Philosophically speaking, certainty is generally viewed with a jaundiced eye. Friedrich Nietzche stated, “Madness is the result not of uncertainty but of certainty.” The famed poet and prosaist, Oliver Wendell Holmes, declared “The longing for certainty… is in every human mind. But certainty is an illusion.” However illusory certainty may be in our collective lives, its value in the context of financial markets and asset prices cannot be overstated. Uncertainty seems to presently weigh heavily on the collective psyche of the investor community and on a global scale.
This will be our last Market Commentary prior to election day on November 3rd. Most obviously, the White House is in play, but so is the U.S. Senate, perhaps the U.S. House and one fifth of the gubernatorial offices across the country. Based on nearly every public opinion poll and voter data surrounding these elections, the future of federal policy across numerous sectors of the U.S. economy is opaque at best, and at worst, subject to highly divergent outcomes.
All of this is set against the backdrop of a resurgent COVID-19 across the globe. The medical community has clearly learned more about COVID-19 than was known at its early onset, and treatments have been effective in diminishing the severity of symptoms, duration of infection and length of hospitalizations. Nonetheless, the increases across the world’s major economies are troubling.
European infection rates have soared recently, with nearly half of the world’s new daily reported coronavirus cases coming from the continent. In response, most all EU countries have re-imposed or are considering restrictions of various degrees. Just this week, Germany announced they will close bars and restaurants (as well as other nonessential businesses) and impose additional restrictions for at least one month. French officials announced a more severe set of restrictions on Wednesday, October 25, closing all nonessential businesses, banning public gatherings, moving universities to online-only formats, and limiting movement outside the home for all individuals. British officials are also considering re-implementation of personal and business restrictions.
America has similarly been subject to this “second wave” as case counts have increased across the country, most acutely in some areas that did not previously share the more severe experiences of larger cities and metropolitan areas. Hospitalizations have increased over 40% across the country and twenty-six states are at or near record infection rates. While the escalation in infection rates was not initially accompanied by increases in death rates, the trend has begun moving in the other direction day-by-day. Although increases in testing can undoubtedly be attributed to new positive cases, the rise in hospitalizations and death rates is worrisome, to say the least. Governors in several states have recently reinstated postures enacted under emergency orders during the late Spring and early Summer of this year, restricting business and personal activities.
Global financial markets have taken notice. Equity indices have seen some of their largest declines in months. Many European indices have fallen to their lowest levels since May. On Wednesday, October 28, the S&P 500 fell over 3.50%, its biggest one-day drop since the middle of June and its third in as many days. While market participants seemed frustrated by the lack of agreement and action on another federal stimulus package, the impacts of the pandemic have clearly become the primary focus of investors.
Economy and Interest Rates
The U.S. economy has been showing signs of positivity in a number of key areas, with some metrics outpacing consensus estimates. There are, undoubtedly, certain sectors demonstrating stronger performance than others since the near total lockdowns in March and April across vast swaths of the United States (and other parts of the world, of course). Labor markets have improved with both initial and continuing jobless claims declining over consecutive weeks and months (depending on the frequency of data), along with the unemployment rate. The housing market has also been resilient, with existing home sales, building permits and housing starts all reporting better than expected data. Durable goods orders for September were reported on October 27, showing 1.9% growth – the fifth consecutive month of growth – and beating the median forecast of -0.2% and the prior month’s growth of 0.4%.
Preliminary 3rd quarter GDP was reported on Thursday, October 29 at an annualized rate of 33.1%. We emphasize annualized versus year-over-year. However, this can be compared against the second quarter’s nearly record decline of 32%. Notably, consumer spending increased at an annualized rate of 40.7% and investment in business equipment improved 70% on an annualized basis. Building of inventory increased $286 billion in the third quarter, contributing meaningfully to the large annualized growth rate.
The Atlanta Federal Reserve prepares a GDP growth forecast dubbed “GDPNow” that uses a series of leading economic indicators. GDPNow has fairly succinctly forecasted the most recent print for 3rd quarter GDP. The graph below shows the forecast as of October 27, along with the component units underlying the forecast. Net exports are the only component currently reducing the forecast with a negative contribution.
