Category: High Yield Quarterly

24 Jan 2024

2023 Q4 High Yield Quarterly

In the fourth quarter of 2023, the Bloomberg US Corporate High Yield Index (“Index”) return was 7.16% bringing the year to date (“YTD”) return to 13.44%.  The S&P 500 index return was 11.68% (including dividends reinvested) bringing the YTD return to 26.26%.  Over the period, while the 10 year Treasury yield decreased 69 basis points, the Index option adjusted spread (“OAS”) tightened 71 basis points moving from 394 basis points to 323 basis points.

All ratings segments of the High Yield Market participated in the spread tightening as BB rated securities tightened 63 basis points, B rated securities tightened 89 basis points, and CCC rated securities tightened 72 basis points.  The chart below from Bloomberg displays the spread moves in the Index over the past five years.  For reference, the average level over that time period was 413 basis points.

The sector and industry returns in this paragraph are all Index return numbers.  The Index is mapped in a manner where the “sector” is broader with the more specific “industry” beneath it.  For example, Energy is a “sector” and the “industries” within the Energy sector include independent energy, integrated energy, midstream, oil field services, and refining.  The Brokerage, Banking, and Finance sectors were the best performers during the quarter, posting returns of 11.80%, 9.37%, and 8.40%, respectively.  On the other hand, Transportation, Energy, and Other Industrial were the worst performing sectors, posting returns of 4.25%, 5.24%, and 6.53%, respectively.  At the industry level, retailers, media, and building materials all posted the best returns.  The retailers industry posted the highest return of 10.03%.  The lowest performing industries during the quarter were oil field services, airlines, and independent energy.  The oil field services industry posted the lowest return of 3.10%.

While there was a dearth of issuance during 2022 as interest rates rapidly increased and capital structures were previously refinanced, the primary market perked up a bit during each quarter this year.  Issuance has remained low by historical standards as so much was pushed out by the large issuance during 2020 and 2021.  For 2024, strategists are looking for issuance in the range of $200-$230 billion.  Of the issuance that did take place during Q4, Finance took 29% of the market share followed by Energy at 28% share and Industrials at 13% share.

The Federal Reserve did hold the Target Rate steady at the November and December meetings.  There was no meeting held in October.  This made three consecutive meetings without a hike.  The last hike was back in July.  For the first time since March of 2021, the Fed is not projecting additional hikes.  In fact, the Fed dot plot shows that Fed officials are forecasting 75 basis points in cuts during 2024.  It sure seems like the worm has finally turned and the market is responding positively.  During the December post meeting press conference, Chair Powell did pay lip service to the ability to hike again if needed, but the focus moved to rate cuts.  With regard to when it will become appropriate to cut rates, Powell said “That begins to come into view and is clearly a topic of discussion out in the world and also a discussion for us at our meeting today.”i  The Fed’s main objective has been lowering inflation and it continues to trend in the desired direction.  The most recent report for Core CPI showed a year over year growth rate of 4.0% down from a peak of 6.6% over one year ago.  Further, the most recent Core PCE growth rate measured 3.2% off the peak of 5.6% from February of 2022.

Intermediate Treasuries decreased 69 basis points over the quarter, as the 10-year Treasury yield was at 4.57% on September 30th, and 3.88% at the end of the fourth quarter.  The 5-year Treasury decreased 76 basis points over the quarter, moving from 4.61% on September 30th, to 3.85% at the end of the fourth 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 4.9% (quarter over quarter annualized rate).  Looking forward, the current consensus view of economists suggests a GDP for 2024 around 1.3% with inflation expectations around 2.6%.ii

Being a more conservative asset manager, Cincinnati Asset Management 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.  During Q4, Index performance was very strong leading to our cash position being a drag on performance.  Additional performance drag was due to our credit selections within banking and brokerage as we positioned in high quality credits in those sectors.  Benefiting our performance this quarter were our credit selections in capital goods, technology, and electric utilities.

The Bloomberg US Corporate High Yield Index ended the fourth quarter with a yield of 7.59%.  Treasury volatility, as measured by the Merrill Lynch Option Volatility Estimate (“MOVE” Index), has picked up quite a bit the past couple of years.  The MOVE averaged 121 during 2023 relative to a 62 average over 2021.  However, the current rate of 114 is well below the spike near 200 back in March during the banking scare.  Data available through November shows 39 defaults during 2023 which is up from 16 defaults during all of 2022.  The trailing twelve month dollar-weighted default rate is 2.46%.iii  The current default rate is relative to the 1.14%, 1.30%, 1.74%, 1.93% default rates from the previous four quarter end data points listed oldest to most recent.  While defaults are ticking up, the fundamentals of high yield companies still look good.  From a technical view, fund flows were positive in the quarter at $6.7 billion and total -$22.6 billion YTD.iv  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.

What a difference several months can make.  Not too long ago 10 year rates were at 15 year highs topping out close to 5%.  Today the 10 year rate is just under 4%.  Crude oil was over $90 per barrel and now it is a touch over $70 per barrel.  As we move forward in 2024, the labor market is holding up but cooling as job seekers are beginning to struggle to find work.  Consumer delinquencies have been ticking up across most loan categories while savings have dwindled and the savings rate remains below average.v  No doubt that this softness is being taken into account by market participants.  That is the reason for the lower GDP projections and the Fed talking potential cuts at this point in time.  Our exercise of discipline and credit selectivity 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 December 13, 2023:  Fed Pivots to Rate Cuts

ii Bloomberg January 2, 2024: Economic Forecasts (ECFC)

iii Moody’s December 14, 2023:  November 2023 Default Report and data file

iv CreditSights December 21, 2023:  “Credit Flows”

v Moody’s December 2023:  State of the US Consumer

08 Oct 2023

2023 Q3 High Yield Quarterly

In the third quarter of 2023, the Bloomberg US Corporate High Yield Index (“Index”) return was 0.46% bringing the year to date (“YTD”) return to 5.86%.  The S&P 500 index return was -3.27% (including dividends reinvested) bringing the YTD return to 13.06%.  Over the period, while the 10 year Treasury yield increased 73 basis points, the Index option adjusted spread (“OAS”) widened 4 basis points moving from 390 basis points to 394 basis points.

All ratings segments of the High Yield Market participated in the spread widening as BB rated securities widened 12 basis points, B rated securities widened 1 basis point, and CCC rated securities widened 10 basis points.  The chart below from Bloomberg displays the spread moves in the Index over the past five years.  For reference, the average level over that time period was 414 basis points.

