Rich Balestra – Portfolio Manager – Page 10

12 Jan 2023

High Yield Quarterly, Insight Rich Balestra - Portfolio Manager 0 comment

2022 Q4 High Yield Quarterly

In the fourth quarter of 2022, the Bloomberg US Corporate High Yield Index (“Index”) return was 4.17% bringing the year to date (“YTD”) return to -11.19%. The S&P 500 stock index return was 7.55% (including dividends reinvested) for Q4, and the YTD return stands at -18.13%.

The 10 year US Treasury rate (“10 year”) finished at 3.88%, up 0.05% from the beginning of the quarter but did show a bit of volatility with a high in October of 4.24% and a low in December of 3.42%. Over the period, the Index option adjusted spread (“OAS”) tightened 83 basis points moving from 552 basis points to 469 basis points. All quality segments of the High Yield Market participated in the spread tightening as BB rated securities tightened 59 basis points, and B rated securities tightened 130 basis points, and CCC rated securities tightened 96 basis points. The chart below from Bloomberg displays the spread moves in the Index over the past ten years with an average level of 428 basis points.

The Basic Industry, Banking, and Finance Companies sectors were the best performers during the quarter, posting returns of 6.52%, 6.33%, and 6.10%, respectively. On the other hand, Communications, Technology, and Other Financial were the worst performing sectors, posting returns of 1.82%, 3.04%, and 3.06%, respectively. At the industry level, gaming, oil field services, and pharma all posted the best returns. The gaming industry posted the highest return 9.04%. The lowest performing industries during the quarter were media, healthcare REITs, and retailers. The media industry posted the lowest return 0.04%.

Crude oil had a few spikes above $90 per barrel as OPEC+ members agreed to cut oil production by two million barrels per day. Those levels did not remain long as a concern for economic growth took hold and prices marched lower by roughly $20 per barrel. As we go to print in early January, crude is at $73 per barrel. “A panel formed of key nations in the OPEC+ alliance is due to hold a monitoring meeting on Feb. 1. In the meantime, Saudi Energy Minister Prince Abdulaziz bin Salman has said the group will remain “pre-emptive” to keep the crude market in equilibrium.”ⁱ

The primary market remained very subdued during the fourth quarter. The weak market led to full year 2022 issuance of $115.9 billion and $20.7 billion in the quarter. The chart to the left gives a sense of just how low issuance was in 2022 relative to the past handful of years. Discretionary took 31% of the market share followed by Technology at a 17% share. Currently, there isn’t much concern for lack of capital access due to issuers being so proactive with refinancing in the past few years

After the Federal Reserve lifted the Target Rate by 0.75% at their June meeting, Fed Chair Jerome Powell acknowledged that the hike was “an unusually large one.” The Fed then proceeded to lift the Target Rate at a 0.75% clip at the next three consecutive meetings before downshifting to a 0.50% increase at the December meeting. All told, the Fed completed 425 basis points of raises in 2022. The dot plot chart shows how the Fed projections of the 2022 year-end Target Rate have evolved over the past year. The Fed was clearly behind the curve in keeping rates too low for too long and needed to play catch-up. It remains to be seen whether they miss on the other side by raising rates too high. Michael Feroli, chief US economist at JPMorgan said, officials “realize that the risk of overtightening is just something that they have to swallow and stomach.”ⁱⁱ Chair Jerome Powell acknowledged at the December post-meeting press conference that there is “more work to do,” and the minutes showed Fed officials are intent on lowering inflation back toward their 2% target at the risk of rising unemployment and slower growth.

Intermediate Treasuries increased 5 basis points over the quarter, as the 10-year Treasury yield was at 3.83% on September 30th, and 3.88% at the end of the third quarter. The 5-year Treasury decreased 9 basis points over the quarter, moving from 4.09% on September 30th, to 4.00% at the end of the third quarter. Intermediate term yields more often reflect GDP and expectations for future economic growth and inflation rather than actions taken by the FOMC to adjust the Target Rate. The revised third quarter GDP print was 3.2% (quarter over quarter annualized rate). Looking forward, the current consensus view of economists suggests a GDP for 2023 around 0.3% with inflation expectations around 4.0%.ⁱⁱⁱ

Being a more conservative asset manager, Cincinnati Asset Management Inc. does not buy CCC and lower rated securities. Additionally, our interest rate agnostic philosophy keeps us generally positioned in the five to ten year maturity timeframe. After three quarters of negative performance, Q4 closed positive with quality leading the way. That quality focus that CAM is known for was certainly on display this quarter. Further, our underweight within communications and our credit selections within aerospace & defense and consumer cyclicals were a benefit to performance. The cash position was a drag on performance as was our credit selections within food & beverage. All totaled, the CAM High Yield Composite Q4 gross of fees total return of 4.78% (4.71% net of fees) outperformed the Index. The full year 2022 Composite gross of fees total return of -12.90% (-13.16% net of fees) underperformed the Index. Additionally, the Composite 5-year annualized gross of fees total return was 1.87% (1.55% net of fees) versus 2.31% for the Index, and the Composite 10-year annualized gross of fees total return was 2.33% (1.99% net of fees) versus 4.03% for the Index.

