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Investing

Commentary published on January 14, 2021

December 2020 Market Commentary

Summary

  • U.S. Treasury Curve: Yields trended marginally higher on the long end of the curve while the short end was steady. Yields in the belly of the curve declined a bit. The curve steepened.
  • Municipal Market Technicals: December new issuance was $30 billion, per The Bond Buyer, higher than the prior month and lower than the year-over-year total for December.
  • Corporate Market Technicals: Investment grade (IG) corporate fixed-rate bond gross supply was about $32 billion, per Barclays, and fund inflows accelerated.
  • Securitized Trends: Mortgage-backed securities (MBS) spreads remain attractive relative to Treasuries, supported by strong technicals due to Fed’s unlimited quantitative easing.

Market Review

Financial markets in December were relatively quiet after an active prior 11 months. The stock market, as measured by the S&P 500 Index closed the month and the year at a new high. Treasury yields moved marginally higher and the curve steepened mildly in intermediate and longer maturities.

Among the conditions most directly influencing investor behavior were back-and-forth negotiations in Washington D.C. over additional fiscal stimulus, which ultimately was passed as the year closed. In addition, the COVID-19 pandemic continued to intensify through the holiday season, causing high human, business and economic costs.

Investors continued to look beyond near-term concerns, projecting positive outlooks for 2021 in terms of vaccine efficacy, business conditions and economic recovery. Our view for growth in the new year is biased to the second half of the year. We expect returning business profits and moderate bond supply with continued strong demand. This combination of economic and market technical conditions should provide opportunity for bond investors in the months ahead.

Municipal Market Review

December issuance and continued strong demand supported municipal bond prices, and municipal bonds outperformed Treasuries. The shape of the municipal yield curve was broadly unchanged during the month. The 2s and 5s, 2s10s and 5s10s curves were unchanged while the 10s30s curve was flatter by a basis point (bp).

The Bond Buyer reported December municipal bond issuance of $30 billion, marking a 37 percent increase from the prior month. Gross supply for 2020 exceeded $474 billion, with more than $145 billion in taxable municipal bonds. The total is an increase of greater than 100 percent over 2019 and exceeds 2017’s record taxable municipal bond supply, per The Bond Buyer.

Lipper reported combined weekly and monthly inflows in excess of $5 billion for the month ended December 31. Municipal fund flows have been a consistently positive market technical for two years as shown in Figure 1. Full year inflows were nearly $40 billion, per Lipper, the fourth highest level in history, and a remarkable turnaround given the $47 billion of outflows during the March and April timeframe.

For December, the Bloomberg Barclays 1-10 Year Blend Index gained 0.39 percent and the Managed Money Short/Intermediate Index finished 0.23 percent higher. Per Barclays, lower-rated bonds outperformed higher-rated bonds by a large margin within the investment grade segment. Longer maturities outperformed shorter maturities.

We expect that municipal credit will begin to heal in 2021 as the COVID-19 pandemic abates and the economy recovers. In the near-term, ratings are likely to migrate lower as issuers suffer revenue and cashflow pressure and regional recoveries diverge. Muted supply and continued strong demand during the first quarter should maintain the current positive technical environment, in our view.

With municipal bond yields remaining rangebound during December, we were discerning about extending duration, believing we likely will see a better opportunity to extend in a more favorable supply environment. Earlier in the year, when the effects of the business slowdowns due to the spread of COVID-19 were at their worst, we limited investments in sectors of the municipal bond market that we believed would be most severely affected. As market data indicated that conditions in certain sectors were improving, we increased our activity in those sectors.

Corporate Market Review

Investment grade (IG) corporate spreads tightened by 9bps in December and ended the year at 96bps. On a spread tightening of 12bps, BBB-rated corporate bonds outperformed AAA/AA-rated bonds, which narrowed 3bps. Longer-maturities tended to outperform shorter-maturities.

The BBG U.S. Corporate Investment Grade Bond Index gained 0.44 percent for the month. Total return performance for the year was 9.89 percent. According to Barclays, the best-performing sectors for the month were oil field services, financial companies, midstream, independent energy and airlines. The worst-performing sectors were supranationals, wirelines, foreign agencies, construction machinery and consumer products.

Index-eligible IG corporate supply moderated to $32 billion over the month, per Barclays, from elevated levels seen during much of 2020. Still, at $1.7 trillion, 2020 set a new record by a large margin for gross issuance of index-eligible IG corporate bonds. IG fund inflows were $17 billion for December, and totaled $297 billion year-to-date, per Wells Fargo.

The Fed’s corporate credit facility, a backstop for the IG market during 2020, ceased operations at the end of December. For 2021, we expect economic and profit growth normalization, particularly toward summertime and the second half of the year, as vaccine distribution accelerates.

While credit fundamentals remain challenged, higher cash balances have begun to stabilize net leverage, while high gross leverage should steady as cash flows rise in 2021. With high IG cash balances and improved visibility, share buybacks and mergers and acquisitions may accelerate in 2021.

After a record year, IG supply is expected to decline in 2021. Investor demand should sufficiently cover net issuance. Improving fundamentals and favorable technicals suggest a rangebound to slight narrowing bias to spreads. Still, spreads are tight and may face resistance. Technicals should continue to support spread product, but further spread tightening may be limited. In this environment, astute credit selection will be important to realizing return objectives.

Securitized Market Review

Based on Barclays index data, excess return earned by MBS during December was 22bps. Conventional 30-year mortgages with coupons in the 2 percent to 3 percent range were the best performers—with the 2.5 percent coupon generating 63bps of excess returns—while mortgages with coupons north of 4 percent were the worst performers. The 30-year mortgage rate hit a new low at 2.67 percent during the month, and refinancing activity remained high.

Commercial mortgage-backed securities (CMBS) was the best performing securitized sector, for the month generating 77bps of excess returns. Agency CMBS (ACMBS) delivered 50bps of excess returns for December. ACMBS outperformed non-agency CMBS by 71bps year-to-date through December and, at 122bps, was the strongest-performing high-quality securitized sector for the year.

Once again, asset-backed securities (ABS) modestly outperformed over the month, earning 15bps of excess returns. Full-year ABS excess return was 106bps. Credit card loans led December with 18bps of excess returns. Auto loans led in excess returns for the year at 116bps.

 

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