The sector and industry returns in this paragraph are all Index return numbers.  The Index is mapped in a manner where the “sector” is broader with the more specific “industry” beneath it.  For example, Energy is a “sector” and the “industries” within the Energy sector include independent energy, integrated energy, midstream, oil field services, and refining.  The Banking, Brokerage, and Other Financial sectors were the best performers during the quarter, posting returns of 3.18%, 2.56%, and 1.96%, respectively.  On the other hand, Electric Utilities, Transportation, and REITs were the worst performing sectors, posting returns of -0.97%,  -0.69%, and -0.46%, respectively.  At the industry level, oil field services, cable, and independent energy all posted the best returns.  The oil field services industry posted the highest return of 3.40%.  The lowest performing industries during the quarter were office REITs, healthcare REITs, and health insurance.  The office REITs industry posted the lowest return of -5.32%.

While there was a dearth of issuance during 2022 as interest rates rapidly increased and capital structures were previously refinanced, the primary market perked up a bit during each quarter this year.  Issuance has remained low by historical standards as so much was pushed out by the large issuance during 2020 and 2021.  Of the issuance that did take place during Q3, Energy took 21% of the market share followed by Discretionary at 17% share and Healthcare at a 12% share.

The Federal Reserve did lift the Target Rate by 0.25% at the July meeting but took a pause at the September meeting.  There was no meeting held in August.  This was the second rate pause, the first being June of this year, during the current 525 basis points hiking cycle that began in March of 2022.  A few of the main takeaways from the September meeting and press conference:  inflation is still too high, the job market is still too tight, the Fed is just about done with the rate hikes, the Fed remains data dependent but expects rates to stay higher for longer.  “We’re fairly close, we think, to where we need to get,” Chair Powell said.  “We are committed to achieving and sustaining a stance of monetary policy that is sufficiently restrictive to bring inflation down to our 2% goal over time,” Powell said at a press conference following the decision.i  Inflation gauges are certainly off their peaks and moving in the proper direction.  The most recent report for Core CPI showed a year over year growth rate of 4.3% down from a peak of 6.6% one year ago.  Further, the most recent Core PCE growth rate measured 3.9% off the peak of 5.6% from February of 2022.

Intermediate Treasuries increased 73 basis points over the quarter, as the 10-year Treasury yield was at 3.84% on June 30th, and 4.57% at the end of the third quarter.  The 5-year Treasury increased 45 basis points over the quarter, moving from 4.16% on June 30th, to 4.61% 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 2.1% (quarter over quarter annualized rate).  Looking forward, the current consensus view of economists suggests a GDP for 2023 around 2.1% with inflation expectations around 4.1%.ii

Being a more conservative asset manager, Cincinnati Asset Management 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.  During Q3, Index performance was once again tilted toward the lowest rated end of the market.  Further, Index performance was heavily tilted toward short duration as all duration buckets over a three year duration underperformed.  Our credit selections within the consumer sectors and aerospace/defense were also a drag to performance.  Benefiting our performance this quarter were our overweights in banking and energy, and our credit selections in airlines and independent energy.

The Bloomberg US Corporate High Yield Index ended the third quarter with a yield of 8.88%.  Treasury volatility, as measured by the Merrill Lynch Option Volatility Estimate (“MOVE” Index), has picked up quite a bit the past couple of years.  The MOVE has averaged 121 during 2023 relative to a 62 average over 2021.  However, the current rate of 113 is well below the spike near 200 back in March during the banking scare. Data available through August shows 33 defaults during 2023 which is up from 16 defaults during all of 2022.  The trailing twelve month dollar-weighted default rate is 1.86%.iii The current default rate is relative to the 1.10%, 1.14%, 1.30%, 1.74% default rates from the previous four quarter end data points listed oldest to most recent.  While defaults are ticking up, the fundamentals of high yield companies still look good.  From a technical view, fund flows were negative in the quarter at -$1.8 billion and total -$27.9 billion YTD.iv 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.

The data dependent Fed will continue to remain a large part of the story as 2023 works its way toward year end.  The data will in fact continue to flow as Congress averted a government shutdown with a last minute agreement.  Had the shutdown taken place, some of the data the Fed looks to would not have been available.  In reality, Congress just kicked the can down the road to buy less than two months of additional time to work on a more substantial funding package.  Adding to the current wall of worry are 10 year rates that are at 15 year highs, oil has ripped higher by $20 per barrel over the past three months, and cracks are seemingly starting to show for the US Consumer.  Credit card delinquencies are at the highest level in more than a decade, and a recent report from Moody’s stated, “consumer debt quality is declining.”  Our exercise of discipline and credit selectivity 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 September 20, 2023:  Fed Leaves Rates Unchanged

ii Bloomberg October 2, 2023: Economic Forecasts (ECFC)

iii Moody’s September 15, 2023:  August 2023 Default Report and data file

iv CreditSights September 28, 2023:  “Credit Flows”

14 Jul 2023

2023 Q2 High Yield Quarterly

In the second quarter of 2023, the Bloomberg US Corporate High Yield Index (“Index”) return was 1.75% bringing the year to date (“YTD”) return to 5.38%.  The S&P 500 index return was 8.74% (including dividends reinvested) bringing the YTD return to 16.88%.  Over the period, while the 10 year Treasury yield increased 37 basis points, the Index option adjusted spread (“OAS”) tightened 65 basis points moving from 455 basis points to 390 basis points.

All ratings segments of the High Yield Market participated in the spread tightening as BB rated securities tightened 31 basis points, B rated securities tightened 67 basis points, and CCC rated securities tightened 136 basis points.  The chart below from Bloomberg displays the spread moves in the Index over the past five years.  For reference, the average level over the five years is 411 basis points.

The sector and industry returns in this paragraph are all index return numbers.  The Other Industrial, Finance Companies, and REITs sectors were the best performers during the quarter, posting returns of 3.90%, 3.66%, and 3.44%, respectively.  On the other hand, Banking, Electric Utilities, and Other Financial were the worst performing sectors, posting returns of -1.68%, -0.26%, and -0.09%, respectively.  At the industry level, retailers, leisure, and retail REITs all posted the best returns.  The retailers industry posted the highest return of 6.39%.  The lowest performing industries during the quarter were wireless, life insurance, and paper.  The wireless industry posted the lowest return of -2.67%.

While there was a dearth of issuance during 2022 as interest rates rapidly increased and capital structures were previously refinanced, the primary market perked up a bit during the second quarter this year.  Of the issuance that did take place, Energy took 23% of the market share followed by Discretionary at an 18% share and Financials at a 15% share.