The Bloomberg US Corporate High Yield Index ended the fourth quarter with a yield of 8.96%. Equity volatility, as measured by the Chicago Board Options Exchange Volatility Index (“VIX”), had an average of 25 over the quarter moving from a high of 33 in mid-October to a low of 19 in early December. For context, the average was 15 over the course of 2019, 29 for 2020, and 19 for 2021. The fourth quarter had zero bond issuers default on their debt. The trailing twelve month default rate stands at 0.84%.^iv The current default rate is relative to the 0.27%, 0.23%, 0.86%, 0.83% default rates from the previous four quarter end data points listed oldest to most recent. The fundamentals of high yield companies still look good considering the economic backdrop. From a technical view, fund flows were positive in October and November but negative in December. The 2022 year-to-date outflow stands at $56.6 billion.^v While this was the second worst high yield market on record, it is important to remember that bonds are a contractual agreement with a defined maturity date. Thus, despite price volatility, without default, par will be paid at the stated maturity date. Currently, defaults are quite low and fundamentals are still providing a cushion. No doubt there are risks, but we are of the belief that for clients that have an investment horizon over a complete market cycle, high yield deserves to be considered as part of the portfolio allocation.

As we move into 2023, the Fed will continue to remain a large part of the story. The message from the Fed is unequivocal. Breaking the back of inflation is job number one. While caution is warranted as uncertainty remains around the cycle’s terminal rate and depth of an economic slowdown, it seems like progress is being made as there has been five consecutive lower inflation reports. Markets have been roughed up this year, but brighter days will eventually appear. As this cycle plays out, current uncertainty and volatility can create opportunities that lead back to positive returns. Our exercise of discipline and selectivity in credit selections is important as we continue to evaluate that the given compensation for the perceived level of risk remains appropriate. As always, we will continue our search for value and adjust positions as we uncover compelling situations. Finally, we are very grateful for the trust placed in our team to manage your capital.

This information is intended solely to report on investment strategies identified by Cincinnati Asset Management. Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. This material is not intended as an offer or solicitation to buy, hold or sell any financial instrument. Fixed income securities may be sensitive to prevailing interest rates. When rates rise the value generally declines. Past performance is not a guarantee of future results. Gross of advisory fee performance does not reflect the deduction of investment advisory fees. Our advisory fees are disclosed in Form ADV Part 2A. Accounts managed through brokerage firm programs usually will include additional fees. Returns are calculated monthly in U.S. dollars and include reinvestment of dividends and interest. The index is unmanaged and does not take into account fees, expenses, and transaction costs. It is shown for comparative purposes and is based on information generally available to the public from sources believed to be reliable. No representation is made to its accuracy or completeness. Additional disclosures on the material risks and potential benefits of investing in corporate bonds are available on our website: https://www.cambonds.com/disclosure-statements/.

i Bloomberg January 4, 2023: Saudi Arabia Kept Oil Exports Steady in December
ii Bloomberg January 4, 2023: Fed Affirms Inflation Resolve
iii Bloomberg January 4, 2023: Economic Forecasts (ECFC)
iv JP Morgan January 3, 2023: “Default Monitor”
v Wells Fargo December 29, 2022: “Credit Flows”

16 Dec 2022

High Yield Weekly, Insight Rich Balestra - Portfolio Manager 0 comment

CAM High Yield Weekly Insights

Fund Flows & Issuance: According to a Wells Fargo report, flows week to date were -$0.6 billion and year to date flows stand at -$48.5 billion. New issuance for the week was $2.2 billion and year to date issuance is at $104.9 billion.

(Bloomberg) High Yield Market Highlights

U.S. junk bonds snapped a six-day rally as yields surged 13bps to 8.45%, marking the biggest one-day loss in more than five weeks, after central banks signaled more rate hikes are needed to cool the rate of inflation. Fed Chair Jerome Powell reiterated the central bank’s hawkish stance and said the bank is not close to ending its rate-hike campaign to tame inflation, a sentiment echoed by European Central Bank President Christine Lagarde.
The hawkish tilts from the FOMC and ECB reversed the more positive sentiment earlier in the week spurred by a slowdown in the consumer-price index, Barclays’s Bradley Rogoff wrote on Friday.
Bloomberg economists Anna Wong, David Wilcox and Eliza Winger wrote that the most striking part of the updated economic projections by the Federal Reserve “is how unified the committee is on the need to raise rates more aggressively – significantly higher than the 4.8% terminal rate markets had priced in ahead of the meeting.”
The losses spanned across all high yield ratings. BB yields rose 11bps to 6.77%, the biggest one- day jump in four weeks. The BB index posted the biggest one-day loss in more than five weeks and ended a six-day gaining streak.
CCC yields rose 13bps to 13.79%. The index posted a loss of 0.37% on Thursday, the most in more than two weeks, after gaining for five straight sessions.
The junk bond primary market has ground to a halt, with just a little over $2b in new bond sales month-to-date, the slowest since December 2018. The rest of the year is expected to be quiet on the new issue front as investors work on the year- end closings.

