Category: Insight

20 Aug 2021
High Yield Weekly Rich Balestra - Portfolio Manager 0 comment

CAM High Yield Weekly Insights

Fund Flows & Issuance:  According to a Wells Fargo report, flows week to date were $0.9 billion and year to date flows stand at -$5.7 billion.  New issuance for the week was $7.8 billion and year to date issuance is at $348.9 billion.

 

 

(Bloomberg)  High Yield Market Highlights

 

  • S. junk bonds are headed for a third straight week of losses, the longest such streak in five months, while the cost of borrowing has jumped. Yields have risen to a more than three-month high of 4.19% amid concerns about the spread of the delta variant and its impact on economic growth, and on expectations that the Federal Reserve will soon scale back bond purchases.
  • CCCs, the riskiest junk bonds, have lost 0.19%, and are on track for the seventh consecutive week of losses. Yields soared 31bps Thursday, the biggest one-day jump in more than three months, to a five-month high of 6.63%
  • Borrowers have retreated amid market volatility after selling more than $33b this month, according to data compiled by Bloomberg
  • Yields on the broader junk-bond index rose 8bps to 4.19% Thursday, and are poised to end higher for the six straight week, the longest stretch since July 2015, the Bloomberg-compiled data show
  • Losses amount to 0.12% this week
  • CCC yields have jumped 66bps this month to a five-month high of 6.63%
  • Markets are fragile again Friday with a key measure of high-yield credit risk higher, and U.S. equity futures lower as faltering growth and China’s regulatory curbs compound risks before the Fed’s Jackson Hole symposium next week. Oil is headed for its longest run of daily declines since 2019 on worries about global energy demand

 

(Bloomberg)  Fed Minutes Show Most Officials See Taper Starting This Year

 

  • Most Federal Reserve officials agreed last month they could start slowing the pace of bond purchases later this year, judging that enough progress had been made toward their inflation goal, while gains had been made toward their employment objective.
  • “Various participants commented that economic and financial conditions would likely warrant a reduction in coming months,” minutes of the Federal Open Market Committee’s July 27-28 gathering, released Wednesday, said. “Several others indicated, however, that a reduction in the pace of asset purchases was more likely to become appropriate early next year.”
  • The minutes also showed that most participants “judged that it could be appropriate to start reducing the pace of asset purchases this year.”
  • S. central bankers next meet September 21-22. While the record shows that they don’t yet have agreement on the timing or pace of tapering asset purchases, most had reached consensus on keeping the composition of any reduction in Treasury and mortgage-backed securities purchases proportional.
  • Policy choices going forward are also likely to be influenced by new appointees to the Fed Board as the Biden administration moves to fill as many as four positions by early 2022.
  • Fed policy makers have differed publicly in the weeks since the meeting over when the central bank should start tapering, with some, like Minneapolis Fed President Neel Kashkari, wanting to a see a “few more” strong jobs reports and others, such as Boston Fed President Eric Rosengren, saying he’s open to announcing plans for a reduction at the next meeting if employment figures come in well.
  • Fed officials cut their benchmark lending rate to zero in March 2020 and announced they would buy $200 billion of agency mortgage-backed securities and $500 billion of Treasuries to support market functioning. By December 2020, they realigned their guidance saying they would purchase $80 billion a month in Treasuries and $40 billion a month on mortgage securities “until substantial further progress has been made toward its maximum employment and price stability goals.
  • The asset purchases have lowered longer-term interest rates and helped fuel a rise in housing prices and other financial assets, with one-month gains in home price indices breaking records while stock indexes trade around record highs.

 

06 Aug 2021
High Yield Weekly Rich Balestra - Portfolio Manager 0 comment

CAM High Yield Weekly Insights

Fund Flows & Issuance:  According to a Wells Fargo report, flows week to date were -$0.1 billion and year to date flows stand at -$7.1 billion.  New issuance for the week was $16.9 billion and year to date issuance is at $327.1 billion.

 

 (Bloomberg)  High Yield Market Highlights

 

  • The rally in the U.S. junk-bond market appears to be losing steam as CCCs, the riskiest segment in high yield, is poised to post a negative return of 0.35% for the week, which would be the biggest such loss in more than nine months. The five straight weeks of losses have been the longest losing streak since November 2018.
  • CCC yields rose 28bps in the last four sessions to 6.25%, and are on track to see the biggest weekly jump in almost three months
  • Junk bond investors pulled cash from retail funds, and the funds have seen cash leak in six of the last 10 sessions
  • The broader junk bond index is also set to post negative returns for the week, with 0.19%, the biggest weekly decline in more than two months
  • That investors were getting wary was evident with BB rated bonds accounting for about 75% of the total bond sales this week
  • Investors, though cautious, were not risk averse as almost $17b of new bonds are set to price this week
  • The index yields rose 14bps week-to-date to close 4.02%, still low and attractive for borrowers

  

(Bloomberg)  Clarida Sees 2021 Taper Announcement, 2023 Fed Rate Liftoff

 