The Federal Reserve did lift the Target Rate by 0.25% at the May meeting but took a pause at the June meeting.  This was the first rate pause during the current 15 month long hiking cycle where the Fed has hiked by 500 basis points.  With inflation still too high and the labor market still too tight, Chair Jerome Powell has provided a clear message that additional hikes this year are to be expected.  “A strong majority of committee participants expect that it will be appropriate to raise interest rates two or more times by the end of the year,” Powell said, referencing the policy-setting Federal Open Market Committee during a conference at the end of June.  “Inflation pressures continue to run high, and the process of getting inflation back down to 2% has a long way to go.”i  Powell did acknowledge that the outlook is “particularly uncertain” and noted that the Fed will pay close attention to ongoing economic data releases.  With regard to the banking turmoil that started back in March, Powell suggested that more supervision and regulation is likely needed but did note that the US banking system is “strong and resilient.”  At this point, treasury rates and high yield spreads are about where they were prior to the banking scare.

 

Intermediate Treasuries increased 37 basis points over the quarter, as the 10-year Treasury yield was at 3.47% on March 31st, and 3.84% at the end of the second quarter.  The 5-year Treasury increased 59 basis points over the quarter, moving from 3.57% on March 31st, to 4.16% at the end of the second 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 first quarter GDP print was 2.0% (quarter over quarter annualized rate).  Looking forward, the current consensus view of economists suggests a GDP for 2023 around 1.3% with inflation expectations around 4.3%.[ii]

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.  During Q2, Index performance was once again tilted toward the lowest rated end of the market as there was a mostly risk-on tone in the quarter.  Additionally, given the positive quarterly return of the Index, our natural cash position was a drag on performance for Q1.  Our credit selections within communications and energy were also a drag to performance.  Benefiting our performance this quarter was our overweight in consumer cyclicals, particularly home construction, and our credit selections in transportation, leisure, and aerospace and defense.

The Bloomberg US Corporate High Yield Index ended the second quarter with a yield of 8.50%.  Treasury volatility, as measured by the Merrill Lynch Option Volatility Estimate (“MOVE” Index), has picked up quite a bit the past 18 months.  Over that timeframe, the MOVE has averaged 122 relative to a 62 average over 2021.  However, the current rate of 110 is well below the spike near 200 back in March during the banking scare.  The second quarter had eight bond issuers default on their debt, taking the trailing twelve month default rate to 1.64%.iii  The current default rate is relative to the 0.86%, 0.83%, 0.84%, 1.27% 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 uncertain economic backdrop.  From a technical view, fund flows were only slightly negative in the quarter at -$0.6 billion after totaling -$24.3 billion during Q1.iv  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

The Fed will continue to remain a large part of the story in the second half of this year.  While their message to expect more hikes remains clear, market participants have listened as they exited previous positioning for rate cuts later in 2023.  As an aggregate of over 50 institutional contributors, the Bloomberg recession probability forecast currently stands at 65%.  Naturally, there are plenty of reasons to be cautious as lending standards have tightened and defaults are on the rise.  That said, the unemployment rate is sub 4%, demand is resilient, and good fundamentals are still providing cushion.  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 June 29, 2023:  Powell Says Likely Need Two or More Hikes to Cool Inflation

ii Bloomberg July 3, 2023: Economic Forecasts (ECFC)

iii JP Morgan July 5, 2023:  “Default Monitor”

iv CreditSights June 29, 2023:  “Credit Flows”

11 Apr 2023

2023 Q1 High Yield Quarterly

In the first quarter of 2023, the Bloomberg US Corporate High Yield Index (“Index”) return was 3.57%, and the S&P 500 stock index return was 7.48% (including dividends reinvested). Over the period, while the 10 year Treasury yield fell 41 basis points, the Index option adjusted spread (“OAS”) tightened 14 basis points moving from 469 basis points to 455 basis points.

All ratings segments of the High Yield Market participated in the spread tightening as BB rated securities tightened 12 basis points, B rated securities tightened 24 basis points, and CCC rated securities tightened 34 basis points. The chart below from Bloomberg displays the spread moves in the Index over the past five years. The average level over the five years is 406 basis points.

The Brokerage, Consumer Cyclical, and Transportation sectors were the best performers during the quarter, posting returns of 5.02%, 4.80%, and 4.75%, respectively. On the other hand, Banking, Communications, and REITs were the worst performing sectors, posting returns of ‐0.40%, 0.78%, and 1.18%, respectively. At the industry level, leisure, building materials, and healthcare all posted the best returns. The leisure industry posted the highest return of 9.38%. The lowest performing industries during the quarter were office REITs, wirelines, and retail REITs. The office REITs industry posted the lowest return of ‐7.16%.

The primary market remained very subdued during the first quarter. Several factors were at play keeping issuance to a minimum: increase in rates volatility, general market uncertainty, and previously refinanced capital structures. Of the issuance that did take place, Discretionary took 26% of the market share followed by Industrials at a 16% share.

The Federal Reserve continued lifting rates in 2023. The Fed held two meetings this quarter and raised the Target Rate by 0.25% at both the February and March meetings. These increases were on top of the 425 basis points of raises the Fed completed in 2022. “We are committed to restoring price stability,” Chair Jerome Powell said at a press conference following the Fed’s two‐day meeting in March. “It is important that we sustain that confidence with our actions as well as our words.” The March hike took place in the midst of a banking sector scare. Powell did comment that the banking turmoil is “likely to result in tighter credit conditions for households and businesses, which would in turn affect economic outcomes,” but added, “It’s too soon to tell how monetary policy should respond.”i The Fed has spoken at length about the tightness in the labor market. After 475 basis points of raises, the tightness continues. In fact, the unemployment rate is currently at 3.6%, the same level at the start of the hiking cycle. It is likely that some cracks in labor will need to emerge prior to any Fed pivot to lower rates.