(Bloomberg) Powell Says Fed Still Has a ‘Ways to Go’ After Half-Point Hike

Chair Jerome Powell said the Federal Reserve is not close to ending its anti-inflation campaign of interest-rate increases as officials signaled borrowing costs will head higher than investors expect next year.
“We still have some ways to go,” he told a press conference on Wednesday in Washington after the Federal Open Market Committee raised its benchmark rate by 50 basis points to a 4.25% to 4.5% target range.
Powell said that the size of the rate increase delivered on Feb. 1 at the Fed’s next meeting would depend on incoming data — leaving the door open to another half-percentage point move or a step down to a quarter point — and he pushed back against bets that the Fed would reverse course next year.
“I wouldn’t see us considering rate cuts until the committee is confident that inflation is moving down to 2% in a sustained way,” he said. “Restoring price stability will likely require maintaining a restrictive policy stance for some time,” he said.
“The committee anticipates that ongoing increases in the target range will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2% over time,” the FOMC said in its statement, repeating language it has used in previous communications.
“It is our judgment today that we are not at a sufficiently restrictive policy stance yet,” the Fed chief said. “We will stay the course until the job is done.”
Powell had previously signaled plans to moderate hikes, while emphasizing that the pace of tightening is less significant than the peak and the duration of rates at a high level.
The decision follows four consecutive 75 basis-point hikes that have boosted rates at the fastest pace since Paul Volcker led the central bank in the 1980s.

09 Dec 2022

High Yield Weekly, Insight Rich Balestra - Portfolio Manager 0 comment

CAM High Yield Weekly Insights

Fund Flows & Issuance: According to a Wells Fargo report, flows week to date were -$0.3 billion and year to date flows stand at -$47.8 billion. New issuance for the week was nil and year to date issuance is at $101.2 billion.

(Bloomberg) High Yield Market Highlights

The recent rally in U.S. junk bonds has been steadily losing steam, edging lower for three consecutive sessions in the run up to a likely modest weekly loss, after warnings from bank chiefs of a slowing economy next year renewed recession fears. The losses extended across ratings as yields rose 17bps week-to-date to 8.55%.
Market tone has softened since mid-October, according to Barclays strategist Bradley Rogoff.
Focus will be on next week’s CPI data and Fed meeting for indications on future rate hikes and terminal rate expectations, wrote Rogoff on Friday.
The rally, though more muted this week, also opened a window for banks to offload a portion of their large hung LBO debt.
A group of banks found willing buyers for $750m of debt tied to the buyout of Citrix Systems.
Thursday end with spread levels of 446 for the high yield market. Spreads by rating: 283 for BB, 464 for B, and 983 for CCC.
Year-to-date the high yield index total return stands at -10.13%.

02 Dec 2022

High Yield Weekly, Insight Rich Balestra - Portfolio Manager 0 comment

CAM High Yield Weekly Insights

Fund Flows & Issuance: According to a Wells Fargo report, flows week to date were -$0.6 billion and year to date flows stand at -$47.5 billion. New issuance for the week was nil and year to date issuance is at $101.2 billion.

(Bloomberg) High Yield Market Highlights

U.S. junk bonds are poised to gain for the fourth straight week, the longest winning streak since mid-August, with yields tumbling to mid-September lows after Federal Reserve Chair Jerome Powell signaled on Wednesday that the central bank will likely slow the pace of interest-rate increases. The biggest gains came on Thursday, when the market saw its best advance in more than three weeks after the Fed’s favored inflation gauge posted a smaller-than-expected monthly advance and data showed a cooling in the manufacturing sector.
The inflation measure, the personal consumption expenditures index, rose 0.3% in October, less than the 0.4% forecast by economists.
The rally that followed the release Thursday drove the junk-bond market to a weekly gain of 0.88% and pushed yields down to 8.43%, a more than 11-week low.
The gains spanned across ratings. CCC yields fell significantly below 14% to close at 13.83%, a more than 11-week low.
CCCs are also headed for the fourth straight week of gains, with week-to-date returns of 0.73%. The 0.99% gains on Thursday were the biggest one-day rally in three weeks.
The recent rally in the junk bond market was also partly fueled by lack of supply. The primary market is expected to largely remain quiet as banks work out of the losses from this year’s leveraged buyout debt.
October was the slowest month for new bond sales since 2008, with a mere $3.7b. November ground to a halt after a promising start to end with a modest $9b, the slowest for that month since 2018.
Year-to-date supply at $95b has also been the lightest in 14 years.
Junk bonds are losing steam early Friday post stronger than expected employment data.

(Bloomberg) Powell Signals Downshift Likely Next Month, More Hikes to Come

Chair Jerome Powell signaled the Federal Reserve will slow the pace of interest-rate increases next month, while stressing borrowing costs will need to keep rising and remain restrictive for some time to beat inflation.
His comments, in a speech Wednesday at the Brookings Institution in Washington, likely cement expectations for the Fed to raise interest rates by 50 basis points when they meet Dec. 13-14, following four straight 75 basis-point moves.
“The time for moderating the pace of rate increases may come as soon as the December meeting,” Powell said in the text of his speech. “Given our progress in tightening policy, the timing of that moderation is far less significant than the questions of how much further we will need to raise rates to control inflation, and the length of time it will be necessary to hold policy at a restrictive level.”
The Fed’s actions — the most aggressive since the 1980s — have lifted the target range of their benchmark rate to 3.75% to 4% from nearly zero in March. Powell said rates are likely to reach a “somewhat higher” level than officials estimated in September, when the median projection was for 4.6% next year. Those projections will be updated at the December meeting.
Investors see the Fed pausing hikes in the second quarter once rates reach about 5%, according to pricing in futures contracts.
Powell said the central bank is forecasting 12-month inflation based on its preferred gauge, the personal consumption expenditures price index, of 6% through October, and a 5% core rate.
There hasn’t been enough strong evidence to make a convincing case that inflation will soon decelerate, he said.
“It will take substantially more evidence to give comfort that inflation is actually declining,” he said. “The truth is that the path ahead for inflation remains highly uncertain.”
He added that “despite the tighter policy and slower growth over the past year, we have not seen clear progress on slowing inflation.”
Powell launched into a discussion of service costs, focusing on scarce supply in the labor market, with the gap in labor-force participation mostly explained by pandemic-era retirements in his view.
“These excess retirements might now account for more than 2 million of the 3 1/2 million shortfall in the labor force,” he said.
He said the labor market is only showing “tentative signs” of what he called “rebalancing,” while wages are “well above” levels consistent with 2% inflation over time.

