4th Quarter 2009 Market Review and Outlook

The municipal market staged a dramatic recovery in 2009, along with equities and most risk sectors in the capital markets.  In fact, the riskier the security, the better was the performance, as top quality municipal bonds outperformed US Treasuries and agencies and lower quality municipal bonds outperformed top quality municipal bonds.  While Samson was bullish on municipal bonds in the first half of 2009, our view changed to moderately bearish with concerns about rich valuations during the second half of the year.  Several key factors contributed to the strong performance of municipal bonds (e.g., Build America Bond issuance coinciding with diminished tax-free bond issuance, strong retail demand and heavy inflows into mutual funds), but most of them were related to supply and demand pressures rather than a fundamental strengthening of the market.

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3rd Quarter 2009

The third quarter saw a sharp turnaround in the domestic bond market, as all sectors and all maturity ranges rallied. The panic of late 2008 continued to subside, and bond market returns correlated directly with credit and duration risk. Treasuries turned in pedestrian gains, but remain mostly down year to date. Municipals and corporates had another very strong quarter, with long-dated bonds producing double-digit returns. The high yield market was up almost 15%, and is now up almost 50% on the year. Stocks told a similar story. In short, investors rushed to purchase securities that they sold indiscriminately late last year. Investors who are desperately trying to rebuild savings quickly realized that the zero-percent money market rate engineered by the Federal Reserve was not the ideal vehicle. Flows into stock and bond funds have increased substantially throughout the year. 

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2nd Quarter 2009

The second quarter of 2009 marked a period of recovery for financial markets, if not for the economy. Global stocks turned in double-digit returns and some credit began to flow again.  Bond returns varied inversely with credit quality, with U.S. Treasury obligations bringing up the rear.  There were tentative signs that the housing market was clearing and business investment and other leading indicators turned modestly higher, but employment and retail consumption remained depressed.

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1st Quarter 2009

As we mentioned in our last report, our investment team moved to lengthen the duration of our clients’ portfolios last fall when municipal yields were much higher, in some cases reaching twice the yield offered by Treasuries.  We believed that municipal yields had overstated the risk of default and understated the decline in future inflation.  We entered 2009 with an optimistic view of the municipal market, convinced that cheap valuations would support municipal prices when Treasury prices began their inevitable decline.  This proved to be accurate.

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4th Quarter 2008

To the relief of almost everyone, 2008 is over.  You are probably tired of reading about the meltdown in the stock market, the excesses and the bailouts.  For the first time in 28 years, the world is in the midst of a consumer-led recession.  The cause, put simply, was the unprecedented availability of inexpensive credit used to excess in certain markets and in certain industry sectors such as housing.  The sources of that credit – primarily large commercial and investment banks – mispriced credit by under-assessing risk.  These and other mistakes put the world’s entire financial system at risk, to the point where the governments of free market countries had to take unprecedented steps requiring staggering amounts of taxpayer funds.

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3rd Quarter 2008

It would be difficult these days to be unaware of the dislocation in the economy and in financial markets.   Stocks are down sharply this year, as are bonds issued by companies with even the slightest hint of financial stress.  We view this period as the culmination of decades of poor management by business and government leaders, excessive consumer borrowing, and increasingly lax regulation.  Derivative markets and off-balance sheet financing created opacity that, even now-eighteen months after the implosion of the two Bear Stearns hedge funds that launched the crisis-exacerbated the illiquidity and lack of confidence in the financial markets.  There is ample evidence that the financial crisis has now spread to the broader economy.

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2nd Quarter 2008

The painful unwinding of the Great American Credit Binge is entering its second year.  The stock market decline reached bear territory late in the second quarter, with financial services companies under the most pressure.  Bond prices declined modestly since March, as yields pressed higher when investors realized that the Federal Reserve could not push short rates lower without further weakening the U.S. Dollar and adding fuel to inflation.  This was a replay of last year, where part of the gains of the first quarter was given back in the second quarter.