Intermediate Treasuries decreased 41 basis points over the quarter, as the 10-year Treasury yield was at 3.88% on December 31st, and 3.47% at the end of the first quarter. The 5‐year Treasury decreased 43 basis points over the quarter, moving from 4.00% on December 31st, to 3.57% at the end of the first 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 fourth quarter GDP print was 2.6%(quarter over quarter annualized rate). Looking forward, the current consensus view of economists suggests a GDP for 2023 around 1.0% with inflation expectations around 4.3%.ii

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 the negative performance of last year, Q1 closed positive across each rating category. The lowest bucket of CCC did perform best over the quarter due to returns built up in January and February. With the banking scare in March, the CCC category returned ‐1.37% relative to the Index return of 1.07%. The quality focus that CAM is known for was a benefit in March. Given the positive quarterly return of the Index, our natural cash position was a drag on performance for Q1. Our credit selections within communications and consumer cyclicals were also a drag to performance. Benefiting our performance this quarter was our underweight in wirelines and communications and our credit selections in consumer noncyclicals, technology, and transportation.

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 the negative performance of last year, Q1 closed positive across each rating category. The lowest bucket of CCC did perform best over the quarter due to returns built up in January and February. With the banking scare in March, the CCC category returned ‐1.37% relative to the Index return of 1.07%. The quality focus that CAM is known for was a benefit in March. Given the positive quarterly return of the Index, our natural cash position was a drag on performance for Q1. Our credit selections within communications and consumer cyclicals were also a drag to performance. Benefiting our performance this quarter was our underweight in wirelines and communications and our credit selections in consumer noncyclicals, technology, and transportation.

The Bloomberg US Corporate High Yield Index ended the first quarter with a yield of 8.52%. Treasury volatility, as measured by the Merrill Lynch Option Volatility Estimate (“MOVE” Index), has picked up quite a bit the past 15 months. Over that timeframe, the MOVE has averaged 121 relative to a 62 average over 2021. The banking turmoil several weeks ago had the MOVE spike up to almost 200 and the 2 year Treasury had the widest intraday range since the early 1980s.iii The first quarter had four bond issuers default on their debt, taking the trailing twelve month default rate to 1.27%.iv The current default rate is relative to the 0.23%, 0.86%, 0.83%, 0.84% 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 negative in each month of the quarter totaling ‐$24.3 billion.v 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.

The Fed will continue to remain a large part of the story throughout this year. While their message currently remains steadfast, market participants are pricing in a possible transition later this year. Although moving in the right direction, inflation is still too high, and the labor market is still too tight from the Fed’s point of view. This led the Fed in keep increasing rates in the face of the recent banking sector trouble. Market participant’s bets of a transition are suggesting that after a year of aggressive increases, there is not much further the Fed can push. The recession probability forecast currently stands at 65%. There are plenty of reasons to be cautious as lending standards have tightened, defaults are on the rise, and trouble brewing in the commercial real estate market is now on many investors’ radars. That said, supply chains are easing, demand is resilient, high yield maturities are low, and good fundamentals are still providing cushion. 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/disclosurestatements/.

i Bloomberg March 22, 2023: Powell Stresses Commitment to Cooling Prices as Fed Hikes Rates
ii Bloomberg April 4, 2023: Economic Forecasts (ECFC)
iii Bloomberg April 4, 2023: Riding Brutal Yield Swings
iv JP Morgan April 3, 2023: “Default Monitor”
v CreditSights March 30, 2023: “Credit Flows”

12 Jan 2023

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”

12 Oct 2022

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.

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.

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

09 Jul 2022

Q2 High Yield Quarterly

In the second quarter of 2022, the Bloomberg Barclays US Corporate High Yield Index (“Index”) return was -9.83% bringing the year to date (“YTD”) return to -14.19%. The CAM High Yield Composite net of fees total return was -10.44% bringing the YTD net of fees total return to -15.91%. The S&P 500 stock index return was -16.11% (including dividends reinvested) for Q2, and the YTD return stands at -19.97%. The 10 year US Treasury rate (“10 year”) was generally marching higher as the rate finished at 3.01%, up 0.67% from the beginning of the quarter. Over the period, the Index option adjusted spread (“OAS”) widened 244 basis points moving from 325 basis points to 569 basis points. Each quality segment of the High Yield Market participated in the spread widening as BB rated securities widened 172 basis points, B rated securities widened 289 basis points, and CCC rated securities widened 418 basis points. The chart below from Bloomberg displays the spread moves in the Index over the past ten years with an average level of 433 basis points.

The Utilities, Energy, and Insurance sectors were the best performers during the quarter, posting returns of -6.98%, -8.02%, and -8.17%, respectively. On the other hand, Brokerage, Finance, and Consumer Non-Cyclical were the worst performing sectors, posting returns of -12.64%, -11.38%, and -11.33%, respectively. Clearly the market was weak as all sectors posted a negative return in the period. At the industry level, refining, food and beverage, and paper all posted the best returns. The refining industry posted the highest return -2.79%. The lowest performing industries during the quarter were pharma, retailers, and building materials. The pharma industry posted the lowest return -19.33%.

The energy sector continues to be a topic within the inflation discussion. Crude oil has continued higher reaching a high of $120 a barrel in early June. OPEC+ members recently bumped up production which was the last bit to restore all that was shuttered due to the pandemic.i President Biden has a scheduled trip to Saudi Arabia later this month. However, asking the Saudis to pump more oil is not on the agenda, as the President indicated that the Gulf Cooperation Council meeting is the more appropriate place for that request.

Given the rising spreads, rising yields, and volatility, the primary market remained very subdued during the second quarter. The weak market led to year-to-date issuance of $75.6 billion and $29.8 billion in the quarter. Energy took 24% of the market share followed by Discretionary at a 19% share. Wall Street strategists continue to lower their full year issuance forecasts. However, 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 $70 billion in high yield bonds are due to mature from now through the end of 2023.

The Federal Reserve lifted the Target Rate by 0.50% at their May meeting and by an additional 0.75% at their June meeting. The chart to the left shows the updated Fed dot plot post the June meeting. Of note, the Fed median Target Rate for 2022 increased from 1.875 to 3.375. Such movement is a clear indication of the dynamic economic backdrop. After the June meeting, Fed Chair Jerome Powell acknowledged that the 0.75% hike was “an unusually large one.” It was the largest hike since 1994. As he later spoke in front of the Senate Banking Committee, he called the possibility of a soft landing “very challenging.”ii He went on to say, “The other risk, though, is that we would not manage to restore price stability and that we would allow this high inflation to get entrenched in the economy. We can’t fail on that task. We have to get back to 2% inflation.” Inflation is running higher than any point in the last 40 years and the Fed, having updated their Summary of Economic Projections, accepts that the continuing rate hikes are going to lower growth and push up unemployment.

