to Financial Bond Outperformance

Tim Benzel, CFA, Portfolio Manager — Mon, 30 Jan 2012 20:20:43 +0000

The ECB’s 3-year bank loan program and the lack of negative headlines from Europe have helped improve the tone surrounding bank bonds in 2012. Year-to-date as measured by Barclays Capital, bonds issued by financial institutions in Europe have gained 3.5% while those issued by financials in the U.S. have risen 3.0%. These returns are on track to be the largest for any month since July 2009 and reflect diminished investor concern over European bank and sovereign viability. Companies are taking advantage of the thaw in credit markets by selling unsecured debt; earlier this month, Goldman Sachs sold $4.5 billion in debt, its largest unsecured bond issue ever. We have been and continue to be positive on select financial companies that have little direct exposure to the ongoing crisis in Europe. As the situation remains fluid and headlines (both positive and negative) cause market volatility, these bonds will react. Over time, however, we feel that their sound credit quality and higher yields will lead to outstanding total return performance relative to other fixed income sectors.

Global Debt Issuance Slowing

Galen True, Portfolio Manager — Tue, 24 Jan 2012 20:22:26 +0000

Total debt outstanding grew to $53 trillion at the end of 2011, according to Bank of America/Merrill Lynch data. This represented a year/year increase of 6.3%, which is the smallest increase since 2000 and well below the last decade’s average growth of 9.3%. One reason for the slowdown in growth is the reduction of bank debt. Both Bank of America and Citigroup have indicated that, rather than refinancing just over $60 billion of maturing TLGP debt (bonds issued through the FDIC with a government guarantee), they will retire it. Another reason for the slowdown in debt growth is that governments have reduced their debt outstanding. Although governments initially stepped in to take on more debt as the financial crisis of 2008 threatened global debt markets, in 2011 quasi-government debt and sovereign debt was the only sector of the global bond market to actually contract, dropping by 2.1%. Bank of America/Merrill Lynch’s Global Broad Market Corporate index, which tracks relative yields on corporate debt globally (spread above government debt yields), tightened 9 basis points last week to 246 basis points. Despite the risks that remain for many issuers, the slowing growth of supply is a major factor that will support bond prices in the future.