(The following commentary is a summary of discussions among members of the Breckinridge Capital Advisors Investment Committee as they reviewed monthly activity in the markets and investment returns. The members of the Investment Committee under the leadership of Chief Investment Officer Ognjen Sosa, CAIA, FRM, are Co-Head of Portfolio Management, Matthew Buscone; Head of Municipal Trading, Sara Chanda; Co-Head of Research, Nicholas Elfner; Co-Head of Portfolio Management, Jeffrey Glenn, CFA; and Co-Head of Research, Adam Stern, JD.)

Market Review

Prices for stocks and bonds reversed course from July, falling during August amid higher market volatility. As the month closed, volatility retreated and equity and fixed income performance improved.

Based on Bloomberg (BBG) data, Treasury yields began to move higher when Fitch Ratings downgraded U.S. sovereign debt on August 1. The U.S. Department of the Treasury said that it would increase longer-term debt issuance through the end of the year, bringing renewed attention to increasing fiscal deficits. Uneasiness appeared to increase as inflation remained above target and the economy expanded. Investors feared the Federal Reserve (Fed) would keep the federal funds rate higher for longer.

During the last week of August, a combination of a lower consumer confidence reading from the Conference Board, signs of easing labor pressures in Bureau of Labor Statistics data, and a Bureau of Economic Analysis adjustment downward in second quarter gross domestic product (GDP) that exceeded expectations suggested to some that the Fed might have more flexibility on rates. Bond market volatility fell, as measured by the Bank of America Merrill Lynch (BofA/ML) MOVE Index¹ (See Figure 2). Weaker manufacturing surveys from Europe and a slowdown in Chinese growth also provided some relief for Treasury yields towards month end.

BBG data showed yields for Treasury bonds with maturities three years and longer increased during August. The 2-year Treasury yield fell 1 basis point (bp), while 3-, 5-, 10-, and 30-year maturities were higher by 3, 8, 15, and 20bps, respectively.

As during the prior month, BBG data showed the most significant increases were in the intermediate and long ends of the curve, helping to lessen a yield curve inversion, which continued to cloud the outlook. The yield gap between 2-year Treasuries and those with 10- and 30-year maturities each narrowed.

The BBG U.S. Treasury Bond Index² fell 0.52 percent. The BBG U.S. Aggregate Bond Index³ lost 0.64 percent.

The Fed will meet beginning September 20 to consider its next step. In our view, the Fed likely will hold rates steady in September. An updated Summary of Economic Projections will provide additional data for assessment before the Fed meets again in November.

Municipal Market Review 

Municipal bond yields closed higher on the month, to reach year-to-date highs across the curve, most notably in 10- and 30-years, both up nearly 40bps (See Figure 3).

Municipal yields gained more than Treasuries, underperforming for the month, per BBG data. Longer segments of the yield curves steepened over the month. Front-end curves remain inverted but the curve between 5-year and 10-year bonds turned positive, offering some better relative value.

Municipal/Treasury (M/T) yield ratios were range-bound most of the month, but the 10-year pushed six ratios higher closing above 70 percent (See Figure 4).

The BBG Managed Money Short/Intermediate (1-10) Index⁴ fell 1.06 percent and the BBG 1-10 Year Municipal Bond Blended Index⁵ was 0.77 percent lower. Higher-quality bonds outperformed lower-rated bonds, with bonds rated AAA faring best. Shorter maturity bonds outperformed longer-date issues.

The Bond Buyer reported that total issuance for August was about $36 billion. While issuance was almost 34 percent higher than the prior month percent, it was 13 percent lower than in August last year. 

Total year-to-date (YTD) issuance was 15 percent lower through August than in 2022, at about $245 billion. For the month, tax-exempt municipal bond issuance increased by about 8 percent year-over-year (Y/Y), while remaining about 7 percent lower YTD than during the same 8-month period in 2022. Taxable municipal bond issuance was $2.5 billion in August, and was approximately 42 percent lower through August YTD than the prior year. 

Outflows from municipal bond funds slowed once again in August, as reported by Lipper/Refinitiv falling to about $111 million YTD by month end.

Heading into September, we expect a more challenging technical environment.

Corporate Market Review

Investment grade (IG) corporate bond spreads widened by 5bps, per BBG data, to close August at an option-adjusted spread of 118bps. Lower-quality bonds outperformed higher-quality corporates on a total return basis, while higher-rated bonds slightly outperformed lower-rated issues on an excess return basis. Shorter-maturity bonds outperformed longer maturities on a total return basis, while longer-maturity bonds tended to have the best excess returns.

For the period ended August 31, the BBG U.S. Corporate Investment Grade (IG) Index⁶ marked a monthly total return that was lower by 0.78 percent and an excess return compared with duration-matched Treasuries that was lower by 0.08 percent. Per BBG, the best-performing sectors and subsectors were Cable/Satellite, Media/Entertainment, Oil Field Services, P&C Insurance, Railroads, and Real Estate Investment Trusts (REITs). Among the worst-performing sectors and subsectors were Automotive, Banking, Gaming, Lodging, Metals and Mining, Supermarkets, and Tobacco.

FactSet reported on the second quarter corporate earnings season in late August, noting that 79 percent of Standard & Poor’s 500 Index⁷ companies reported earnings per share (EPS) above their estimated EPS, which exceeds the five-year average of 77 percent. While, overall, S&P 500 Index companies reported a 4.1 percent decline in earnings for the quarter—the third straight quarterly earnings decline—the Consumer Discretionary sector reported earnings growth of 54 percent, the best earnings growth result among all 11 market sectors.

Investment grade corporate bond supply for August was about $74 billion, BBG reported. About $4 billion in assets flowed out of IG bond mutual funds in August, per Lipper.