Intermediate Treasuries increased 67 basis points over the quarter, as the 10-year Treasury yield was at 2.34% on March 31st, and 3.01% at the end of the second quarter. The 5-year Treasury increased 58 basis points over the quarter, moving from 2.46% on March 31st, to 3.04% at the end of the second 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 first quarter GDP print was -1.6% (quarter over quarter annualized rate). Looking forward, the current consensus view of economists suggests a GDP for 2022 around 2.5% with inflation expectations around 7.5%.iii The will we or won’t we recession camps are still divided. The former Vice Chair of the FOMC Bill Dudley said a recession is inevitable within the next 12 to 18 months. The Chief Economist at JP Morgan said “there’s no real reason to be worried about a recession.” Meanwhile, strategists at Citi wrote in a report that the market is pricing in a 50% probability.

Being a more conservative asset manager, Cincinnati Asset Management Inc. does not buy CCC and lower rated securities. This policy generally served our clients well in 2020. While this segment did outperform last year, after 15 months CCC’s are again underperforming as we expect in times of market stress. 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 as the sub-three year maturity cohort provided the best performance in the quarter. As a result and noted above, our High Yield Composite net of fees total return did underperform the Index in Q2. Additionally, our credit selections within cable/satellite and leisure were a drag on performance. Benefiting our performance was our lack of exposure to pharma and our credit selections within consumer services, midstream, and retail.

The Bloomberg Barclays US Corporate High Yield Index ended the second quarter with a yield of 8.89%. The market yield is an average that is barbelled by the CCC rated cohort yielding 13.63% and a BB rated slice yielding 7.24%. Equity volatility, as measured by the Chicago Board Options Exchange Volatility Index (“VIX”), had an average of 27 over the quarter moving as high as 35 in the beginning of May. For context, the average was 15 over the course of 2019, 29 for 2020, and 19 for 2021. The second quarter had four bond issuers default on their debt. The trailing twelve month default rate stands at 0.86%.iv The current default rate is relative to the 1.63%, 0.92%, 0.27%, 0.23% 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 negative in all three months of the quarter. The 2022 year-to-date outflow stands at $46.0 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 any price volatility, without default, par will be paid at the stated maturity date. Currently, defaults are quite low and fundamentals are quite high. 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.

The backdrop as we move into the second half of 2022 is quite interesting. The University of Michigan Consumer Sentiment reading is the worst ever, the S&P 500 recorded the worst first half in over fifty years, inflation is at levels not seen in over forty years, the Fed hiked a rate at one meeting not seen in almost thirty years, and naturally the bond markets are under heavy pressure. Implied inflation, using breakeven inflation rates, is well off recent highs. Further, corn and wheat have fallen about 20% from recent highs. Given all of this, the high yield market is yielding almost 9% with a spread north of 550 basis points. Clearly, it is important that we exercise discipline and selectivity in our credit choices moving forward. We are very much on the lookout for any pitfalls as well as opportunities for our clients. We will continue to carefully monitor the market to evaluate that the given compensation for the perceived level of risk remains appropriate on a security by security basis. 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.
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 June 30, 2022: OPEC+ Ratifies August Supply Hike
ii Bloomberg June 22, 2022: Powell Says Soft Landing ‘Very Challenging’
iii Bloomberg July 1, 2022: Economic Forecasts (ECFC)
iv JP Morgan July 1,, 2022: “Default Monitor”
v Wells Fargo June 30, 2022: “Credit Flows”

11 Apr 2022

2022 Q1 High Yield Quarterly

In the first quarter of 2022, the Bloomberg Barclays US Corporate High Yield Index (“Index”) return was ‐4.84% while the CAM High Yield Composite net of fees total return was ‐ 6.11%. The S&P 500 stock index return was ‐4.60% (including dividends reinvested) over the same period. The 10 year US Treasury rate (“10 year”) had a steady upward move as the rate finished at 2.34%, up 0.83% from the beginning of the quarter.  During the quarter, the Index option adjusted spread (“OAS”) widened 42 basis points moving from 283 basis points to 325 basis points. Each quality segment of the High Yield Market participated in the spread widening as BB rated securities widened 38 basis points, B rated securities widened 29 basis points, and CCC rated securities widened 76 basis points. Take a look at the chart below from Bloomberg to see a visual of the spread moves in the Index over the past five years.

The Energy, Other Financial, and REITs sectors were the best performers during the quarter, posting returns of ‐2.54%, ‐2.73%, and ‐3.82%, respectively. On the other hand, Banking, Communications, and Utilities were the worst performing sectors, posting returns of ‐7.27%, ‐6.54%, and ‐5.71%, respectively. Clearly the market was weak as all sectors posted a negative return in the period. At the industry level, oil field services, independent energy, and leisure all posted the best returns. The oil field services industry posted the highest return 3.05%. The lowest performing industries during the quarter were wireless, food and beverage, and banking. The wireless industry posted the lowest return ‐11.79%.

The energy sector has been quite topical. Crude oil had a $45 per barrel range in Q1 and averaged $92 per barrel. Meanwhile, the natural gas market also moved steadily higher during the quarter reaching highs not seen in nine years. OPEC+ members are “refusing to deviate from their schedule  of  gradual production increases.”i They are also refusing to discuss the Russia‐Ukraine conflict with the last few meetings lasting less than fifteen minutes. Russia is a significant member of the broader group. Therefore, there likely needs to be much more political wrangling before the group takes a stand against one of their own.

During the first quarter, the high yield primary market finally took a break after three years of strong issuance. The weak market led by rising rates kept companies on the sidelines as only $45.8 billion posted in the quarter. Consumer Discretionary did continue to lead and took 33% of the market share. Second place was Materials at 12% of the total. Wall Street strategists have begun to lower their full year issuance forecasts. However, there isn’t much concern for lack of capital access due to issuers being so proactive with refinancing in the past few years.

The Federal Reserve did lift the Target Rate by 0.25% at their March meeting. That was the first increase since 2018. The chart to the left shows the updated Fed dot plot post the March meeting. Of note, the Fed median Target Rate for 2022 increased from 0.875 to 1.875. Such movement is a clear indication of the dynamic economic backdrop. Furthering the point, Fed Chair Jerome  Powell  commented just days after the March meeting, “If we conclude that it is appropriate to move more aggressively by raising the federal funds rate by more than 25 basis points at a meeting or meetings, we will do so.”ii He then went on to say, “And if we determine that we need to tighten beyond common measures of neutral and into a more restrictive stance, we will do that as well.” These moves are being driven by a tight employment market and inflation that is running higher than any point in the last 40 years. The Fed is undoubtedly looking to bring inflation lower while keeping the economy at some sustainable growth rate.

