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Investing Podcast recorded on August 9, 2018

From the Desk - July Recap 2018

Podcasts Transcripts

Muni Recap

Hi this is Sara Chanda, welcome to the Breckinridge podcast. We are excited to have you here with us today. We are actually going to be introducing a new format. While we will continue to cover market-related topics, our material is going to be structured a little bit differently in that we are going to be talking about several key themes and topical pieces of information that were noteworthy over the course of the month or the quarter. Our format will be a little bit different in that we are going to have two portfolio managers, myself included today, interacting, and having a conversation about what has been going on over the course of the month, and we are hoping that this will be more engaging for folks in the field, and the outcome we are hoping for is that it will be more concise material that people can bring back to their client base. And so, let us get started. With me today, I have my colleague, Eric Haase, who is a portfolio manager alongside me. Several key themes we will be discussing today include market volatility, market technicals, and high-yield outperformance. So Eric, when we talk about volatility in the market, what is that, exactly?

Sure. So there a number of different ways to measure volatility, whether it is through metrics or just observations, and one thing that we look at it is looking at a change in interest rates. So we buy a lot of bonds in the 5-year part of the curve, and when we look at that part of the curve in the first quarter of the year, yields from peak to trough moved around 39 basis points. And if you look at July, they only moved 9 basis points, so we are in a much less volatile period of time versus Q1.

Right, so despite this lower volatility environment, we have actually posted positive performance over the month, and that really is due to carry. And so when we talk about carry for folks in the field, what do we mean by that?

When you are talking about total return of an asset you are really talking about with bonds two major parts. There is your price appreciation or depreciation, and then there is also the income you receive, your coupon. So carry is essentially the income or coupon you have earned on your investment.

Right, and so we talked about what volatility is, what we have seen over the course of the month but let us cover now why we have seen less volatility. And really as a reminder for folks, in Q1 we saw Treasury yields spike pretty dramatically. That was really due to inflation and rate hike fears over the course of the quarter and munis tend to track Treasuries, so we also had a bit of volatility as well and followed them directionally. However, more recently, Treasuries have been more range bound, less yield movement is what I mean by that, and that is really coupled with lower new issuance or new issue supply in the muni side and we have seen more steady demand for mutual funds which really have acted as a market stabilizer, so with those two components effectively, we talk about technicals.

Right, so that is your supply and demand dynamic that we have seen in the market.

That is right, and so supply this year, as I mentioned, so it has declined. We are probably about 16% lower than we were year-over-year last year. We have had several steady months, but July was actually a bit of a drop about $25 billion or so. So all told now, we are year to date about $190 billion.

Right, so we are sitting at lower supply than we are used to seeing, or have seen recently, and the demand has been around $9 billion for mutual funds. So that is a positive number and it is fairly strong.

Right. One other metric we tend to look at with mutual fund demands, inflows or outflows tend to be good proxy, generally speaking, for the market. We also look at a metric called net negative supply, and what I mean by that is just by definition, it is just the amount of gross supply we are seeing in the market coupled with what we are going to see as far as demand is concerned. So whether it's mutual fund inflows or it could be maturities or coupon payments coming into the market, and we are kind of at this period right now where we are in a net negative supply environment. What are we seeing?

Yes, so we are in the middle of this period, and really over the summer is generally where you see it occurring and due to the number of maturities that come back to investors. But for July and August, the estimate is around $60 billion of negative net supply and when you look back historically over the last five years, that number is closer to 30 on an annual basis, so again significantly more demand for a lower amount of municipal supply.

Right. It is kind of an important metric because it can potentially be a predictor of performance, independent of Treasury movements, that is, you know, factors that may enhance or inhibit performance as a result of what we are seeing. And then the third, speaking of performance, we have seen a lot of performance in high-yield. While we do not purchase high-yield muni debt here at Breckinridge, we do track stories and themes within the sector. It really helps inform us with overall market sentiment and tone, especially in the most recent years it has been a big focus because we have been in such a low yield interest rate environment. So what have we seen this year?

Essentially the broad market, municipal market, is flat on the year through July. And when you look at high-yield, high yield is up around 5% and within that high-yield complex, the best performers have been Puerto Rico and the tobacco sector.

Right. Puerto Rico, I know, is up over 12% year-to-date while tobacco nearly 8%. So pretty dramatic, but how about on a cumulative basis, what we looking at?

Sure, so when you are looking at investment grade bonds which is the portion of the market that we invest in, the total return for the last five years has been around 21% cumulatively. High-yield munis on the other hand, have been as high as 35%.

Right, and if you exclude Puerto Rico and tobacco in that number, it is actually an eye-popping 52%. And that is really the result of two reasons, the additional care you receive alongside spike compression that we have been seeing. In fact, if we look back since the middle of 2009, when BBB spreads actually peaked at 350 basis points over AAA's, we are now sitting at 270 basis points, so dramatic move.

Right, and what we see in the high-yield space from looking at historical data is that the spreads are usually driven tighter by fund flows, not necessarily fundamentals and an improving environment.

Right, and that is actually really good to point out. It underscores why technicals play an important role but also just thinking about credit itself, while it does remain stable, we do feel at Breckinridge that we are on the later stages of the credit cycle and fundamentals over time may deteriorate in a downturn, pushing spreads wider and this spread widening could be exacerbated by an outflow cycle.

So we hope you found this information informative. We do publish a monthly commentary if you have any other information or questions about what we covered today I would love to hear from you, if you want to drop us a line at Thanks for joining us.


