(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

While many forecasts continue to call for a shallow recession in the near-term due to an inverted yield curve, tighter lending standards, and aggressive Fed tightening, factors including stronger-than-expected economic data, relative calm in the banking sector, and the debt ceiling debate resolution caused Treasury yields to rise during the second half of the month.

Overall, uncertainty drove bond market volatility higher, as measured by the Bank of America Merrill Lynch MOVE Index¹ higher (See Figure 1).

For now, the economy may be in the desired soft-landing scenario, with positive but low gross domestic product (GDP) growth and falling inflation.

Several key April economic readings showed persistent strength across several areas. The Personal Consumption Index and Consumer Price Index, as reported by the Bureau of Economic Analysis, each registered an increase. Headline retail sales rose, following consecutive monthly declines. Industrial production posted a solid April increase, with downward revisions to March. The second estimate of first quarter gross domestic product (GDP) by the Bureau of Economic Analysis was a seasonally adjusted annual rate (SAAR) of 1.3 percent, quarter-over-quarter (Q/Q), up 0.2 percent from the first estimate.

Offsetting the growth data, real gross domestic income (GDI) fell for a second consecutive quarter, although the second estimate of consumer spending ticked up to 3.8 percent, Q/Q SAAR. The April Senior Loan Officer Opinion Survey on Bank Lending Practices showed lending standards tightened further and first quarter loan demand weakened. The latest Atlanta Fed wage tracker showed an abrupt deceleration in April, in contrast with average hourly earnings reports in May.

By month-end, investors turned their attention to the Federal Reserve’s (Fed’s) two-day meeting starting on June 13. A notable gap closed between market expectations (no more hikes and 3 rate cuts before year-end) and Fed forecasts (stubborn inflation and no cuts until 2024). Market expectations, per fed funds futures contracts as of the third week of May, now show slightly higher odds of a rate hike over the next three months and just one cut by year-end.

Some observers contended a pause would afford the Fed an opportunity to gather and assess more data to inform deliberations. Others pointed to strong economic readings as evidence of a still hot economy that might be cooled with another rate increase. The Breckinridge Investment Committee is more in line with the Fed, anticipating no additional hikes this year and no cuts until 2024.

Treasury bond yields increased across the curve. The 2-year added 40 basis points (bps), according to data from the U.S. Department of the Treasury. The 5-year was 27bps higher, the 10-year and the 30-year added 18bps and 19bps, respectively. The curve remained inverted.

The Bloomberg U.S. Treasury Bond Index² declined 1.16 percent. The Bloomberg U.S. Aggregate Bond Index³ fell 1.09 percent.

Municipal Market Review

Municipal bond yields moved higher with Treasury yields (See Figure 3). Two-year yields were higher by 43bps, 5-years by 42bps, 10-years by 33bps, and 30-years by 20bps, per Municipal Markets Analytics (MMA) data.

Once again in May, Muni/Treasury (M/T) ratios improved. They reached year-to-date highs at 71, 75, 74, and 93 in 2, 5, 10, and 30 years, respectively (See Figure 4), using MMA and U.S. Treasury data. 

The Bloomberg Managed Money Short/Intermediate (1-10) Index⁴ fell 1.21 percent and the Bloomberg 1-10 Year Municipal Bond Blended Index⁵ fell 0.8 percent. Generally, short-maturity bonds outperformed longer-maturities. Total returns for bonds in the 7- to 10-year segment of the curve trailed other segments, while bonds with 15-year maturities marginally outperformed shorter-term maturities. Lower-rated bonds outperformed higher-quality bonds, with bonds rated AA faring the worst.

The Bond Buyer reported that total issuance for May was $26 billion, down 29 percent from $36.6 billion a year earlier. Total issuance year-to-date was $136.6 billion, falling 24 percent from the same period of 2022. Tax-exempt municipal bond issuance was about 16 percent lower year-over-year (Y/Y), while taxable municipal bond issuance was down approximately 82 percent Y/Y. Lipper/Refinitiv reported municipal bond mutual fund outflows of about $1.1 billion in May. 