Intermediate Treasuries increased 83 basis points over the quarter, as the 10‐year Treasury yield was at 1.51% on December 31st, and 2.34% at the end of the first quarter. The 5‐year Treasury increased 120 basis points over the quarter, moving from 1.26% on December 31st, to 2.46% at the end of the first 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 fourth quarter GDP print was 6.9% (quarter over quarter annualized rate). Looking forward, the current consensus view of economists suggests a GDP for 2022 around 3.4% with inflation expectations around 6.2%.iii Worth mentioning is the yield curve inverting for the first time since 2019. Historically, inversion is an indication of pessimism in the growth outlook and concern of a nearing recession. The recent reports have been split between “the sky is falling” and “this time is different,” neither of which seems all that compelling at the present moment. Perhaps a more appropriate view is one attributed to Barclays. They suggest looking at the current environment in terms of recession probabilities. Based on their model, recession probabilities are not elevated coming in at roughly 20%. This is leading them to currently have the view that inflation is likely to brake rather than break the growth outlook.

Being a more conservative asset manager, Cincinnati Asset Management Inc. does not buy CCC and lower rated securities. This policy generally served our clients well in 2020. However, the lowest rated segment of the market outperformed during 2021. Thus, our higher quality orientation was not optimal last year.

That higher quality focus continued to have a tough time against the rising rate environment during Q1, as it is the most rate sensitive group within the broader high yield market. As a result and noted above, our High Yield Composite net of fees total return did underperform the Index in Q1. The higher quality positioning was the sizeable negative contributor relative to the Index, slightly offset by the cash position in an overall negative total return market.

The Bloomberg Barclays US Corporate High Yield Index ended the first quarter with a yield of 6.01%. The market yield is an average that is barbelled by the CCC rated cohort yielding 9.06% and a BB rated slice yielding 5.00%. Equity volatility, as measured by the Chicago Board Options Exchange Volatility Index (“VIX”), had an average of 25 over the quarter with a spike to a high of 36 as the market sold off during the first two and a half months of the year.

For context, the average was 15 over the course of 2019, 29 for 2020, and 19 for 2021. The first quarter had two bond issuers default on their debt. The trailing twelve month default rate fell to 0.23%. The current default rate is relative to the 4.80%, 1.63%, 0.92%, 0.27% default rates from the previous four quarter end data points listed oldest to most recent. The fundamentals of high yield companies are in great shape as leverage, profit margins, and debt servicing all look good. From a technical view, fund flows were negative in all three months of the quarter. The 2022 year‐to‐date outflow stands at $28.5 billion.iv 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 any price volatility, without default, par will be paid at the stated maturity date. Currently, defaults are at historic lows and fundamentals are at highs. Further, as the quarter closed, the market saw a weekly inflow, only the second of the year. Additionally, market returns coincidently bottomed just as the Fed started raising rates. That seems interesting to say the least. Naturally, 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.

The backdrop as we move into the second quarter of 2022 is quite intriguing. Inflation is at four decade highs, the yield curve is inverting, recession fears are bubbling, supply chain disruptions are ongoing, energy markets are heading skyward, the Federal Reserve is starting a hiking cycle, and there is a war that has the attention of the entire world. But, the market just had the biggest weekly gain in over fifteen months, rising stars are at a record pace, companies are in solid financial shape, and default rates are extremely low. Clearly, it is important that we exercise discipline and selectivity in our credit choices moving forward. We are very much on the lookout for any pitfalls as well as opportunities for our clients. We will continue to carefully monitor the market to evaluate that the given compensation for the perceived level of risk remains appropriate on a security by security basis. 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.

i Bloomberg March 31, 2022: OPEC+ Stands Back as Oil Consumers Move to Ease Prices

ii Bloomberg March 22, 2022: Powell Is Ready to Back Half‐Point Hike

iii Bloomberg April 4, 2022: Economic Forecasts (ECFC)

iv Wells Fargo March 31, 2022: “Credit Flows”

11 Jan 2022

2021 Q4 High Yield Quarterly

In the fourth quarter of 2021, the Bloomberg Barclays US Corporate High Yield Index (“Index”) return was 0.71% bringing the year to date (“YTD”) return to 5.28%. The CAM High Yield Composite net of fees total return was 0.45% bringing the YTD net of fees return to 4.03%. The S&P 500 stock index return was 11.02% (including dividends reinvested) for Q4, and the YTD return stands at 28.68%.

The 10 year US Treasury rate (“10 year”) was mostly range bound finishing at 1.51%, up 0.02% from the beginning of the quarter. Over the period, the Index option adjusted spread (“OAS”) tightened 6 basis points moving from 289 basis points to 283 basis points. The top two quality segments of the High Yield Market participated in the spread tightening as BB rated securities tightened 9 basis points and B rated securities tightened 14 basis points, while the CCC rated securities widened 25 basis points. Take a look at the chart below from Bloomberg to see a visual of the spread moves in the Index over the past five years. The graph illustrates the speed of the spread move in both directions during 2020 and the continuation of lower spreads in the first half of 2021. The OAS record low (not shown) is 233 basis points set back in 2007.

The Energy, Other Industrial, and Finance Companies sectors were the best performers during the quarter, posting returns of 1.56%, 1.38%, and 1.23%, respectively. On the other hand, Communications, Banking, and REITs were the worst performing sectors, posting returns of -0.24%, 0.05%, and 0.27%, respectively. Clearly the market was strong as only one sector posted a negative return in the period. At the industry level, auto, midstream, life insurance, and independent energy all posted the best returns. The auto industry posted the highest return 2.17%. The lowest performing industries during the quarter were cable, media, wirelines, and retailers. The cable industry posted the lowest return -0.66%.

The energy sector performance has continued to remain strong. Crude oil had a $20 per barrel range in Q4 and averaged $77 per barrel. Meanwhile, the natural gas market moved lower throughout the quarter coming down off highs not seen in three years. OPEC+ recently had a meeting and decided to further raise production levels.i The group has “restarted about two-thirds of the production they halted in 2020, and are seeking to drip-feed the remainder at a pace that will satisfy the recovery in fuel consumption — and stave off any inflationary price spike — without sending the market into a new slump. So far they’ve succeeded, with international crude prices trading near $78 a barrel.” OPEC has also chosen a new Secretary General that will take over in August as the group’s public face. The outgoing Secretary General will step down after completing a full term as permitted by governing rules.