    • Federal Reserve Vice Chairman Richard Clarida said the central bank is on course to pull back on the massive support it is providing to the pandemic-damaged economy, starting with an announcement later this year that it is paring bond purchases and moving on to a liftoff in interest rates in 2023.
    • While acknowledging that the rapid spread of the Delta virus posed a downside risk to the economy, Clarida on Wednesday painted an upbeat picture of the outlook in the coming years as growth powers ahead and inflation falls back from its recent elevated levels.
    • The “necessary conditions for raising the target range for the federal funds rate will have been met by year-end 2022,” paving the way for a lift-off from near-zero rates in 2023
    • His comments helped to harden wagers in the money markets for an initial rate hike in early 2023, after they wavered earlier on news of a marked slowdown in private sector hiring last month
    • The Fed has said it will keep short-term interest rates pinned near zero until the labor market has reached maximum employment and inflation has risen to 2% and is on track to moderately exceed that level for some time. In economic projections released in June, a preponderance of policy makers penciled in two interest-rate hikes by the end of 2023
    • The economy has forged ahead strongly this year, after swooning in 2020 amid the pandemic. Gross domestic product rose at a 6.5% annualized rate in the second quarter, following a 6.3% gain in the first three months of the year
    • “The monetary and fiscal policies presently in place should continue to support the strong expansion in economic activity that is expected to be realized this year, although, obviously, the rapid spread of the Delta variant among the still considerable fraction of the population that is unvaccinated is clearly a downside risk for the outlook,” Clarida said
    • If growth does stay strong, Clarida said he’d be in favor of the Fed making an announcement later this year that it will begin to scale back its bond purchases
    • The Fed is currently buying $120 billion of assets per month — $80 billion of Treasury securities and $40 billion of mortgage backed debt — and has pledged to keep up that pace “until substantial further progress” has been made toward its goals of maximum employment and 2% inflation.

(Bloomberg)  U.S. Job Growth Exceeds Forecast as Unemployment Rate Falls

 

    • S. employers added the most jobs in nearly a year and the unemployment rate declined faster than forecast, showing the labor market is making more robust gains toward a full recovery.
    • Payrolls climbed by 943,000 last month after an upwardly revised 938,000 increase in June, a Labor Department report showed Friday. The median estimate in a Bloomberg survey of economists called for a 870,000 gain. The unemployment rate dropped by a half percentage point to 5.4%.
    • The dollar and 10-year Treasury yields advanced while stock futures erased gains as traders bet a strengthening labor market will lead Federal Reserve officials to begin pulling back monetary support, including bond buying.
    • A resurgence in economic activity has sparked a surge in labor demand — particularly in the leisure and hospitality industry — since the beginning of the year. At the same time, payrolls remain 5.7 million short of pre-pandemic levels and many employers have struggled to fill a record number of vacant positions.
    • The figures mark a big step toward the Fed’s goal of “substantial” further progress in the labor market recovery. Fed officials including Chair Jerome Powell and Governor Lael Brainard have indicated the labor-market recovery had some way to go before the central bank could begin tapering asset purchases.
    • Fed Governor Christopher Waller said this week that if the next two monthly employment reports show continued gains, he could back such a move.

 

06 Aug 2021
Investment Grade Weekly Josh Adams - Portfolio Manager 0 comment

CAM Investment Grade Weekly Insights

Spreads are set to finish the week wider to the tune of 1-2 basis points.  The OAS on the Bloomberg Barclays Corporate Index closed Thursday August 5 at a spread of 88 after having closed the week prior at 86.  We are going to print amid a positive market tone on this Friday morning after a strong unemployment report.  The yield on the 10yr Treasury traded higher this week but most of that move occurred this morning after the aforementioned employment report.  The 10yr closed last week at 1.22% and is trading at 1.28% at the moment.   Through Thursday, the Corporate Index had posted a year-to-date total return of +0.08% and an excess return over the same time period of +1.54%.

 

 

It was the busiest week for the new issue market in over 2 months according to Bloomberg, as weekly volume eclipsed $32bln.  Next week should also see brisk issuance before things slow down at the end of August for the last salvo of summer vacations. According to data compiled by Bloomberg, $909bln of new debt has been issued year-to-date.

We have seen more of a two-way flow in the market the past several weeks.  The reopening trade has lost some steam as investors weigh the risks of the delta variant.  For most of 2021, credits levered to reopening were in the midst of a one-way trade to tighter spreads and lower yields but those credits have seen mixed and in some cases poor performance in recent trading sessions.

Per data compiled by Wells Fargo, inflows into investment grade credit for the week of July 29–August 4 were +$5.7bln which brings the year-to-date total to +$247bln.

 

12 Jul 2021
High Yield Weekly Rich Balestra - Portfolio Manager 0 comment

CAM High Yield Weekly Insights

Fund Flows & Issuance:  According to a Wells Fargo report, flows week to date were $1.0 billion and year to date flows stand at -$6.0 billion.  New issuance for the week was $0.8 billion and year to date issuance is at $286.8 billion.

