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The Markets – November 2016

Cash Review & Outlook

  • While the 30-day A1/P1 rated US commercial paper widened 5 basis points to close out October at 0.59% (average yield at maturity), the 30-day moving average actually tightened 2 basis points to 0.52%.
  • The October 14th deadline for money market reform came and went, and the exodus from prime and municipal/tax-exempt money market funds to US government money market funds brought with it opportunity for us and other short duration and liquid strategy funds.
  • We reinvested roughly 15.0% of maturities within the portfolio into very high quality, liquid, variable rate demand notes (VRDN’s) at spreads of 30-50 basis points wide of equivalent A1+/P1 rated commercial paper.
  • The VRDN’s we purchased are highly liquid due to the buyer’s right to “put” the issue back on a daily or weekly basis. They are high quality given that they are backed by the underlying credit quality of the borrower, as well as through credit enhancement such as letters of credit or stand-by bond purchase agreements.
  • While the basis between VRDN’s and commercial paper have already compressed, we will continue to maintain an allocation to the sector until the relative value goes away.

Investment Grade Bonds Review & Outlook

  • The credit index performed well in October, tightening 0.05% and providing 0.47% in excess returns. The total return of the credit index for the month, however, was -1.16% as U.S. Treasuries sold off. Year to date total returns for the credit index declined to 6.87%, while excess returns improved to 3.33%.
  • A Treasury sell-off and subsequent higher yields inspired buyers in the credit market despite an active primary market with just over $100 billion in origination relative to $113 billion last year. Year to date, new supply has nearly reached $1.1 trillion easily surpassing last year’s total and most forecasts.
  • Roughly half of the S&P 500 has reported 3-quarter 2016 earnings, and results have been relatively benign with respect to credit. Although, expectations are relatively low. M&A activity has picked up on the heels of earnings results and looks to be active as we go into year-end, potentially creating a supply backlog for 2017.
  • The structured product sector outperformed U.S. Treasury hedges for the month of October by 2 basis points.
  • While unable to escape the negative price action in the bond market, overall, investors put money to work in structured product, adding incremental yield in the face of healthy supply throughout October.
  • We continue to favor shorter duration, high quality assets in the ABS and CMBS space where we are able to add additional potential return without taking on undue risk as we head into an election, uncertain timing of Federal Reserve rate moves, and new risk retention rules set to take effect in 2017.

High Yield Bonds Review & Outlook

  • The BofA Merrill Lynch High Yield Cash Pay Index returned 0.30% in the month of October, bringing the year-to-date return of the Index to 15.55%.
  • The high yield market outperformed investment grade bonds amid rising rates with the 10-year yield rising 26 basis points.
  • U.S. Treasury yields rose in October amid concerns about low government rates globally.
  • We realized profits on certain defense and construction positions and took advantage of some opportunities in the new issue market.

Equity Review & Outlook

  • Equity markets fell in October and broke a string of 7 consecutive monthly gains. The S&P 500, DOW, and Nasdaq all fell during the month of October, down 1.82%, 0.79%, and 2.25% respectively.
  • U.S. equities rallied to mid-month highs and then steadily declined into month end.
  • In contrast, International markets performed well with Europe, China and Japan gaining 1.90%, 3.19% and 5.93%, respectively.
  • Sector rotation played a role this month with the meaningful capital flows from safe-haven (bond proxy), dividend paying sectors- utilities, telecoms, REITS and consumer staples.
  • Market-moving news was more muted in October, with third quarter corporate earnings taking center stage.
  • Earnings results have been better than expected but are confirming growth is slowing as 2017 guidance is below 2016 estimates.
  • The presidential election is weighing on investor sentiment, as well as which party will control the House and the Senate.
  • Oil prices fell 4.0% during the month and pressured energy company shares to the downside.

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