Securitized Market Review

ABS earned positive excess returns, with the auto loan segment earning the best returns among securitized sectors. Credit card loan ABS and Non-Agency Commercial Mortgage-Backed Securities (CMBS) also earned positive total and excess returns.

While overall MBS returns were negative for the month, the higher-coupon (5 percent to 6 percent) conventional¹¹ and Ginnie Mae¹² securities delivered the best relative returns. 

Equity Market Review 

The S&P 500 Index declined 1.59 percent on the month, the Russell 1000 Value Index¹³ fell 2.69 percent, and the Russell 1000 Growth Index¹⁴ dropped 0.91 percent. Beyond the U.S. debt downgrade by Fitch as well as inflation and interest rate concerns, analysts noted bearish influences such as tightening of bank lending standards and softening loan demand, a looming potential United Auto Workers strike, as well as high mortgage rates and low home purchase applications.

Positive developments included continued disinflation traction and soft-landing expectations for the economy. In addition, an earnings season that beat consensus expectations helped, according to FactSet.

After spiking early in August, the Chicago Board Options Exchange (BoE) Volatility Index¹⁵ (VIX) returned to low levels seen during July (See Figure 5).

S&P 500 sector performance was led by Energy (1.3 percent total return in August), the only positive return among the 11 sectors during August. Communication Services (-0.4 percent), and Health Care (-0.8 percent) fell least, while Utilities (-6.7 percent), Consumer Staples (-3.8 percent), and Materials (-3.5 percent) fell the most. 

[1] The Bank of America Merrill Lynch MOVE Index measures U.S. interest rate volatility by tracking the movement in U.S. Treasury yield volatility implied by current prices of one-month over-the-counter options on 2-year, 5-year, 10-year and 30-year Treasuries. Historically, the index rises as concerns grow that interest rates are moving higher. You cannot invest directly in an index.

[2] The Bloomberg U.S. Treasury Bond Index is an unmanaged index of prices of U.S. Treasury bonds with maturities of 1 to 30 years. You cannot invest directly in an index.

[3] The Bloomberg U.S. Aggregate Bond Index is a broad-based benchmark that measures the investment-grade, U.S.-dollar-denominated, fixed-rate taxable bond market, including Treasuries, government-related and corporate securities, mortgage-backed securities (agency fixed-rate and hybrid adjustable-rate mortgage pass-throughs), asset-backed securities, and commercial mortgage-backed securities. You cannot invest directly in an index.

[4] The Bloomberg Municipal Managed Money Short/Intermediate Index measures the performance of the publicly traded municipal bonds that cover the USD-denominated short/intermediate term tax-exempt bond market, including state and local general obligation bonds, revenue bonds, insured bonds, and pre-refunded bonds. It is rules-based, and market-value weighted. You cannot invest directly in an index.

[5] The Bloomberg Municipal 1-10 Year Blend 1-12 Year Index measures the performance of short and intermediate components of the Municipal Bond Index — an unmanaged, market value-weighted index which covers the U.S. investment grade, tax-exempt bond market. You cannot invest directly in an index.

[6] The Bloomberg U.S. Corporate Bond Index is an unmanaged market-value-weighted index of investment-grade corporate fixed-rate debt issues with maturities of one year or more. You cannot invest directly in an index.

[7] The S&P 500 Index consists of 500 stocks chosen for market size, liquidity, and industry group representation. It is a market-value-weighted index with each stock’s weight in the index proportionate to its market value. You cannot invest directly in an index.

[8] The Bloomberg MBS Index tracks agency mortgage-backed pass-through securities (both fixed-rate and hybrid ARM) guaranteed by government-sponsored enterprises (GSEs) Government National Mortgage Association (Ginnie Mae) (GNMA), Federal National Mortgage Association (Fannie Mae) (FNMA), and Federal Home Loan Mortgage Corporation (Freddie Mac) (FHLMC). The index is constructed by grouping individual pools into aggregates or generics based on program, coupon, and vintage. You cannot invest directly in an index.

[9] The Bloomberg U.S. CMBS Investment Grade Index measures the market of U.S. Agency (GNMA, FNMA, and (FHLMC) and US Non-Agency conduit and fusion CMBS deals with a minimum current deal size of $300mn. You cannot invest directly in an index.

[10] Bloomberg U.S. Asset-Backed Securities (ABS) Index is the ABS component of the Bloomberg U.S. Aggregate Bond Index, a flagship measure of the U.S. investment grade, fixed-rate bond market. The ABS index has three subsectors: credit and credit cards, autos and utility. You cannot invest directly in an index.

[11] Conventional MBS are issued by the FNMA and FHLMC.

[12] Ginnie Mae MBS are issued by the GNMA.

[13] The Russell 1000® Value Index is an unmanaged market capitalization-weighted index of value-oriented stocks of U.S. domiciled companies that are included in the Russell 1000 Index. Value-oriented stocks tend to have lower price-to-book ratios and lower forecasted growth values. You cannot invest directly in an index.

[14] The Russell 1000® Growth Index is an unmanaged market capitalization-weighted index of growth-oriented stocks of U.S. domiciled companies that are included in the Russell 1000 Index. Growth-oriented stocks tend to have higher price-to-book ratios and higher forecasted growth values. You cannot invest directly in an index.

[15] The Chicago Board Options Exchange (OEX) Volatility (VIX) Index is the ticker symbol and name for the Chicago Board Options Exchange's (CBOE) Volatility Index, a measure of the stock market's expectation of volatility based on S&P 500 index options. You cannot invest directly in an index.

#BCAI-09062023-WYCP6EGE (9/11/2023)

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