 (Bloomberg)  High Yield Market Highlights

  •  The U.S. junk bond primary market finally emerged from its post-holiday malaise with Jaguar Land Rover set to sell $500 million of 8-year bonds as soon as today.
  • The U.S. junk bond market is poised to post gains for the third consecutive week, with returns of 0.16%
  • Barclays revised the spread and returns forecast for high yield as the macro backdrop changed with vaccine rollout, fiscal stimulus and overall growth environment
  • High yield index spreads will end the year at 275-300bps, revised from 250-375. The total returns will be 4%-4.5%, from 3.5%-4.5%, Brad Rogoff wrote in a note on Friday
  • After a relentless rally plunged junk bond yields to all- time lows across ratings, the market stalled yesterday following fluctuating equities and volatile oil prices amid concerns how the clashes inside OPEC+ will play out
  • Yields rose for the second straight session to close at 3.67% after setting a record low of 3.53% earlier in the week. The yields were up 8bps, the biggest one-day jump in seven weeks. Spreads closed at +271bps, also up 8bps
  • The broader index came under pressure after a long rally as equities fell to post a modest loss of 0.11% on Thursday. The market is ending the week with gains of 0.16%
  • CCC yields also rose for the second straight session to close at 5.48%, up 7bps. It hit a new low of 5.15% on July 6. The index posted a loss of 0.19% on Thursday and is expected to end the week with a loss of 0.04%


(The Wall Street Journal)  Borrowing Is Back as Sign-Ups for Auto Loans, Credit Cards Hit Records

  •  Americans are borrowing again, in some cases at levels not seen in more than a decade.
  • Consumer demand for auto loans and leases, general-purpose credit cards and personal loans was up 39% in April compared with the same period last year, according to credit-reporting firm Equifax It was also up 11% compared with April 2019, according to Equifax, which measured how often lenders checked consumers’ credit reports to make loan decisions.
  • Lenders are meeting the moment. Equifax said lenders extended a record number of auto loans and leases in March, the latest month for which data are available. They also bumped up credit-card originations, issuing more general-purpose credit cards than any other March on record. Equifax’s data goes back to 2010.
  • With vaccinations readily available in the U.S. and the economy reopening, many Americans are splurgingon cars, vacations and eating out. Higher prices, especially for cars and trucks, have also stoked loan demand.
  • “There’s a significant increase in consumer-credit demand and a growing appetite to use credit on things like those vacations that were postponed for 18 months,” said Tom Aliff, senior vice president of analytics consulting at Equifax.


(Bloomberg)  Oil Prices in Flux While OPEC+ Remains Deadlocked on Supply

  • Oil prices continued to swirl as traders tried to fathom how the clash inside the OPEC+ alliance will play out in global markets.
  • Early in the week, U.S. crude soared to a six-year high near $77 a barrel on fears that OPEC’s failure to agree a production increase would leave markets desperately tight. But the gains soon fizzled on concern that the dispute between Saudi Arabia and the United Arab Emirates could splinter the entire alliance and undo its production cuts agreement.
  • Futures advanced 0.9% on Friday, gaining in tandem with other commodities. Nonetheless, crude is down 2.1% for the week and the main focus for traders in coming days will be whether the Organization of Petroleum Exporting Countries and its partners can repairs its split.
  • Before talks broke down on Monday, Saudi Arabia proposed that the coalition gradually revive the 5.8 million barrels of daily capacity it still has off-line in monthly installments of 400,000 barrels through to the end of next year. But the UAE blocked an agreement, saying it will only support an extension of the pact if there are revisions to its own quota, which the country contends is outdated.
  • The existing OPEC+ agreement states that output remains steady next month. That could cause world markets to tighten sharply, with forecasters such as Goldman Sachs Group Inc. warning the shortfall will amount to several million barrels a day.
  • Yet the longer the dispute goes unresolved, traders are reckoning with another possible outcome: that the UAE follows through on veiled threats to quit OPEC, which could cause the entire alliance to dissolve into a production free-for-all reminiscent of last year’s Saudi-Russia price war.
  • “The OPEC+ impasse could turn sour,” analysts at market intelligence firm Kpler Ltd. said in a report. “While the prospect of a non-agreement sounds like a bullish scenario, the less likely bearish scenario where OPEC+ tumbles and goes back to a free-for-all remains on the table.”
11 Jul 2021
Insight, Investment Grade Quarterly Josh Adams - Portfolio Manager 0 comment

2021 Q2 Investment Grade Quarterly

Investment grade corporate credit experienced positive performance during the quarter with a one-two punch of lower Treasury rates and tighter credit spreads. As a result, investors were able to claw back some of the losses that were incurred during the first quarter of 2021. The option adjusted spread (OAS) on the Bloomberg Barclays US Corporate Bond Index compressed 11 basis points during the quarter, opening at 91 and closing at 80.

