(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

Stock and bond market performance during July suggested that investors increasingly adopted a view that the Fed is achieving the soft-landing economic scenario often hoped for following a period of elevated inflation.

Parts of the economy showed cooling trends, amid mixed economic data. For example, in their second quarter earnings reports, rail operator CSX Corporation and trucking company Old Dominion Freight Line, Inc., cited lower shipping volumes. Federal Reserve Bank of Richmond data showed capital expenditures fell. The Bureau of Economic Analysis reported lower inflation readings and strong consumer spending. Data from the Bureau of Labor Statistics showed unemployment was low, even as wage growth moderated.

Yields for Treasury bonds with maturities longer than five years increased during July. The most significant increases were in the intermediate and long ends of the curve. The Fed increased the fed funds rate near the end of the month by 25bps to a range of 5.25 percent to 5.50 percent. Bond market volatility during July fell back to lower levels, as measured by the Bank of America Merrill Lynch (BofA/ML) MOVE Index¹ (See Figure 2).

With no meeting in August, the next opportunity for the Fed to raise rates will be September 20. By that date, it will have two more consumer price index (CPI) and employment reports, an employment cost index (ECI) reading, and other data to consider before making a rate decision.

For July, the 2-year added 1bp. The 3-year and 5-year bonds were 3bps and 5bps higher, respectively, while the 7-, 10-, and 30year bonds were up by 11bps, 16bps, and 17bps, respectively. The yield gap between 2-year Treasuries and those with 10 and 30 year maturities each narrowed marginally.

The Bloomberg (BBG) U.S. Treasury Bond Index² declined 0.35 percent. The BBG U.S. Aggregate Bond Index³ fell 0.07 percent.

Municipal Market Review 

Municipal bond yield changes were fairly muted during the month. Yields shorter than 5 years rose by more than corresponding Treasuries, while maturities of longer than 10 years rose by less than Treasuries did (See Figure 3). The outperformance of longer maturities pushed Municipal/Treasury (M/T) yield ratios lower and the ratio curve was very flat from 2 to 10 years (See Figure 4). 

The municipal yield curve remains inverted from 2 to 10 years, though not to the same degree as the Treasury curve. The modest pace of the economy’s continued growth—gross domestic product rose at a 2.4 percent annualized pace in the second quarter, the Bureau of Economic Analysis announced in July—is good news for credit fundamentals and credit rating agency downgrades have been rare year-to-date.

The BBG Managed Money Short/Intermediate (1-10) Index⁴ gained 0.29 percent and the BBG 1-10 Year Municipal Bond Blended Index⁵ was 0.34 percent higher. Generally, shorter-maturity bonds outperformed longer-maturities. Lower-rated bonds outperformed high-rated bonds.

The Bond Buyer reported that total issuance for July was nearly $26 billion, down 8 percent from about $28 billion a year earlier. Total year-to-date (YTD) issuance was 16 percent lower than the same period of 2022, at about $206 billion. In July, tax-exempt municipal bond issuance was about 4 percent lower year-over-year (Y/Y). Taxable municipal bond issuance YTD of $23 billion is approximately 37 percent lower than the total through July 2022. Outflows from municipal bond funds slowed in July, as reported by Lipper/Refinitiv falling to about $7 billion YTD by the end of July.

Corporate Market Review

Investment grade (IG) corporate bond spreads tightened 10bps tighter, per BBG data, to close July at an option-adjusted spread of 112bps. Bonds rated BBB outperformed higher-quality corporates on total and excess return bases. shorter-maturity bonds outperformed longer maturities.

For the period ended July 31, the BBG U.S. Corporate Investment Grade (IG) Index⁶ earned a monthly total return of 0.34 percent and an excess return of 0.90 percent, compared with duration-matched Treasuries. Per BBG, the best-performing sectors and subsectors were Independent Energy, Oil Field Services, Life Insurance, Refining, and Midstream Oil Services. Among the worst-performing sectors and subsectors were Wirelines, Supranationals, Telecommunication, Foreign Local Governments, and Construction Machinery. 

Investors are watching the second quarter reporting period for corporate earnings for signals that might indicate the course of the U.S. economy for the second half of 2023 and into 2024. FactSet reported that as of July 28 that 51 percent of the companies in the S&P 500 reported results for Q2 2023. Of these companies, 80 percent reported earnings per share (EPS) above estimates, which is above the 5- and 10-year averages of 77 percent and 73 percent, respectively. 

In aggregate, companies reported earnings that are 5.9 percent above estimates, below the 5-year (8.4 percent) and 10-year (6.4 percent) averages. The index marked the largest Y/Y decline in earnings among the companies reporting since Q2 2020.

Fixed-rate, gross investment grade supply for July was about $96.6 billion, BBG reported, with net issuance of $44.2 billion after $52.5 billion in redemptions. About $10 billion in assets flowed into IG bond mutual funds in July, per CreditSights.

Securitized Market Review

July excess returns were mostly positive across securitized sectors—MBS, CMBS, and ABS. In our view, rate volatility could continue to moderate as investors grow more confident that the Fed is closer to the end of its rate hiking cycle than it is to the beginning, which likely would benefit MBS spreads.

The most favorable MBS excess returns were among 4.5 to 6 percent coupon conventional¹⁰ and Ginnie Mae¹¹ securities. 

Equity Market Review 

In July, the S&P 500 Index¹² returned 3.2 percent, the Russell 1000 Value Index¹³ returned 3.5 percent, and the Russell 1000 Growth Index¹⁴ returned 3.4 percent. With 51 percent of companies in the S&P500 reporting 2Q23 results as of July 28, the results have been better than expected with 80 percent of reporting companies posting EPS above consensus estimates, according to FactSet, however, expectations for earnings had been low and the overall Y/Y decline in earnings is down the most since 2Q 2020. 

S&P 500 sector performance was led by Energy (7.4 percent total return in July), Communication Services (6.9 percent) and Financials (4.9 percent), while Healthcare (1 percent), Real Estate (1.3 percent) and Consumer Staples (2.1 percent) were bottom performers during the month. 

Thematically, earnings calls have highlighted positive dynamics around consumer resilience, deposit stabilization, strong travel demand, structural tailwinds around housing demand, and disinflationary evidence. On the negative side, some earnings calls highlighted macro uncertainty, more focus on mega-cap technology companies’ growth prospects following a strong 1H2023 rally, lower pricing power, some continued destocking impacts and fundamental headwinds on office commercial real estate as reported by Factset. 

The Chicago Board Options Exchange (BoE) Volatility Index¹⁵ (VIX) recorded year-to-date lows for the equity market (See Figure 5).

#BCAI-08042023-eiuxzzdi (8/10/2023)

[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 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.

[8] 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.

[9] 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.

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

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

[12] The S&P 500 Index consists of 500 stocks chosen for market size, liquidity, and industry group representation. Itis 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.

[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.

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