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1st Quarter 2008

Investors are unaccustomed to seeing stories about credit markets on the front page of the press, despite the fact that credit markets are vast, dynamic, and underpin all other capital markets.  Subprime mortgages, failed municipal auctions, downgrades, write-offs, and more have all contributed to turbulence, headlines, and concern over the past several months.  The new-found attention given investment grade municipal markets creates opportunities for disciplined investors with a time-tested investment process that relies on fundamental credit research.

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4th Quarter 2007

The year 2007 was of historic significance for municipal bonds.  Many of the assumptions that served as the foundation of the municipal market had been compromised.  The events of 2007 highlighted the importance of a disciplined risk management process.  The year began with tight spreads, investor complacency towards credit risk, and a market operating on the assumption that the work of bond insurers and credit ratings agencies could protect investors from risk.  As a result credit risk was mispriced, and yield differences between higher and lower quality rated instruments was minimal.  Furthermore, many securities rated AAA truly did not deserve this designation as experience would show.  Investors learned they could not rely solely on rating agencies and bond insurers to preserve their principal against credit risk and spread volatility.

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3rd Quarter 2007

September 30th ended an exceptionally good quarter for fixed income securities.  Both municipals and Treasuries provided the strongest quarterly showing in several years, serving their historic role of safe harbor during turbulent times.  Five-year municipal and Treasury indices recorded returns of 2.56% and 4.21%, respectively, over the three months.

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2nd Quarter 2007

The second quarter was a difficult one for the bond market and there was little shelter from the storm as interest rates rose across the yield curve.  The capital markets continued to be volatile during the quarter, as concerns about sub-prime mortgages, the economy and terrorism ebbed and flowed.  By quarter end, bond yields had increased modestly in what can be described as a bear steepener (e.g. long rates increased more than shorter rates).  During most of the quarter and year to date we have focused on four key areas that have allowed us to outperform the market.

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1st Quarter 2007

The stalemate in the fixed income markets continued during the first quarter, with a resolute Federal Reserve holding short rates at 5.25%, while foreign buyers and investors expecting lower inflation and softer economic growth held bond yields much lower.  Corporate and municipal borrowers rushed to the market in record volume, while investors bought with abandon.  Treasury and municipal yields are close to year-end levels.  Furthermore, 5, 7, 10, and 30-year municipal yields are almost exactly unchanged from year-end, although they remain well below the levels of last June when the Federal Reserve last raised the Fed Funds rate.

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4th Quarter 2006

In 2006, bonds produced their best returns in three years, as the Lehman 5 Year Municipal Index came in at 3.34% for the year and the Lehman Intermediate Aggregate Index returned 4.58%.  The gains in the bond market were broad based, but grew with the risk characteristics of the class.  High yield corporates and emerging markets bonds continued a four-year run of outsized returns – as did stocks – and the Treasury market lagged.  Treasurys were the only sector to suffer principal declines across the yield curve.

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3rd Quarter 2006

The 3rd quarter was characterized by a significant decline in intermediate and long term bond rates.  For example, the 10-Year Treasury opened the quarter at 5.14% (after having peaked at 5.25% on June 28), while it ended the quarter at 4.65%, a remarkable decline of 60 basis points.  Similarly, the 5-Year Treasury opened the quarter yielding 5.09%, and ended at 4.54%.  Throughout this period, the Fed held short term rates constant at 5.25%, significant in that it was the first time they paused in raising rates since June of 2004.

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2nd Quarter 2006

The lackluster returns in the second quarter from most asset classes are a reflection of divergent economic indicators.  On one side of the argument is the concern that the economy is slowing, a concern based on evidence of a weaker housing market, higher energy prices, and slowing retail sales.  This concern led to marked contractions in global equity prices this past spring.  Of equal importance is the concern about rising inflation brought on by demand from emerging nations and by strained resources typical at this stage of the business cycle.  The Federal Reserve, of course, is caught in the middle, and it will fall to the Governors to determine what level of interest rates will be necessary to stem inflation and achieve a soft landing for the economy.