Lower Treasury rates benefited returns during the quarter as the 10yr Treasury opened at 1.74%, drifting lower throughout the stanza before finishing at 1.47%. Recall that the 10yr moved 83 basis points higher during the first quarter which was the primary driver of negative performance during that period. The Corporate Index posted a total return of +3.55% during the second quarter. This compares to CAM’s gross quarterly total return of +2.78%. Through the first six months of 2021, the Corporate Index total return was -1.27%, while CAM’s gross year-to-date total return was -0.81%.

Portfolio Management & Positioning

We often find ourselves fielding questions from investors regarding the difference between our portfolio and the investment grade universe so we will walk through and refresh some of the ways that we differentiate. We build our investors highly customized separately managed accounts. Unlike a mutual fund or ETF, our clients know what they own within their portfolios down to the exact issuer and quantity. This is important for the individual investor because of the complete transparency it provides. Each individual account will be built with 20-25 positions. The invest-up period will occur over what we like to refer to as an abbreviated economic cycle, generally a period of 8-10 weeks that allows us to invest over a myriad of rate and spread environments.

Relative to the Bloomberg Barclays Corporate Index, we would best be described as “index aware” rather than looking to track or hug the benchmark. At the end of the day, we aim to provide our investors with a return that is as good or better than the Corporate Index but we would like to get there by taking less credit risk and less interest rate risk while incurring limited volatility along the way.

We manage credit risk through our bottom up research process. We thoroughly study each holding within the portfolio, evaluating individual credit metrics, looking to populate our investor portfolios with stable to improving credits that provide an opportunity to benefit from credit spread compression. Our composite consists of 100 issuers and 340 individual bond issues. The Corporate Index had 6,817 individual issues at the end of the second quarter, 4,290 of which would be classified as intermediate maturities, where we primarily invest. Simply put, we are highly selective while populating our investor portfolios and our research process dismisses a large percentage of the investable universe. We also have some hard and fast rules on the quality of our portfolio, the biggest of which is our 30% limitation to BAA-rated credit. BAA-rated bonds represent the riskier portion of the investment grade universe and the corporate index was 51.4% BAA-rated at the end of the second quarter, leaving CAM with a material underweight in lower quality credit relative to the index. Our up-in-quality bias allows us to target a solid A3 rating for each individual separately managed account.

As far as interest rate risk is concerned, we limit ourselves to intermediate maturities. During the invest-up period, we will populate new portfolios with maturities that range from 8 to 10 years. Then we will take advantage of the steepness of the 5/10 Treasury curve as well as the slope of the intermediate corporate credit curve, allowing those bonds to season, rolling down to the 5 year mark, at which point they will be ripe for sale and opportunistic redeployment of proceeds back into the 8-10 year range. This is one of the reasons we advise our investors to look at our portfolios with a 3-5 year time horizon, at a minimum, if they would like to get the most out of the strategy. As a result of our intermediate positioning, our composite modified duration at the end of the second quarter was 6.4 while the Corporate Index had a modified duration of 8.7.i We wrote at length on curves in our 1st quarter 2021 commentary and would encourage you to revisit if you would like to learn more.

As always, although we are attempting to maximize total return, the primary focus of our strategy is preservation of capital. We are not infallible but rarely will you see us pick up pennies in front of the proverbial steam roller to eke out a few extra basis points of return. Our decision process always comes down to risk and reward and although we will certainly take risks for the right reasons, our investors must be appropriately compensated.

Current Market Conditions

2020 will be a year that was remembered for liquidity runway, something that is not often associated with investment grade rated borrowers. Due to the uncertainty surrounding the depth and severity of the pandemic, we saw issuers rush to the new issue market in 2020 in an effort to bolster their balance sheets. In many cases, these were extremely high quality issuers who did not necessarily need to borrow, but at that time the mentality had become “borrow when you can, not when you have to”. Records for new issuance volume were shattered in 2020 as a result of this borrowing binge and the Corporate Index (excluding Financials) net leverage ratio rose from 2.5x at the end of Q1 2020 to 3.6x at the end of Q4 2020.ii There is evidence that the peak has passed as net leverage has since ticked down to 3.5x at the end of Q1 2021.iii It stands to reason that now, as North American economies are largely re-opened or getting more open by the day, we will continue to see an increase in earnings by those sectors most affected by the pandemic. There is reason to be optimistic about credit conditions as earnings rebound, borrowing abates and debt pay down follows suit. That said there are several risks that continue to loom through 2021 and beyond: lingering worries regarding inflation, Federal Reserve tapering and tight spread valuations amid a backdrop of eager lenders.