During the fourth quarter, the high yield primary market continued at a strong pace posting $84.3 billion in issuance and making 2021 a record year. After two very active years for issuance, 2022 is likely to take a breather but the expectation is still in the ballpark of $400 billion. The issuance in Consumer Discretionary continued to be very strong with approximately 19% of the total during the quarter. Second place was broad based as Communications, Energy, and Financials each made up 14% of the total new paper placed in the market.

The Federal Reserve maintained the Target Rate to an upper bound of 0.25% at both the meetings in November and December. The chart to the left shows the updated Fed dot plot post the December meeting. Of note, the Fed median Target Rate for 2022 increased from 0.25 to 0.875, and the median increased for 2023 from 1.00 to 1.625. Additionally, at the December meeting the Fed agreed to accelerate the taper pace of their asset purchases. The change in the taper pace sets in place a plan for the program to end in March of 2022. The Fed has previously spoken of the desire to end the taper before starting Target Rate hikes. These moves are being driven by a tight employment market and inflation that is running higher than any point in the last 30 years. “There’s a real risk now, I believe, that inflation may be more persistent and…the risk of higher inflation becoming entrenched has increased,” said Mr. Powell at a news conference after the December meeting.

“That’s part of the reason behind our move today, is to put ourselves in a position to be able to deal with that risk.”ii

Intermediate Treasuries increased 2 basis points over the quarter, as the 10-year Treasury yield was at 1.49% on September 30th, and 1.51% at the end of the fourth quarter. The 5-year Treasury increased 29 basis points over the quarter, moving from 0.97% on September 30th, to 1.26% at the end of the fourth 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 2.3% (quarter over quarter annualized rate). Looking forward, the current consensus view of economists suggests a GDP for 2022 around 3.9% with inflation expectations around 3.5%.iii

Being a more conservative asset manager, Cincinnati Asset Management Inc. does not buy CCC and lower rated securities. This policy generally served our clients well in 2020. However, the lowest rated segment of the market outperformed during 2021. Thus, our higher quality orientation was not optimal for the year. As a result and noted above, our High Yield Composite net of fees total return did underperform the Index YTD. Our Composite also underperformed over the fourth quarter measurement period. A sizeable contributor was the Index strong performance in the under one year and over ten year duration buckets. These are both areas that our strategy tends not to participate in any meaningful way. Further, with the market staying strong during the fourth quarter, our cash position remained a drag on overall performance. Outside of that, credit selection drove much of the story in Q4. The downside was driven by selections in the energy sector and retailer industry, while the top positive offsets were found within the homebuilders and wireline industries.

The Bloomberg Barclays US Corporate High Yield Index ended the fourth quarter with a yield of 4.21%. The market yield is an average that is barbelled by the CCC rated cohort yielding 6.82% and a BB rated slice yielding 3.30%. Equity volatility, as measured by the Chicago Board Options Exchange Volatility Index (“VIX”), had an average of 19 over the quarter with a spike to a high of 35 as the market was coming to grips with the omicron variant. For context, the average was 15 over the course of 2019 and 29 for 2020. The fourth quarter had one bond issuer default on their debt. The trailing twelve month default rate fell to 0.27%.iv The current default rate is relative to the 6.17%, 4.80%, 1.63%, 0.92% default rates from the previous four quarter end data points listed oldest to most recent. Pre-Covid, fundamentals of high yield companies had been mostly good and in the aggregate fundamentals are back to those pre-covid levels. From a technical view, fund flows were roughly flat in October, negative in November, and positive in December. The 2021 year-end outflow stands at $4.8 billion.v In spite of this outflow, a strong bid remains in the market for high yield paper, and the declining default rate is keeping a risk on attitude in place for market participants. 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.

Covid, then delta, now omicron….the hits just keep on coming. All things considered, the market did very well this year. This is no doubt in part due to Congress and the Fed supplying trillions of dollars of support in response to the pandemic. November was indeed a tough month as market participants dealt with news of an emerging new variant. Many naturally sensed a buying opportunity as December was quite strong posting the best monthly return for the year. Participants surely understood that we are no longer in March 2020 operating largely in the dark and full of uncertainty. Uncertainty will always be a factor in the equation, but today we are much better prepared to deal with the ongoing pandemic. The vaccine has been rolled out and according to the CDC, 86% of the US population ages 18+ has received at least one shot. We now have boosters and emergency use pills approved. As cases continue to climb, signs point to much less severe outcomes.vi Additionally, companies are generally in good financial shape. As a country, we are currently in a place where the economy is booming and inflation is escalated. That is the backdrop as we move into 2022. Clearly, it is important that we exercise discipline and selectivity in our credit choices moving forward. We are very much on the lookout for any pitfalls as well as opportunities for our clients. We will continue to carefully monitor the market to evaluate that the given compensation for the perceived level of risk remains appropriate on a security by security basis. 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.

i Bloomberg January 4, 2022: OPEC+ Agrees to Revive More Output
ii The Wall Street Journal December 15, 2021: Fed Officials Project Three Interest Rate Rises in 2022
iii Bloomberg January 4, 2022: Economic Forecasts (ECFC)
iv JP Morgan January 3,, 2022: “Default Monitor”
v Wells Fargo January 3, 2022: “Credit Flows”
vi Bloomberg January 4, 2022: Omicron Spares US ICUs So Far, Mirroring S. Africa Trajectory

15 Oct 2021

2021 Q3 High Yield Quarterly

In the third quarter of 2021, the Bloomberg Barclays US Corporate High Yield Index (“Index”) return was 0.89% bringing the year to date (“YTD”) return to 4.53%. The CAM High Yield Composite net of fees total return was 1.10% bringing the YTD net of fees return to 3.56%. The S&P 500 stock index return was 0.58% (including dividends reinvested) for Q3, and the YTD return stands at 15.91%.

The 10 year US Treasury rate (“10 year”) had a move down to a 1.17% low in early August and then moved back up to finish at 1.49%, up 0.02% from the beginning of the quarter. Over the period, the Index option adjusted spread (“OAS”) widened 21 basis points moving from 268 basis points to 289 basis points. Each quality segment of the High Yield Market participated in the spread widening as BB rated securities widened 3 basis points, B rated securities widened 33 basis points, and CCC rated securities widened 62 basis points. Take a look at the chart below from Bloomberg to see a visual of the spread moves in the Index over the past five years. The graph illustrates the speed of the spread move in both directions during 2020 and the continuation of lower spreads in 2021. The OAS record low (not shown) is 233 basis points set back in 2007.