04 Nov 2022

High Yield Weekly, Insight Rich Balestra - Portfolio Manager 0 comment

CAM High Yield Weekly Insights

Fund Flows & Issuance: According to a Wells Fargo report, flows week to date were $4.7 billion and year to date flows stand at -$55.1 billion. New issuance for the week was $1.5 billion and year to date issuance is at $93.5 billion.

(Bloomberg) High Yield Market Highlights

U.S. junk bonds are set for the biggest weekly loss in six, snapping a two-week gaining streak as yields surge to 9.22% as recession fear spurred a selloff in equities and an extreme inversion in a key portion of the Treasury yield curve. The low-grade market erased most recent gains across ratings. CCCs, the riskiest of junk bonds, posted a loss of 1.04% Thursday, the biggest one-day fall in more than four months. That’s put the notes on track to end a two-week gaining stretch, with a week-to-date drop of 1.08%.
The October rally fueled and lured investors into junk bond market as US high-yield funds reported a cash intake of $4.7b for the week, the third biggest weekly inflow this year.
The cash haul came in at the time of acute shortage of new supply, bolstering secondary market prices as investors looked for new paper. The primary market was mostly quiet until this week.
The rally brought some relief to bankers who have long waited to clear all pending deals to fund leveraged buyout. Apollo’s Tenneco was the first to get out of the gate earlier this week. Nielsen Holdings, a US TV rating business firm, kicked off a bond sale Wednesday to fund its buyout by Elliott Investment Management and Brookfield Asset Management.
Satellite TV company Dish Network also jumped into the market Wednesday to start marketing 5-year notes to fund the build-out of wireless infrastructure, among other purposes.
The rally was sapped after the Federal Reserve signaled a higher terminal rate against a backdrop of slowing growth.
Despite continued near-term pressures Morgan Stanley expects a “significant deceleration in the inflation path” to take hold by mid-2023, Morgan Stanley’s Srikanth Sankaran wrote last week.

(Bloomberg) Powell Sees Higher Peak for Rates, Path to Slow Tempo of Hikes

Federal Reserve Chair Jerome Powell opened a new phase in his campaign to regain control of inflation, saying US interest rates will go higher than earlier projected, but the path may soon involve smaller hikes.
Addressing reporters Wednesday after the Fed raised rates by 75 basis points for the fourth time in a row, Powell said “incoming data since our last meeting suggests that ultimate level of interest rates will be higher than previously expected.”
Powell said it would be appropriate to slow the pace of increases “as soon as the next meeting or the one after that. No decision has been made,” he said, while stressing that “we still have some ways” before rates were tight enough.
“It is very premature to be thinking about pausing,” he said.
The Federal Open Market Committee said that “ongoing increases” will still likely be needed to bring rates to a level that are “sufficiently restrictive to return inflation to 2% over time,” in fresh language added to their statement after a two-day meeting in Washington.
The Fed’s unanimous decision lifted the target for the benchmark federal funds rate to a range of 3.75% to 4%, its highest level since 2008.
“Slower for longer,” declared JP Morgan Chase & Co, chief US economist Michael Feroli in a note to clients. “The Fed opened the door to dialing down the size of the next hike but did so without easing up financial conditions.”
Officials, as expected, said they will continue to reduce their holdings of Treasuries and mortgage-backed securities as planned.
The higher rates go, the harder the Fed’s job becomes. Having been criticized for missing the stubbornness of the inflation surge, officials know that monetary policy works with a lag and that the tighter it becomes the more it not only slows inflation, but economic growth and hiring too.
Still, Powell stressed that they would not blink in their efforts to get inflation back down to their 2% target.
“The historical record cautions strongly against prematurely loosening policy,” he said. “We will stay the course, until the job is done.”
Fed forecasts in September implied a 50 basis points move in December, according to the median projection. Those projections showed rates reaching 4.4% this year and 4.6% next year, before cuts in 2024. Powell’s remarks made clear that the peak signaled in that projection would be higher if it came at this meeting.
No fresh estimates were released at this meeting and they won’t be updated again until officials gather Dec. 13-14, when they will have two more months of data on employment and consumer inflation in hand.

28 Oct 2022

High Yield Weekly, Insight Rich Balestra - Portfolio Manager 0 comment

CAM High Yield Weekly Insights

Fund Flows & Issuance: According to a Wells Fargo report, flows week to date were $3.7 billion and year to date flows stand at -$59.9 billion. New issuance for the week was nil and year to date issuance is at $92.0 billion.