The first two risks really go hand in hand –mounting inflationary pressures and the associated FOMC response. It is likely that each of our readers has experienced price increases in one way or another but the Fed insists that much of these will be “transitory” in nature. We tend to agree with the Fed on this one and we revert to the official definition of inflation which is an unrelenting broad-based and sustainable increase in prices across the board. We, like the Fed, would argue that just because the cost of some goods have increased due to things like inventory and production shortages or a disruption of the semiconductor supply chain, it does not mean the table is set for runaway inflation. We believe that as inventory levels are right-sized and household balance sheets deploy excess capital, supply and demand will find equilibrium over time. Additionally, there are still millions of Americans that are unemployed and as federal unemployment assistance reverts to more normalized historical levels it will result in easing price pressures as workers rejoin the labor force. As far as the FOMC response is concerned, the results from the June meeting showed that the median projection is for an unchanged Fed funds rate in 2021 and 2022 with two rate hikes in 2023. While rate hikes are important for the front end of the yield curve, it is tapering that is the more immediate concern, in our view. We argue that technically the Fed has already begun tapering with its exit from the corporate bond market and the sale of its holdings which began in June of this year.iv Its corporate bond holdings, however, were miniscule in the grand scheme of things, at less than $14 billion total. Much larger pieces to this puzzle are its monthly purchases of Treasury securities at $80 billion and mortgage-backed securities at $40 billion. The Fed has yet to supply a timeline of when it will start to normalize its policy, perhaps dialing back on these purchases, but the market is now expecting a possible announcement on tapering at the end of August during the Fed’s Jackson Hole policy symposium. We think that the Fed will continue to be deliberate and cautious in its messaging and that it will be able to avoid a taper-tantrum like event, but we do acknowledge the risks associated with this view.

As far as the credit market goes, we do have some concerns about current valuations in some portions of the market but we also believe spreads can go tighter from here, especially in more non-discretionary sectors. The areas of uneasiness are largely corners of the market that are highly levered to reopening such as automotive, unsecured airlines, leisure, gaming, lodging and restaurants. The bonds of many of these companies are priced to perfection and some of the companies have borrowed to fund their way through the pandemic. It will take time to repair these balance sheets and unless the rosiest of reopening scenarios come to fruition these companies will not be able to remain investment grade rated entities. We are taking little to no exposure for our portfolio in these areas and ironically they have been some of the best performing portions of the bond market year to date. This illustrates our point about lenders and investors that are perhaps too eager to lend to such entities and what we would classify as classic “reach” in the search for yield. We may sacrifice some near term performance by not participating in these riskier areas of the market but we manage the portfolio with an eye on the long term and will continue to do so. While there is a risk that we could be wrong and these sectors will in fact live up to the most optimistic predictions, we remain skeptical.

Halfway Home

We have a sense of guarded optimism as we enter the second half of the year but risks remain. Unfortunately, the pandemic is not over and continues to rage on in some portions of the world. Thankfully, vaccination progress has the potential to achieve global normalization over the course of the next year, but variants and vaccine-resistant strains could threaten this timeline. The FOMC will remain in the spotlight as it attempts to manage investor expectations and craft its moves carefully. We at CAM plan to stick to the script. We will not be making wholesale changes to our strategy and we will likely be taking less risk than usual in the coming months given the current risk reward backdrop we are seeing in our market. Please reach out to us with any questions or concerns. We thank you for your continued interest and for placing your trust and confidence in us to manage your money.

This information is intended solely to report on investment strategies identified by Cincinnati Asset Management. Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. This material is not intended as an offer or solicitation to buy, hold or sell any financial instrument. Fixed income securities may be sensitive to prevailing interest rates. When rates rise the value generally declines. Past performance is not a guarantee of future results. Gross of advisory fee performance does not reflect the deduction of investment advisory fees. Our advisory fees are disclosed in Form ADV Part 2A. Accounts managed through brokerage firm programs usually will include additional fees. Returns are calculated monthly in U.S. dollars and include reinvestment of dividends and interest. The index is unmanaged and does not take into account fees, expenses, and transaction costs. It is shown for comparative purposes and is based on information generally available to the public from sources believed to be reliable. No representation is made to its accuracy or completeness.

i A representative sample of a newly invested individual separately managed account had a modified duration of 8.4 at 06/30/2021
ii Barclays, June 23 2021 “US Investment Grade Credit Metrics Q1 21 Update”
iii Barclays, June 23 2021 “US Investment Grade Credit Metrics Q1 21 Update”
iv Reuters, June 2 2021 “NY Fed says it will begin to sell corporate bond ETFs on June 7”

11 Jul 2021
High Yield Quarterly, Insight Rich Balestra - Portfolio Manager 0 comment

2021 Q2 High Yield Quarterly

In the second quarter of 2021, the Bloomberg Barclays US Corporate High Yield Index (“Index”) return was 2.74% bringing the year to date (“YTD”) return to 3.62%. The CAM High Yield Composite gross total return was 2.61% bringing the YTD return to 2.59%.

The S&P 500 stock index return was 8.55% (including dividends reinvested) for Q2, and the YTD return stands at 15.24%. The 10 year US Treasury rate (“10 year”) had a steady downward move as the rate finished at 1.47%, down 0.27% from the beginning of the quarter. Over the period, the Index option adjusted spread (“OAS”) tightened 42 basis points moving from 310 basis points to 268 basis points. Each quality segment of the High Yield Market participated in the spread tightening as BB rated securities tightened 27 basis points, B rated securities tightened 40 basis points, and CCC rated securities tightened 86 basis points. Take a look at the chart below from Bloomberg to see a visual of the spread moves in the Index over the past five years. The graph illustrates the speed of the spread move in both directions during 2020 and the continuation of lower spreads in 2021. The 268 OAS is the lowest since the record low of 233 OAS back in 2007.