Corporate Market Review

Investment grade (IG) corporate bond spreads were 2bps wider, per Bloomberg data, to close at an option-adjusted spread of 138bps. Credit curves flattened and higher-quality corporates outperformed in May on an excess return basis. The Banking sector outperformed as Regionals retraced some of their widening in recent weeks. 

The Bloomberg U.S. Corporate Investment Grade (IG) Index⁶ fell almost 1.5 percent on a total return basis, with a negative excess return of 8bps compared with duration-matched Treasuries. 

Per Bloomberg, the best-performing sectors were Financial Companies, Sovereigns, Airlines, Life Insurance, and Home Construction. The worst-performing were Integrated Energy, Refining, Natural Gas, Midstream Oil Service Companies, and Electric Utilities. 

Based on Bloomberg data, while total returns for bonds in the 1- to 3-year segment were negative, they exceeded other maturity segments on a relative basis and delivered positive excess returns. 

Fixed-rate, gross investment grade supply for May was about $172.8 billion, Bloomberg reported, with a net total issuance of $83.3 billion after redemptions. About $12 billion in assets flowed onto IG bond mutual funds in May, per EPFR Global. 

Securitized Market Review

Securitized markets delivered negative total returns and positive excess returns. The Bloomberg MBS Index⁷ had a negative total return of 0.73 percent and a positive excess return of 0.41 percent. The most favorable excess returns were among 2 and 2.5 percent coupon conventional⁸ and Ginnie Mae⁹ securities. 

Bloomberg data showed Agency Commercial MBS (CMBS) earned a negative total return of 0.54 percent and a positive excess return of 51bp. Non-Agency CMBS had a negative total return of 0.67 percent and excess return of 0.14 percent. 

Within the ABS sector, securities backed by credit cards and auto loans had negative total and positive excess returns. Total returns were negative 0.28 and negative 0.15 percent, respectively, while excess returns were 16bps and 14bps, respectively, per Bloomberg.

Equity Market Review

Stock market indices were mixed and the Chicago Board Options Exchange Volatility Index¹⁰ (VIX) finished at its lowest level since November 2021 (See Figure 5). The S&P 500 Index¹¹ was up 0.3 percent. The Dow Jones Industrial Average¹² fell 3.5 percent. Bolstered by a favorable market for technology stocks, the NASDAQ Composite Index¹³ closed 5.8 percent higher.

With 92 percent of S&P 500 companies reporting Q1 earnings, FactSet noted that 78 percent announced actual earnings per share (EPS) above estimated EPS. That is above the five-year average of 77 percent and the highest percentage of S&P 500 companies reporting a positive EPS surprise since Q3 2021, when the total was 82 percent.

In aggregate, earnings exceeded estimates by 6.5 percent, which is above the 10-year average of 6.4 percent, FactSet said. It is also the highest surprise percentage reported by S&P 500 companies since Q4 2021, when the total was 8.1. The S&P reported a decline in earnings of 2.1 percent, the second straight Y/Y decrease, FactSet reported on June 1.

[1] The 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 Ginnie Mae (GNMA), Fannie Mae (FNMA), and 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] Conventional MBS are issued by the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation.

[9] Ginnie Mae MBS are issued by the Government National Mortgage Association.

[10] 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.

[11] The S&P 500 Index tracks the performance of 500 widely held, large-capitalization U.S. stocks. You cannot invest directly in an index.

[12] The Dow Jones Industrial Average Index is a price-weighted average of 30 actively traded blue chip stocks as selected by the editors of The Wall Street Journal. You cannot invest directly in an index.

[13] The NASDAQ Composite Index is a market capitalization price-only index that tracks the performance of domestic common stocks traded on the regular NASDAQ market as well as National Market System-traded foreign common stocks and America Depository Receipts. You cannot invest directly in an index.

#BCAI-06052023-39pfffwj (6/10/2023)

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