(Bloomberg) High Yield Market Highlights

U.S. junk bonds are headed for their biggest weekly gain in more than three months after a four-session rally as investors flooded the market with cash looking for new paper. A gauge of the debt rose 0.57% Thursday, the biggest one-day gain in more than three weeks. It was headed for the best week since June, up 1.93% so far this week. The rally was partly fueled by investors returning to the asset class as US high-yield funds reported a cash influx of $3.7b for the week.
The cash haul came at a time when the junk bond primary market faced an acute shortage of new supply, helping to bolster secondary-market prices.
October supply is down by more than 85% from 2021; The year-to-date supply is the lowest since 2008 at $92b, versus more than $415b for the same period last year.
The recent rally in junk bonds suggests the high-yield market is slowly coming around to the view that inflation’s pace is slowing and may begin to decline in the middle 2023.
Despite continued near-term pressure, Morgan Stanley expects a “significant deceleration in the inflation path” to take hold by mid-2023, Srikanth Sankaran wrote on Monday.
A potential window of respite from rates volatility and a more dispersed period of earnings risk should help to provide tactical support for credit markets, Sankaran wrote.
Amid this issuance-starved market, a group of banks led by Citigroup may sell as soon as next month part of a leveraged loan that’s financing Apollo’s buyout of Tenneco, according to people with knowledge of the matter.
The rally extended across all high yield ratings. Yields tumbled to a five-week low of 9.12% after falling for five sessions in a row, the longest declining streak in almost three months. Yields fell 56bps in the last four sessions.
Single B and BB rated bond yields also fell to a five-week low of 9.35% and 7.33%, respectively.
CCCs, the riskiest of junk bonds are up 1.52% this week as of Thursday, set for the biggest weekly advance in almost three months. CCC yields dropped 38bps this week to close at 15.44%, a more than two-week low.

14 Oct 2022

High Yield Weekly, Insight, Uncategorized Rich Balestra - Portfolio Manager 0 comment

CAM High Yield Weekly Insights

Fund Flows & Issuance: According to a Wells Fargo report, flows week to date were -$1.0 billion and year to date flows stand at -$61.7 billion. New issuance for the week was $1.2 billion and year to date issuance is at $89.6 billion.

(Bloomberg) High Yield Market Highlights

U.S. junk bonds shrugged off the equity rally as yields climbed toward 10%. CCC yields, the riskiest of junk bonds, jumped to a 30-month high of 15.79% after core US inflation rose by more than forecast, pressuring the Federal Reserve to keep raising interest rates again. Junk bonds are set to end the week with a decline, heading for a fourth weekly loss in five. The bonds were down 1.2% so far this week as yields rose to 9.70%.
The rise in core consumer price index only reinforced the Fed officials’ commitment to raise rates to a restrictive level in the near term and holding them there to curb inflation.
The heightened asset volatility, as the Fed is expected to hike another 75bp in November with core inflation at multi-decade highs, increases tail risks for the economy and markets, Barclays’s Brad Rogoff wrote on Friday.
The losses spanned across ratings in junk bond market, with CCCs posting losses of 1.44% week-to- date, the most in two weeks.
Macro volatility, steady losses and continuing concern that the Fed may disrupt growth rattled junk bond investors.
The high yield primary market volume has been low amid rising cost of debt.
Third quarter supply was a modest $19b, the lowest 3Q volume since 2008.
New bond sales in September totaled $9b, the slowest September since 2011.
Year-to- date volume was at $88b, the lowest since 2008 and down about 78% from 2021.

(Bloomberg) Core US Inflation Rises to 40-Year High, Securing Big Fed Hike

A closely watched measure of U.S. consumer prices rose by more than forecast to a 40-year high in September, pressuring the Federal Reserve to raise interest rates even more aggressively to stamp out persistent inflation.
The core consumer price index, which excludes food and energy, increased 6.6% from a year ago, the highest level since 1982, Labor Department data showed Thursday. From a month earlier, the core CPI climbed 0.6% for a second month.
The overall CPI increased 0.4% last month, and was up 8.2% from a year earlier.
The advance was broad based. Shelter, food and medical care indexes were the largest of “many contributors,” the report said. Prices for gasoline and used cars declined.
On the heels of a solid jobs report last week, the inflation data likely cement an additional 75-basis point interest rate hike at the Fed’s November policy meeting and spurred speculation for a fifth-straight increase of that size in December. Traders also priced in a higher peak Fed rate for next year.
Policy makers have responded with the most aggressive tightening campaign since the 1980s, but so far, the labor market and consumer demand have remained resilient. The unemployment rate returned to a five-decade low in September, and businesses continue to raise pay to attract and retain the employees needed to meet household demand.
The CPI report is the last one before next month’s U.S. midterm elections and poses fresh challenges to President Joe Biden and Democrats as they seek to retain thin congressional majorities. Already, the surge in inflation has posed a serious threat to those prospects.
Shelter costs — which are the biggest services’ component and make up about a third of the overall CPI index — rose 0.7% for a second month. Both rent of shelter and owners’ equivalent rent were up 6.7% on an annual basis, the most on record.
Economists see the housing components of the report as being elevated for quite some time, given the lag between real-time changes in rents and home prices and when those are reflected in Labor Department data. Bloomberg Economics doesn’t expect year-over-year rates for the major shelter components to peak until well into the second half of next year.
While the Fed bases its 2% target on a separate inflation measure from the Commerce Department — the personal consumption expenditures price index — the CPI is closely watched by policy makers, traders and the public.
Fed officials have repeatedly emphasized in recent weeks the need to get inflation under control, even if that means higher unemployment and a recession. In minutes from their September meeting released Wednesday, many policy makers emphasized “the cost of taking too little action to bring down inflation likely outweighed the cost of taking too much action.”