The Energy, Basic Industry, and Transportation sectors were the best performers during the quarter, posting returns of 6.13%, 2.78%, and 2.69%, respectively. On the other hand, Utilities, Communications, and Capital Goods were the worst performing sectors, posting returns of 1.38%, 1.89%, and 2.00%, respectively. Clearly the market was strong as no sector posted a negative return in the period. At the industry level, oil field services, independent energy, midstream, and life insurance all posted the best returns. The oil field services industry posted the highest return (11.34%). The lowest performing industries during the quarter were pharma, tobacco, refining, and utilities. The pharmaceuticals industry posted the lowest return (-0.93%).

The energy sector performance has remained strong through June in part due to the strengthening economy and very warm temperatures throughout the country. As can be seen in the chart to the left, the price of crude has continued its upward trajectory during the quarter. OPEC+ members recently met to discuss increasing oil production. The early reports were that Saudi Arabia and Russia had a deal but UAE took issue with individual production baselines. As we go to print, it appears that no agreements have been reached, and the group did not set a date for a follow-up meeting.

During the second quarter, the high yield primary market continued its record pace and posted $155.0 billion in issuance. Many companies continued to take advantage of the open new issue market that is offering very attractive financing. In June, a new record low coupon was set at 2.45% in the 7+ year maturity category.i Consumer Discretionary issuance continued to be very strong with approximately 26% of the total during the quarter. Communications and Financials tied for the next largest issuance each accounting for approximately 16% more of the total new paper placed in the market.

The Federal Reserve maintained the Target Rate to an upper bound of 0.25% at both the April and June meetings. The June meeting was held several days after an inflation report showed the largest year over year increase since 2008. Interestingly, approximately one third of the inflation jump was due to the increasing price of used cars and trucks.ii While economic activity has rebounded and inflation is running hot, the Fed maintained their position that the price increases are likely to be transitory in nature. Therefore, their accommodative stance remains, but they are beginning to shift the target rate forecast while maintaining communication with market participants. Federal Reserve Chair Jerome Powell said “you can think about this meeting that we had as the ‘talking about talking about tapering,’ if you like.”iii The attached chart shows the Fed’s changing forecast of the target rate.

Intermediate Treasuries decreased 27 basis points over the quarter, as the 10-year Treasury yield was at 1.74% on March 31st, and 1.47% at the end of the second quarter. The 5-year Treasury decreased 5 basis points over the quarter, moving from 0.94% on March 31st, to 0.89% at the end of the second quarter. Intermediate term yields more often reflect GDP and expectations for future economic growth and inflation rather than actions taken by the FOMC to adjust the Target Rate. The revised first quarter GDP print was 6.4% (quarter over quarter annualized rate). Looking forward, the current consensus view of economists suggests a GDP for 2021 around 6.6% with inflation expectations around 3.5%.iv

Being a more conservative asset manager, Cincinnati Asset Management Inc. does not buy CCC and lower rated securities. This policy generally served our clients well in 2020. However, the lowest rated segment of the market outperformed again in the second quarter of 2021. Thus, our higher quality orientation was not optimal during the period. As a result and noted above, our High Yield Composite gross total return did underperform the Index over the second quarter measurement period. With the market staying strong during the second quarter, our cash position remained a drag on overall performance. Additionally, our lack of exposure to the oil field services industry, which is rated very low in credit quality, was a drag on performance. Benefiting our performance was our underweight in the communications and pharma sectors. Further, our credit selections within the consumer cyclicals and consumer non-cyclicals sectors were a positive.

The Bloomberg Barclays US Corporate High Yield Index ended the second quarter with a record low yield of 3.75%. The market yield is an average that is barbelled by the CCC-rated cohort yielding 5.65% and a BB rated slice yielding 3.04%. Equity volatility, as measured by the Chicago Board Options Exchange Volatility Index (“VIX”), had an average of 18 over the quarter. For context, the average was 15 over the course of 2019 and 29 for 2020. The second quarter had only 3 bond issuers default on their debt. The trailing twelve month default rate was 1.63% with the energy sector accounting for a large amount of the default volume. Excluding the energy sector from the calculation drops the trailing twelve month default rate to 0.92%.v The current 1.63% default rate is relative to the 6.19%, 5.80%, 6.17%, 4.80% default rates for the second, third, fourth quarters of 2020, and the first quarter of 2021 respectively. Pre-Covid, fundamentals of high yield companies had been mostly good and with the continued strong new issuance, companies have been doing all they can to bolster their balance sheets and take advantage of the exceptional financing currently available. From a technical view, fund flows were positive in April, negative in May, roughly flat in June, and the year-to-date outflow stands at $7.1 billion.vi In spite of this outflow, a strong bid remains in the market for high yield paper, and the declining default rate is keeping a risk on attitude in place for market participants. We are of the belief that for clients that have an investment horizon over a complete market cycle, high yield deserves to be considered as part of the portfolio allocation.