Corporate Recap

Good day and welcome to the Breckinridge podcast. This is Laura Lake. I am the director of investment strategy here at Breckinridge and I am joined by Khurram Gillani, a portfolio manager at Breckinridge. We are launching a new type of podcast this month and relaunching with a new format and really the aim of this is to make the podcast more conversational, engaging, and hopefully more digestible for the field. Our goal is to have a handful of takeaways that listeners can have that they'll find useful as a recap over the previous month. So with that, I’ll start with a high-level overview of what happened in the bond market. So looking back on the month of July, when we look at the Treasury market, Treasury rates moved around 10 basis points higher over the course of the month and it was generally a parallel shift so the slope of the curve, or the yield differential between 2-year Treasuries and 10-year Treasuries, remained fairly stable. We found this interesting, especially in light of the strong economy, where we have unemployment claims at around a 49-year low. The second-quarter GDP came out a very strong 4.1%. So strong economic data did move Treasury rates higher but not in a dramatic fashion that we would have normally expected. This is interesting in terms of where investors are looking to find income in the bond markets, and one of the places they have been finding it has been in the corporate market. So Khurram, the corporate market in July, what are some your thoughts?

So in the corporate market it has become a little bit more difficult, frankly, to source bonds and definitely source bonds at levels that we have become accustomed to sourcing them earlier this year. Spreads have tightened. Spreads tightened in the month of July by 14 basis points, that’s about half of the widening that has occurred year-to-date was undone in July, and it is not surprising, number one, supply was down 50% versus July of 2017 and two, demand definitely picked up, demand domestically, but also from foreign buyers, given the fact that it has become a little bit more profitable for them to buy corporate bonds given where the yield curve is currently.

So what we have really seen is a risk on trade in the market and investors really reaching for yield in the corporate space. And I think it is interesting in terms of how performance has played out especially in long corporates. They were a very strong performer in July, the best part of the yield curve to be involved in, in the corporate space.

That's right so cumulatively, year-to-date the corporate credit curve has steepened, but that was definitely not the case in July, where it did flatten, so as a result, long corporates handedly outperformed intermediate and short corporates, even though for the year, long corporates have lagged.

And down in quality did well as well.

That is right, so BBB’s and A’s, year-to-date BBB’s have done a little bit better than A’s, but it is not significant but there was significant outperformance in the month of July, so it was a risk on trade. BBB's outperformed A’s and AA corporates during the month.

And we have seen this even more broadly in high-yield market, not an area that Breckinridge invests in, but high-yield spreads, narrowed anywhere from 25 to 45 basis points in July, so very strong returns across the corporate space.

That is right, and one thing to add to that is that Q2 earnings, so most companies have now reported Q2 earnings. If you look at the S&P 500 earnings. Revenues are up double digits, earnings are also up double digits, the energy sector and also the materials sector has definitely outperformed the other sectors in terms of growth. However, it is broad-based, so I think that is another reason why spreads were so supportive in the month of July.

Outside corporates, another area where we have seen some interesting themes is within agency mortgages, and one of the big drivers there has been net supply. “Net supply”, that term comes up quite a bit. What is net supply, Khurram?

So net supply is just the gross supply minus the pay-downs, basically the pay-downs being when people pay their mortgage, that is considered a pay-down, so that is what net supply is. And that is what if you are in the MBS, market, that is kind of the main thing you look at.

So what was the big driver of net supply last month?

So one of the biggest drivers of net supply is obviously home prices, which are potentially starting to peak if you look at the data. If you look at the indices that track this sort of stuff, they are definitely running lower versus last year. They are still growing but the rate of growth has definitely slowed down. Also higher benchmark rates, you know, you have got a higher 10-year, 30-year, that has also bled over to higher mortgage rates and the combined effect of the two is lower affordability, which translates into lower home sales obviously, and that is evidenced by what you see when figures come out for new and existing home sales and ultimately lower MBS supply. At the end of the day, you know, we do still expect 2018 to have about $250 billion range overall net supply, which would still be one of the highest numbers we have seen since the crisis.

So there is a lot going on in the agency mortgage market, a lot of headlines about what is going on with Fannie Mae, Freddie Mac, and they are going to be combining issuance going forward. That has been one of the big announcements, UMBS, or uniform mortgage-backed securities, which will kind of change the face of the agency mortgage market.

That is right, so on June 3, 2019, Fannie and Freddie will start issuing a new common security called the UMBS, uniform mortgage-backed security. It is important to note that Freddie and Fannie are not merging. This is just a common security that they will be issuing. Legacy holdings will have the option to trade in their holdings for the new UMBS holdings. It is important to note that this is a mirror security, it is backed by the same underlying loans as the original Freddie MBS pools. We are still waiting for final guidance from the IRS and the SEC, so it is a moving situation and we are monitoring and preparing for it.

Yeah, and this is a sector that we do invest in for many Breckinridge clients. And it is a situation that we are monitoring and looking to take advantage of relative value opportunities as they present themselves in the future. So that wraps up our themes for the month of July. Thank you for joining the Breckinridge podcast.


DISCLAIMER: The opinions and views expressed are those of Breckinridge Capital Advisors, Inc. They are current as of the date(s) indicated but are subject to change without notice. Any estimates, targets, and projections are based on Breckinridge research, analysis and assumptions. No assurances can be made that any such estimate, target or projection will be accurate; actual results may differ substantially.

Nothing contained herein should be construed or relied upon as financial, legal or tax advice. All investments involve risks, including the loss of principal. An investor should consult with their financial professional before making any investment decisions.

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Any specific securities mentioned are for illustrative and example only. They do not necessarily represent actual investments in any client portfolio.