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1st Quarter 2006

The first quarter of 2006 ended with an exclamation point as rates rose sharply on longer maturity bonds and the yield curve inversion that began in January abruptly ended. 

Since the Fed began to tighten in 2004, the yield curve flattened as short rates increased far more than longer-dated rates – a very typical response.  The public press and market journals made much of Greenspan’s “conundrum”, whereby longer rates fell as short rates were being pushed upward.  Indeed, the yield curve inverted, however slightly and briefly, in the quarter that just passed.  But that no longer is the case as the curve then flattened and now slopes modestly upward.

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4th Quarter 2005

The most remarkable fact about the fixed-income markets for 2005 is that, despite a 200 basis point increase in the Fed Funds rate, from 2.25% to 4.25%, virtually all sectors of the fixed income markets – both taxable and tax-exempt – showed positive returns.  These returns may not have been especially robust, but they were competitive with some major stock indices, such as the DJIA and NASDAQ 100.  Throughout this period of low interest rates, Samson has worked to protect portfolios’ principal and flexibility to be in a position to enjoy higher returns when rates peak.  We believe that returns in 2006 will be better than those of 2005, in part because 2005 ended with short and intermediate-dated interest rates significantly higher than where they began the year.

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3rd Quarter 2005

The Federal Reserve continued its campaign to increase short term rates in September resulting in the end of the resistance of long rates to the Fed actions.  Surprising some who thought they may skip a turn in deference to the destruction brought about by Hurricane Katrina, Fed governors continued its program of one-quarter point increases in the overnight bank rate.  They assumed that while the resulting disruptions to employment and consumption would be temporary, “higher energy and other costs have the potential to add to inflation pressures.”  We continue to monitor inflation pressures to determine if the current environment reflects a temporary phenomenon or the beginning of a longer trend.

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2nd Quarter 2005

Our earlier Market Commentaries have observed that the existing interest rate structure in the bond market is not consistent with a growing economy, unrelenting tightening by the Federal Reserve, record trade and budget deficits, the prospect of a lengthening military commitment overseas, an overheated housing market, and rising commodities prices.  Accordingly, we have maintained a modestly defensive duration posture with respect to bond investments in our portfolios.  Those issues notwithstanding, the second quarter brought a shift in the psychology of bond market participants.  Although the expectations for continued economic growth remain, the expectations of sharply higher interest rates have waned dramatically.

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1st Quarter 2005

Our last quarterly review focused on the shrinking risk premiums that developed in most markets through 2004.  Two years of aggressively stimulative monetary policies on the part of the world’s central banks, our own prominently among them, left the world awash in liquidity and investors gasping for yield.  Investors responded as they always have, and as the central bankers hoped they would, by reaching for longer-dated and lower-rated bonds.  They also borrowed to purchase new homes and consumer items, thereby driving the global recovery.  Credit spreads narrowed as the stock market surged and emerging markets and high yield debt outperformed.  Central bankers were able to pursue this tactic without generating inflation because the glut in worldwide supply of productive capacity, especially labor, at first made it impossible for businesses to raise prices.  This all began to change in the quarter just ended.

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4th Quarter 2004

The sense of calm and tranquility pervading the securities markets during the fourth quarter was at odds with the significant shifts that occurred beneath the surface.  While the U.S. economy continues to grow at a healthy, moderate pace, and CPI has accelerated from a 2.5% annual rate to a 3.5% annual rate, the bond market has remained serene and undisturbed.  Longer term interest rates remain near twenty-year record low levels, despite the fact that the Federal Reserve added two more 25 basis point tightening moves to its measured pace.  Though the yield on the one-year Treasury rose from 2.18% to 2.79% during the quarter, the yield on the ten-year Treasury note increased just 9 basis points to close at 4.25%.

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