The actions last year by the Treasury and the Federal Reserve helped to put in a bottom and allow the capital markets to function amid the Covid pandemic. Against this backstop, the market has recovered, the economy is booming, and inflation is escalating. There is a trillion dollar plus bipartisan infrastructure framework that is being worked out in Congress to provide even more juice. Things are good and the administration has been clear in their intent to increase taxes as a way to try and help offset all of the spending. Tax reform is also a global issue as the G7 finance ministers are looking to implement a global minimum tax on companies. Also, it appears likely that the G20 finance ministers will support the effort at an upcoming meeting. The vaccine rollout continues and according to the CDC, 55% of the US population has received at least one shot. This is up from 32% at the time of our last commentary. There is certainly a lot going on as we move into the second half of 2021. Clearly, it is important that we exercise discipline and selectivity in our credit choices moving forward. We are very much on the lookout for any pitfalls as well as opportunities for our clients. We will continue to carefully monitor the market to evaluate that the given compensation for the perceived level of risk remains appropriate on a security by security basis. As always, we will continue our search for value and adjust positions as we uncover compelling situations. Finally, we are very grateful for the trust placed in our team to manage your capital through such a historic time.

This information is intended solely to report on investment strategies identified by Cincinnati Asset Management. Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. This material is not intended as an offer or solicitation to buy, hold or sell any financial instrument. Fixed income securities may be sensitive to prevailing interest rates. When rates rise the value generally declines. Past performance is not a guarantee of future results. Gross of advisory fee performance does not reflect the deduction of investment advisory fees. Our advisory fees are disclosed in Form ADV Part 2A. Accounts managed through brokerage firm programs usually will include additional fees. Returns are calculated monthly in U.S. dollars and include reinvestment of dividends and interest. The index is unmanaged and does not take into account fees, expenses, and transaction costs. It is shown for comparative purposes and is based on information generally available to the public from sources believed to be reliable. No representation is made to its accuracy or completeness.

i Bloomberg June 25, 2021: US Junk Bond Coupon Sets Record Low
ii The Wall Street Journal June 10, 2021: US Inflation is Highest in 13 Years
iii The Wall Street Journal June 16, 2021: Fed Pencils In Earlier Interest-Rate Increase
iv Bloomberg July 1, 2021: Economic Forecasts (ECFC)
v JP Morgan April 1,, 2021: “Default Monitor”
vi Wells Fargo July 1, 2021: “Credit Flows”

02 Jul 2021
High Yield Weekly Rich Balestra - Portfolio Manager 0 comment

CAM High Yield Weekly Insights

Fund Flows & Issuance:  According to a Wells Fargo report, flows week to date were $0.7 billion and year to date flows stand at -$7.1 billion.  New issuance for the week was $7.2 billion and year to date issuance is at $286.0 billion.

 

 

(Bloomberg)  High Yield Market Highlights

 

  • The U.S. junk-bond market’s riskiest slice of debt saw yields plunge to the lowest level on record Thursday as a fierce rally continued to roar full steam ahead across the high-yield ratings spectrum. CCC yields fell to 5.60% while spreads tightened to +456bps.
  • Broader index yields dropped to 3.72% to reach a new low for the fifth time in about five months, while spreads rallied to +265bps, the lowest since June 21, 2007
  • Single B yields closed at 4.04%, also a record, while spreads were +292bps, the tightest in about 14 years
  • The primary market is expected to be quiet Friday as borrowers wait to strike until after the Fourth of July weekend
  • Retail investor confidence was evident in fund-flow data as there was an inflow of $700mm for the week, which was the biggest influx since April
  • S. equity futures have climbed ahead of key jobs data while oil was steady after infighting within OPEC+ delayed a decision on raising output levels

 

02 Jul 2021
Investment Grade Weekly Josh Adams - Portfolio Manager 0 comment

CAM Investment Grade Weekly Insights

Spreads continued to trade sideways this week, having exhibited little change, though the index itself did hit a new mark for its tightest level of the year when it closed Wednesday at a spread of 80.  The OAS on the Blomberg Barclays Corporate Index closed Thursday July 1 at a spread of 81 after having closed at the same level the week prior.  The 10yr Treasury traded slightly lower throughout the week and a payroll report on Friday that modestly beat expectations did nothing to change the direction of that trade.   Through Thursday, the Corporate Index had posted a year-to-date total return of -1.34% and an excess return over the same time period of +1.97%.

New issuance volume was light during the week which was expected given the timing of quarter end and the 4th of July holiday.  $11.9bln of new debt was priced during the week, with the bulk of that consisting of an outsize $8bln print by Salesforce.  According to data compiled by Bloomberg, $790bln of new debt has been issued year-to-date.   Consensus estimates are looking for $15-20bln of issuance next week, which will consist of only 4 trading days.

Per data compiled by Wells Fargo, inflows into investment grade credit for the week of June 24–30 were +$3.5bln which brings the year-to-date total to +$208bln.

Have a safe and enjoyable 4th of July.