12 Oct 2022

High Yield Quarterly, Insight Rich Balestra - Portfolio Manager 0 comment

2022 Q3 High Yield Quarterly

In the third quarter of 2022, the Bloomberg US Corporate High Yield Index (“Index”) return was ‐0.65% bringing the year to date (“YTD”) return to ‐14.74%. The S&P 500 stock index return was ‐4.89% (including dividends reinvested) for Q3, and the YTD return stands at ‐23.88%.

The 10 year US Treasury rate (“10 year”) generally marched higher after a small dip in July as the rate finished at 3.83%, up 0.82% from the beginning of the quarter. Over the period, the Index option adjusted spread (“OAS”) tightened 17 basis points moving from 569 basis points to 552 basis points. The higher quality segments of the High Yield Market participated in the spread tightening as BB rated securities tightened 50 basis points, and B rated securities tightened 12 basis points. Meanwhile, CCC rated securities widened 61 basis points. The chart below from Bloomberg displays the spread moves in the Index over the past ten years with an average level of 430 basis points.

The Energy, Transportation, and Other Industrial sectors were the best performers during the quarter, posting returns of 1.28%, 1.20%, and 0.54%, respectively. On the other hand, Banking, Consumer Non‐Cyclical, and Brokerage were the worst performing sectors, posting returns of ‐3.91%, ‐2.82%, and ‐2.06%, respectively. At the industry level, aerospace and defense, refining, and gaming all posted the best returns. The aerospace and defense industry posted the highest return 3.49%. The lowest performing industries during the quarter were pharma, healthcare REIT, and retailers. The pharma industry posted the lowest return ‐9.57%. Crude oil has continued trending lower as can be seen on the chart at the left. OPEC+ members just met and agreed to cut oil production by two million barrels per day in a bid to help support the price of oil in the face of a weakening global economy. However, it is noted that the impact to supply is likely to be smaller than the headline number. “OPEC and its partners have been meeting online on a monthly basis and weren’t expected to arrange an inperson gathering until at least the end of this year. The slump in prices may have been what prompted the change of tack, requiring the first face‐to‐face talks since 2020.”ⁱ

The primary market remained very subdued during the third quarter. The weak market led to year‐to‐date issuance of $95.2 billion and $19.6 billion in the quarter. That is the lowest quarter of issuance in four years. Discretionary took 37% of the market share followed by Technology at a 28% share. Currently, there isn’t much concern for lack of capital access due to issuers being so proactive with refinancing in the past few years. In fact, only about $50 billion in high yield bonds are due to mature from now through the end of 2023.

After the Federal Reserve lifted the Target Rate by 0.75% at their June meeting, Fed Chair Jerome Powell acknowledged that the hike was “an unusually large one.” It may have been a large one, but apparently it was not enough as the Fed raised an additional 0.75% at both the July and September meetings. For those keeping score, that brings the Fed to 300 basis points of raises this year.

The dot plot chart shows how the Fed projections of the 2022 year‐end Target Rate have evolved over the past year. The Fed was clearly behind the curve and now believes stuffing the market with three consecutive “unusually large” hikes in a singular bid to break inflation is the appropriate move, notwithstanding all the other consequences. “We have always understood that restoring price stability while achieving a relatively modest increase in unemployment and a soft landing would be very challenging,” Powell said. “We have got to get
inflation behind us. I wish there were a painless way to do that. There isn’t.”ⁱⁱ Based on the Fed’s Summary of Economic Projections, they accept that the continuing rate hikes are going to lower growth and push up unemployment.

Intermediate Treasuries increased 82 basis points over the quarter, as the 10‐year Treasury yield was at 3.01% on June 30th, and 3.83% at the end of the third quarter. The 5‐year Treasury increased 105 basis points over the quarter, moving from 3.04% on June 30th, to 4.09% at the end of the third quarter. Intermediate term yields more often reflect GDP and expectations for future economic growth and inflation rather than actions taken by the FOMC to adjust the Target Rate. The revised second quarter GDP print was ‐0.6% (quarter over quarter annualized rate). Looking forward, the current consensus view of economists suggests a GDP for 2022 around 1.6% with inflation expectations around 8.0%.ⁱⁱⁱ

Being a more conservative asset manager, Cincinnati Asset Management Inc. does not buy CCC and lower rated securities. Additionally, our interest rate agnostic philosophy keeps us generally positioned in the five to ten year maturity timeframe. Due to the continued rate moves, this positioning was a detractor of performance in the quarter as short‐end maturities outperformed. Further, our credit selections within communications and energy were a drag on performance. Benefiting our performance was our lack of exposure to pharma and our credit selections within healthcare. All totaled, the CAM High Yield Composite Q3 net of fees total return of ‐1.38% underperformed the Index. The Composite YTD net of fees total return of ‐17.06% also underperformed the Index.