The Energy, REITs, and Other Financial sectors were the best performers during the quarter, posting returns of 1.70%, 1.22%, and 1.17%, respectively. On the other hand, Finance Companies, Consumer Cyclicals, and Communications were the worst performing sectors, posting returns of 0.44%, 0.56%, and 0.56%, respectively. Clearly the market was strong as no sector posted a negative return in the period. At the industry level, life insurance, independent energy, restaurants, and paper all posted the best returns. The life insurance industry posted the highest return 3.43%. The lowest performing industries during the quarter were refining, gaming, cable, and health insurance. The refining industry posted the lowest return -0.63%.

The energy sector performance has continued to remain strong. While crude oil held its own averaging $70 per barrel in Q3, the natural gas market has moved steadily higher. The acceleration to the upside is a function of both supply and demand being impacted. Excessive summer heat particularly in the northwest called for higher than normal power demand. This left a situation of below average gas storage. Then hurricane Ida resulted in knocking much of the Gulf of Mexico production offline. In fact, over 75% of the production is still shut-in. The icing on this story is that traders are beginning to look towards the possibility of a colder than normal winter. If that situation comes to be more priced in as consensus, this price train will just keep chugging higher.

During the third quarter, the high yield primary market continued its record pace and posted $115.9 billion in issuance. Many companies continued to take advantage of the open new issue market that is offering very attractive financing. Year to date there has been $433 billion in issuance and will no doubt set a new record by topping last year’s $442 billion. The issuance in Consumer Discretionary continued to be very strong with approximately 22% of the total during the quarter. Financials issuance was best for second place by making up 17% of the total new paper placed in the market.

The Federal Reserve maintained the Target Rate to an upper bound of 0.25% at both the July and September meetings. The chart to the left shows the updated Fed dot plot post the September meeting. Also, the market is currently pricing in one rate hike by year end 2022.i As expected, the Fed signaled that the time to taper is at hand with Chair Powell commenting that tapering “could come as soon as the next meeting.” He further noted that the taper is separate and distinct from rate hikes by saying “the timing and pace of the coming reduction in asset purchases will not be intended to carry a direct signal regarding the timing of interest-rate liftoff.”ii The transitory nature of red hot inflation is very much a front and center concern with supply chain issues being particularly troubling. Recently, on a panel including several central bankers from across the globe, Powell said “it is also frustrating to see the bottlenecks and supply chain problems not getting better — in fact, at the margin, apparently getting a little bit worse. We see that continuing into next year, probably, and holding inflation up longer than we had thought.”iii On October 1st, the personal consumption expenditures report was released. This is a price gauge that the Fed uses for its inflation target. The report showed the largest increase in 30 years.

Intermediate Treasuries increased 2 basis points over the quarter, as the 10-year Treasury yield was at 1.47% on June 30th, and 1.49% at the end of the third quarter. The 5-year Treasury increased 8 basis points over the quarter, moving from 0.89% on June 30th, to 0.97% 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 6.7% (quarter over quarter annualized rate). Looking forward, the current consensus view of economists suggests a GDP for 2022 around 4.1% with inflation expectations around 2.5%.iv

Being a more conservative asset manager, Cincinnati Asset Management Inc. does not buy CCC and lower rated securities. This policy generally served our clients well in 2020. However, the lowest rated segment of the market has outperformed year to date in 2021. Thus, our higher quality orientation was not optimal during the first half of the year, but it was once again a benefit during Q3. As a result and noted above, our High Yield Composite gross total return has underperformed the Index YTD. However, our Composite did outperform over the third quarter measurement period. With the market staying strong during the third quarter, our cash position remained a drag on overall performance. Outside of that, credit selection drove much of the story in Q3. The downside was driven by selections in the consumer cyclical services and wirelines industries while the top positive offsets were found within aerospace/defense, autos, and transportation

The Bloomberg Barclays US Corporate High Yield Index ended the third quarter with a yield of 4.04%. The market yield is an average that is barbelled by the CCC-rated cohort yielding 6.26% and a BB rated slice yielding 3.18%. Equity volatility, as measured by the Chicago Board Options Exchange Volatility Index (“VIX”), had an average of 18 over the quarter. For context, the average was 15 over the course of 2019 and 29 for 2020. The third quarter had zero bond issuers default on their debt. The trailing twelve month default rate fell to 0.92% with the energy sector accounting for about a third of that rate.<sup>v</sup> The current 0.92% default rate is relative to the 5.80%, 6.17%, 4.80%, 1.63% default rates for the third and fourth quarters of 2020, and the first and second quarters of 2021 respectively. Pre-Covid, fundamentals of high yield companies had been mostly good and in the aggregate fundamentals are back to those pre-covid levels. From a technical view, fund flows were roughly flat in July, positive in August and September, and the year-to-date outflow stands at $1.3 billion.<sup>vi</sup> In spite of this outflow, a strong bid remains in the market for high yield paper, and the declining default rate is keeping a risk on attitude in place for market participants. 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.

It is quite interesting to think through just how much has transpired over the last year and a half. The US has spent trillions in response to the covid pandemic providing support to people and companies impacted. The vaccine has been rolled out and according to the CDC, 77% of the US population ages 18+ has received at least one shot. This is up from 55% at the time of our Q2 commentary and 32% as of our Q1 commentary. As a country, we are currently in a place where the economy is booming and inflation is escalated. The Federal Reserve has signaled that they will begin the taper of asset purchases in short order. Moving from Q3 into Q4, Congress is wrangling with funding to avoid a shutdown, raising the debt ceiling, passing an infrastructure bill, and passing a fresh social programs spending bill that will have a price tag in the trillions of dollars. There is certainly no slowdown of information flow as we move into the last quarter of 2021. Clearly, it is important that we exercise discipline and selectivity in our credit choices moving forward. We are very much on the lookout for any pitfalls as well as opportunities for our clients. We will continue to carefully monitor the market to evaluate that the given compensation for the perceived level of risk remains appropriate on a security by security basis. 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 through such a historic time.

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.

i Bloomberg September 30, 2021: WIRP – World Interest Rate Probability
ii Bloomberg September 22, 2021: Powell Says Fed Taper Could Start ‘Soon’
iii The New York Times September 29, 2021: The World’s Top Central Bankers See Supply Chain Problems Prolonging Inflation
iv Bloomberg October 1, 2021: Economic Forecasts (ECFC)
v JP Morgan October 1,, 2021: “Default Monitor”
vi Wells Fargo October 1, 2021: “Credit Flows”