 

 

 

18 Jun 2021
Investment Grade Weekly Josh Adams - Portfolio Manager 0 comment

CAM Investment Grade Weekly Insights

Spreads touched their narrowest levels of the year this week but are slightly wider off those tights as we go to print this Friday morning.  The OAS on the Blomberg Barclays Corporate Index closed Thursday at 82, after closing the previous week at 84.  Spreads have traded in a 5 basis point range over the course of the past four weeks.  The FOMC took center stage with its meeting and commentary on Wednesday, and while most investors would agree that the Fed was more hawkish this week than it has been recently, it had little effect on Treasuries, with the biggest story being lower rates on the long end and flatter curves.  The 10yr Treasury remains wrapped around 1.46%, nearly 30 basis points lower than the highs we saw at the end of March.   Through Thursday, the Corporate Index had posted a year-to-date total return of -1.74% and an excess return over the same time period of +1.88%.

 

 

The amount of new issuance in recent weeks has been solid by historical standards but demand has been strong and frankly the market could use some more issuance to restore some two-way flow to its price action.  $22bln of new debt priced during the week  according to data compiled by Bloomberg and more than  $757bln of new debt has been issued year-to-date.

Per data compiled by Wells Fargo, inflows into investment grade credit for the week of June 10–16 were +$10bln which brings the year-to-date total to +$203bln.  According to Wells data compilation, this was the largest inflow into IG funds since September.

 

 

18 Jun 2021
High Yield Weekly Rich Balestra - Portfolio Manager 0 comment

CAM High Yield Weekly Insights

Fund Flows & Issuance:  According to a Wells Fargo report, flows week to date were -$0.9 billion and year to date flows stand at -$8.9 billion.  New issuance for the week was $13.5 billion and year to date issuance is at $274.2 billion. 

(Bloomberg)  High Yield Market Highlights 

  • U.S. junk bonds remained relatively steady Thursday amid a retreat in the reflation trade that has dominated markets for the majority of this year. The broader high-yield index is poised to see a modest weekly loss of 0.03% — its first decline in four weeks — as investors also weigh the Federal Reserve’s signals that it’s ready to withdraw stimulus.
  • The index posted a small loss of 0.07% for the second consecutive session while yields rose 5bps to close at 3.94%
  • The primary market was quiet Thursday amid the market reordering, which has seen commodities dip for five-straight sessions and Brent crude slip from this week’s 2018 high
  • Borrowers are expected to remain in wait-and-see mode and issuance is likely to be subdued ahead of the weekend.
  • Equity futures are mixed this morning Oil, meanwhile, also extended its decline, with prices falling below $71 a barrel as fears of earlier than expected rate hike derailed bets on commodities


(Wall Street Journal)  Fed Pencils In Earlier Interest-Rate Increase 

  • Federal Reserve officials signaled they expect to raise interest rates by late 2023, sooner than they anticipated in March, as the economy recovers rapidly from the effects of the pandemic and inflation heats up.
  • Their median projection showed they anticipate lifting their benchmark rate to 0.6% from near zero by the end of 2023. In March they had expected to hold it steady through that year.
  • Fed officials also discussed an eventual reduction, or tapering, of the central bank’s bond-buying program, Chairman Jerome Powell said at a press conference after the central bank’s two-day policy meeting. The timing of such a move remains uncertain, he added.
  • Prompting the policy shift is a much stronger economic rebound and hotter inflation than the Fed anticipated just a few months ago.
  • “Progress on vaccinations has reduced the spread of Covid-19 in the United States,” the Fed said in a statement following the meeting. “Amid this progress and strong policy support, indicators of economic activity and employment have strengthened.”
  • In updated projections released Wednesday, 13 of 18 officials indicated they expect to lift short-term rates by the end of 2023, up from seven who expected that outcome in March. In March, most of them anticipated holding rates steady through 2023.
  • The Fed has its benchmark federal-funds rate steady since March 2020, when the effects of the pandemic caused the sharpest economic contraction in generations. The central bank also has been purchasing at least $120 billion a month of Treasury and mortgage bonds since June 2020 to hold down longer-term borrowing costs, providing further support to the recovery.
  • The Fed reiterated that it expects to continue bond purchases until “substantial further progress” has been made in the recovery, counting from December 2020.
  • Fed officials want the economy to get closer to their goals of “maximum employment” and sustained 2% inflation before reducing the bond purchases. They have said they want to fully achieve those objectives before they raise interest rates.
  • “Honestly the main message I would take away from the [forecasts] is that participants—many participants—are more comfortable that the economic conditions in the committee’s forward guidance could be met somewhat sooner than anticipated,” Mr. Powell said. “That would be a welcome development.”
  • He said meeting the standard for reducing bond purchases remains “a ways away.” But he added that the economy is making progress toward the Fed’s goals and that policy makers will be assessing the appropriate time to begin scaling back the purchases at coming meetings.
  • “You can think about this meeting that we had as the ‘talking about talking about tapering,’ if you like,” Mr. Powell said.
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