The Bloomberg US Corporate High Yield Index ended the third quarter with a yield of 9.68%. Equity volatility, as measured by the Chicago Board Options Exchange Volatility Index (“VIX”), had an average of 25 over the quarter moving from a low of 20 in mid‐August to a high of 32 atthe end of September. For context, the average was 15 over the course of 2019, 29 for 2020, and 19 for 2021. The third quarter had two bond issuers default on their debt. The trailing twelve month default rate stands at 0.83%.iv The current default rate is relative to the 0.92%, 0.27%, 0.23%, 0.86% default rates from the previous four quarter end data points listed oldest to most recent. The fundamentals of high yield companies still look good considering the economic backdrop. From a technical view, fund flows were positive in July but negative in August and September. The 2022 year-to‐date outflow stands at $61.5 billion.^v Without question there has been a fair amount of damage in bond markets so far this year. It is important to remember that bonds are a contractual agreement with a defined maturity date. Thus, despite price volatility, without default, par will be paid at the stated maturity date. Currently, defaults are quite low and fundamentals are still providing a cushion. No doubt there are risks, but
we are of the belief that for clients that have an investment horizon over a complete market cycle, high yield deserves to be considered as part of the portfolio allocation.

As we move into the last quarter of 2022, fixed income markets remain pressured as the Fed continues raising the Target Rate. The US dollar has been moving higher all year. Over 80% of central banks around the world are now hiking, the highest percentage on record.vi Japan has taken to currency intervention. The Bank of England is hiking while the British government is pushing through their largest tax cut package since 1972. Citi’s London team commented that euro credit markets are disorderly. Subsequently, the Bank of England started buying gilts while some of the tax cut package was walked back. Back in the US with the message from the Fed steadfast, caution is warranted as uncertainty remains around the cycle’s terminal rate and the resulting depth of an intentional economic slowdown. Markets have been roughed up this year, but brighter days will eventually appear. As this cycle plays out, current uncertainty and volatility can create opportunities that lead back to positive returns. Our exercise of discipline and selectivity in credit selections is important as we continue to evaluate that the given compensation for the perceived level of risk remains appropriate. As always, we will continue our search for value and adjust positions as we uncover compelling situations. Finally, we are very grateful for the trust placed in our team to manage your capital.

The information provided in this report should not be considered a recommendation to purchase or sell any particular security. There is no assurance that any securities discussed herein will remain in an account’s portfolio at the time you receive this report or that securities sold have not been repurchased. The securities discussed do not represent an account’s entire portfolio and in the aggregate may represent only a small percentage of an account’s portfolio holdings. It should not be assumed that any of the securities transactions or holdings discussed were or will prove to be profitable, or that the investment decisions we make in the future will be profitable or will equal the investment performance of the securities discussed herein.

i Bloomberg October 4, 2022: OPEC+ Considers Output Limit Cut
ii Bloomberg September 22, 2022: Powell Signals Recession May Be the Price for Crushing Inflation
iii Bloomberg October 3, 2022: Economic Forecasts (ECFC)
iv JP Morgan October 3, 2022: “Default Monitor”
v Wells Fargo September 29, 2022: “Credit Flows”
vi Goldman Global Markets Insights September 23, 2022: Markets/Macro

07 Oct 2022

High Yield Weekly, Insight, Uncategorized Rich Balestra - Portfolio Manager 0 comment

CAM High Yield Weekly Insights

Fund Flows & Issuance: According to a Wells Fargo report, flows week to date were $0.8 billion and year to date flows stand at -$60.7 billion. New issuance for the week was nil and year to date issuance is at $88.3 billion.

(Bloomberg) High Yield Market Highlights

U.S. junk bonds were headed for a weekly gain heading into the jobs report on Friday morning, as yields moved to 9.13% from 9.88%, the highest since April 2020.
The gains came amid weak US manufacturing data and a 14-month low in US job openings.
The junk-bond rally followed a broad risk-on move as equities rebounded from the worst monthly loss in more than two years in September.
Still, the gains may be short-lived as Fed officials warn that market expectations for a pivot are misplaced and that there’s a need to boost rates to “restrictive territory.”
Continuing macro uncertainty, rising oil prices and steadily rising yields have turned issuers away from the primary market.
The sudden rally in junk bonds after the September losses brought investors back to the asset class with a cash inflow of just under $1b this week.

(Bloomberg) US Jobs Rise While Unemployment Drops, Keeping Pressure on Fed

U.S. employers continued to hire at a solid pace last month and the jobless rate unexpectedly returned to a historic low, indicating a sturdy labor market that puts the inflation-focused Federal Reserve on course for another outsize interest-rate hike.
Nonfarm payrolls increased 263,000 in September after a 315,000 gain in August, a Labor Department report showed Friday. The unemployment rate unexpectedly dropped to 3.5%, matching a five-decade low. Average hourly earnings rose firmly.
The median estimates in a Bloomberg survey of economists called for a 255,000 advance in payrolls and for the unemployment rate to hold at 3.7%. Hiring was relatively broad based, led by gains in leisure and hospitality and health care.
The figures are the latest illustration of the perennial strength of the US job market. While there have been some indications of moderating labor demand — most notably a recent decline in job openings and an uptick in layoffs in some sectors — employers, many still short-staffed, continue to hire at a solid pace. That strength is not only underpinning consumer spending but also fueling wage growth as businesses compete for a limited pool of workers.
The Fed, meanwhile, is hoping to see a significant softening in labor market conditions, with the goal of cooling wage growth and ultimately inflation. While the payrolls advance was the smallest since April 2021, policy makers are watching to see if their rate hikes spur an increase in the unemployment rate.
This is the last jobs report Fed officials will have in hand before their November policy meeting as they consider a fourth-straight 75-basis point interest-rate hike. Fresh inflation data out next week will also play a fundamental role in their decision making. The report is projected to show the depth and breadth of the Fed’s inflation problem, with a key gauge of consumer prices potentially worsening.
The labor force participation rate — the share of the population that is working or looking for work — eased to 62.3%. Among those ages 25 to 54, it also dipped.
The jobs report showed average hourly earnings were up 0.3% from August and up 5% from a year earlier, a slight deceleration from the prior month but still historically elevated. The solid increase suggests the Fed will have to continue to raise interest rates as it aims to rein in rapid wage growth that has bolstered household spending.
Central bank officials have been clear recently about their commitment to taming inflation, even if that leads to higher unemployment and recession, because they say that failing to do so would be worse for Americans. Fed Chair Jerome Powell said last month that slower growth and a softer labor market are painful for the public, but that there isn’t a “painless” way to get inflation down.

