February – 2019 Newsletter

[media-downloader media_id=”3986″ texts=”Download PDF” class=”cherry-btn”]

10yr UST began the month at 2.68% and finished at a yield of 2.62%

We had a partial swap and sold AmTrust preferred securities AFSI 7.5% 9/15/55 (BB+) and purchased Best Buy bonds- BBT 4.55% 10/01/28 (Baa1/BBB). While the yield is lower on the Best Buy bonds this was a credit “up-grade” trade to lower the risk in the portfolio on a credit basis and a duration or interest rate basis.

Markets

In January, big investors seemed to shift their focus mainly to positive and hopeful financial news. As a result, the stock market remained relatively stable, and both the Dow Jones Industrial Average and S&P 500 increased by just over 7% (although the market overall is still down from its peak highs).* This was a dramatic change from 2018, when Wall Street suffered its worst year since the Financial Crisis, and its worst December since the Great Depression.

One of the main drivers for the new cautious optimism in January was the more dovish language coming from the Federal Reserve about short-term interest rates. In its January meeting, the Fed said it would be “patient” with further interest rate hikes, and removed language about “further gradual increases” from its policy statement.**

This came as welcome news to Wall Street given that long-term interest rates continued to exhibit a strong resistance level throughout January, with the yield on the 10-Year Treasury rate ending the month almost exactly where it started it, at around 2.7%. With short-term rates now 2.5%, that means the yield curve is perilously close to being completely flat. It has been partially flat ever since December 3rd when yields on the 2-Year Treasury rate rose higher than yields on 5-Year Treasuries. As I’ve pointed out before, a flat yield curve preceded both of the last two market crashes and is widely regarded as a red flag of a coming recession.

Even if a recession doesn’t hit this year, most economists are forecasting a significant economic slowdown. As for now, what we’re seeing with the markets is fairly common. Investors typically fall into

a trend of shaking off bad news toward the end of a cyclical bull market period. I believe we’re in just such a period, as further evidenced by the bond market’s ongoing resistance level. Remember, the bond market is often said to be “smarter” than the stock market when it comes to forecasting economic trends.

So, just how long can investors continue shaking off bad news and ignoring warning signs near the end of a cyclical bull rally? Well, remember that in 2007, it was widely known in February and March that the subprime mortgage crisis was coming, but it wasn’t until November that the markets started to drop. So, this “shaking off” period might continue for a while… or it might not.

Portfolio Transactions:

When managing your portfolio at SIS, we look for one of four possible “enhancement” trades while reviewing securities and possible transactions. Income generation is our primary goal for our clients, and we consider the following four portfolio enhancements before transacting: current yield, yield to worst (minimum projected annualized total return), interest rate risk, and default risk. The intents of these transactions are categorized as follows:

• Pay Me Now – Enhancing current yield
• Pay Me Later – Enhancing yield to worst
• Cover My Assets I. – Managing interest rate risk
• Cover My Assets II. – Managing default risk

We evaluate the transactions by determining whether they meet one, two, three, or all four enhancements. A baseball analogy for this: SINGLES, DOUBLES, TRIPLES, and HOME RUNS.

*“Stocks Wrap Up Best January in 30 Years,” CNN Business, Jan. 31, 2019

**“Treasury Yields Fall Further After Fed Vows Patience,” CNBC, Jan. 31, 2019