It could be argued improving economic conditions have contributed to recent increases in interest rates, however, with the prominence of increased COVID cases globally and decline in stocks across the world’s largest economies, rates have declined this last week across the entirety of the interest rate curve, most acutely at intermediate and long-term maturities. The chart below shows benchmark constant maturity rates for U.S. treasuries at two, five, ten and thirty years. The gaps are days the bond market has been closed.
The 10-year U.S. treasury is down from its recent high of 0.86% to 0.77% as of the publishing of this Market Commentary. These yield levels should be viewed in the context of global sovereign yields. In Britain, the 10-year “Gilt” yields just over 0.20% and the German 10-year “Bund” is near its record low at -0.63%. Clearly U.S. treasuries represent value when compared against global counterparts in developed economies.
The municipal market has experienced tremendous supply during the month of October. Preliminary estimates of new issue volume for the month are approaching $60 billion. The primary issue calendar for the week of October 26 is slated for nearly $16 billion, with about $6 billion of that taxable obligations. The average weekly new issue volume for 2020 has been roughly $6.2 billion, although the market was effectively “closed” for a few weeks in March, with very light new issue activity. Taxable municipal issuance for calendar year 2020 is estimated to comprise about a third of the total market. The dramatic increase in taxable issuance is unlikely to change as look forward to 2021, barring changes in tax law at the federal level to again allow for tax-exempt advance refundings.
Treasuries have generally outperformed municipals the last couple of weeks, with the ratio of tax-exempt munis to taxable treasuries increasing to over 120%, its highest level in some time. Benchmark ten-year AAA tax exempt yields are currently around 0.95%, essentially flat with the beginning of October and up marginally over the end of the prior quarter.
Based on results of competitive sales during the last two weeks, it would seem the bank qualified market is experiencing stronger demand than the non-bank qualified space based on the number of bids on these sales. All transactions are pricing well, but BQ sales are receiving a larger number of bids per sale, with winning bids sometimes strongly through the cover (second) bid. The demand for BQ bonds seems to be corroborated by the current level of bank deposits across all commercial banks, which is at its highest figure on record.
Ehlers Municipal Advisors can assist you in evaluating the advisability of taking advantage of issuing tax-exempt debt within bank qualified limitations, which can include two or more transactions over multiple calendar years for the same project. Similarly, we regularly review the economics of refunding prior obligations through a taxable advance refunding, forward delivery of tax-exempt obligations, or waiting until a current refunding can be achieved in a standard fashion.
The month of October witnessed a modest steepening of the treasury yield curve, as intermediate and long-term treasury yields generally trended higher, although yields fell with weakness in equity markets the final week of the month. The 10-year Treasury yield vacillated in a roughly 15 basis point range during the month from 0.69% to 0.86%, while the short end of the interest rate curve saw much less volatility. The 1-year Treasury remained firm around 0.12%, performing as expected given the Federal Reserve’s Federal Open Market Committee’s (FOMC) unwavering stance on the fed funds rate.
A steeper yield curve presents opportunities for investors as there is incremental return to be gained by moving out in term on the maturity spectrum. For instance, the 3-year Treasury yields 0.18%, representing a 50% yield pickup when compared to the 1-year Treasury. Extending the weighted average maturity of a portfolio can be accomplished several ways and should be built on the foundation of a confident liquidity profile through cash forecasting.
Additionally, purchasing alternatives to traditional investments like U.S. treasuries, agencies and FDIC-insured brokered CDs can prove valuable, although expanding your investable universe may require a modest of education on such products and potentially amending your investment policy. Ehlers is happy to assist our clients in both regards.
Following the FOMC’s October meeting, Fed officials stated that the outlook has mildly improved while great risks remain. They stated that their projections for the fed funds policy rate (near zero until 2023) were “most likely to be consistent” with the Fed’s goals, while reassuring that “the appropriate rate path would depend on the evolution of the economic outlook.”
We continue to focus on safety of your principal, liquidity needs through asset allocation strategies, and an eye towards a competitive rate of return.
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