16 Sep 2022

High Yield Weekly, Insight Rich Balestra - Portfolio Manager 0 comment

CAM High Yield Weekly Insights

Fund Flows & Issuance: According to a Wells Fargo report, flows week to date were $0.1 billion and year to date flows stand at -$54.8 billion. New issuance for the week was $3.0 billion and year to date issuance is at $82.3 billion.

(Bloomberg) High Yield Market Highlights

U.S. junk bonds are headed for a weekly loss to end the August rebound after a higher-than-expected inflation reading on Tuesday triggered a broad market selloff. Yields surged to a two-month high of 8.61% after steadily rising for three straight sessions, pushing the week-to-date loss to 1.5%.
The losses extended across ratings in the U.S. high yield market, with CCCs leading the pack with the worst week-to- date loss of 1.7%, after sliding for three consecutive sessions. Yields rose to a two-week high of 13.72% and spreads were approaching distressed levels.
The primary market was suddenly jolted after the CPI data earlier in the week fueled concerns that the Federal Reserve may need to raise benchmark interest rate by even 100bps to tame inflation and trigger a recession.
The primary market may pause after the Citrix debt sale was used to assess the risk appetite and clearing price levels for new debt amid rising rates and slowing economy. Nielsen Holdings and Tenneco are among the other leveraged buyouts in the queue to sell debt at some point.

(Bloomberg) Inflation Surprise Puts Onus on Fed to Hit Brakes Even Harder

The U.S. economy has shown surprising resilience in the face of the fastest inflation and interest-rate hikes in a generation. That means the Federal Reserve will have to stomp even harder on demand.
What started as a pandemic-driven supply shock has morphed into widespread inflation rooted just as much in resilient demand, underscored by unexpectedly high numbers that dashed hopes price gains were ebbing. While consumers are showing some signs of slowing, they’re still largely keeping up with persistent price pressures, powered by historic wage gains.
All told, the Fed has a much harder task on its hands than previously thought. If Americans won’t dial back spending further, odds favor the central bank becoming that much more aggressive to take more wind out of the economy’s sails with the goal of bringing inflation down.
“It tells you that it’s going to take a longer time, and will require higher rates — and in macro language, maybe even require more demand destruction,” as in higher unemployment and slower growth, said Torsten Slok, chief economist at Apollo Management. “It raises the probability of a recession.”
Consumer prices advanced by more than forecast in August, defying expectations for a monthly drop due to falling gasoline prices. Shelter, food and medical care were among the largest contributors to price growth, underscoring the breadth and severity of inflation with several categories posting record increases.
“My experience with inflation is that some of the components that were very strong in today’s report, they tend to be sticky and have a lot of inertia,” like rent, said Blerina Uruci, U.S. economist at T. Rowe Price Associates. “So I would expect those to remain pretty strong in the coming months.”
The Atlanta Fed’s so-called sticky CPI measure rose 6.1% in August from a year ago, the biggest gain in 40 years. Meantime, the Cleveland Fed’s median CPI, which excludes categories with the largest price changes, increased by the most in data back to 1983.
Excluding the volatile food and energy categories, the so-called core CPI climbed 0.6% from July, double the median estimate in a Bloomberg survey of economists. The core measure rose 6.3% from a year ago, the first acceleration in six months and near a four-decade high, the Labor Department’s report showed.
“The composition is even more troubling than the aggregate reading,” Stephen Stanley, chief economist at Amherst Pierpont Securities, said in a note. “Outside of falling gasoline prices, inflation appears to be just as hot as ever, which means that the Fed still has plenty of work to do.”
It also means that the Biden administration and fellow Democrats have plenty of work to do, as the latest data may threaten what had been growing optimism in the party that they would hold their congressional majorities in November.
Traders are now fully expecting the central bank to raise interest rates by another 75 basis points when policy makers meet next week, which would be the third-straight hike of that size. They’re also upping bets that officials will go bigger at their November gathering and see the tightening cycle peaking around 4.3% early next year — more than a quarter-point higher than what was projected before the CPI report.
Chair Jerome Powell has communicated a stronger resolve to stamp out inflation since the Fed’s summit in Jackson Hole last month, signaling that the central bank is likely to keep raising interest rates and leave them elevated for a while. He’s stuck to that hawkish view and several of his colleagues also support hiking rates to a point that more clearly restricts demand.

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