Fixed Income Commentary – February 2021

“Honesty”

Billy Joel


Key Takeaways

Yields across the curve nudged higher in January, led by the 10-year Treasury yield piercing through the psychological 1% level for the first time since March 2020.  Considering the events of the past year related to the global pandemic, a print of 4% (annualized) on GDP gives us some hope for growth momentum to continue in 2021.

January in Review

  • The 10- year Treasury yield finished the month with a yield of 1.07%, up 16 bps month over month.
  • Munis had a strong month, up 0.64%.
  • With the strong move higher on the back end of the Treasury yield curve, Treasuries finished the month down 0.96% in total return.


Commentary

January proved relatively eventful for bond investors as the yield on 10-year Treasuries rose above the psychologically-important 1% level for the first time since March 2020.  Longer-term yields have been slowly trending higher since bottoming in August as the vaccine roll-out led to optimism for a sustainable recovery from the pandemic.  The rise in yield was halted due to renewed concerns on the pace of vaccinations, the risks stemming from new strains of the virus, and the uneven pace of recovery around the world.

After all the “drama” of yields on 3-year and longer Treasuries moving higher, the total return on the Bloomberg Barclays Intermediate Aggregate Index was -0.15% for the month.  MBS, corporate bonds, and municipal bonds all outperformed Treasuries.

“Drama” may be a slight exaggeration but that’s what qualifies for excitement these days in the bond market.  We just don’t get to experience the dizzying excitement of 1,700% price gains like some equity investors enjoyed recently — yes, we’re referring to GameStop.  While it may be outside our normal parameters to opine on the trading mania made prominent in the financial media, we simply can’t resist offering a few comments:

  1. Call us old-fashioned, but we remain firm believers in fundamental analysis based on historical trends in profit generation, balance sheet metrics, and competitive positioning, among other things.
  2. We think there is value in establishing a sound investment plan based on diversification with an emphasis on long term value creation.
  3. We believe investment ideas emanating from chat rooms, tweets from well-known billionaires, or trending memes should be treated with a modicum of caution (in other words, ignore them).

The widespread mania reminded us of a Latin proverb: “Mundus vult decipi; ergo decipatur.”  Translation: “The world wants to be deceived.  Let it therefore be deceived.”  This may be a somewhat harsh view but how else to describe the gambling parlor mentality inherent in these brokerage chat rooms?  It may be a good time to dust off our copy of “Extraordinary Popular Delusions and the Madness of Crowds” for a little light reading by the fire while the cold wind blows outside.

The sudden appearance of these equity stories allowed for a temporary but welcome pause in Bitcoin’s domination of the financial news.  We are struck by the acceptance of this new invention (by a relatively obscure individual) as a “currency” simply due to the clever use of the word “coin” as a naming convention.  We also have doubts that a new digital device can suddenly claim to have inflation-hedging characteristics simply because so few can be created.  The ready acceptance of cryptocurrencies by some appears to capitalize on the widespread fear and distrust of fiat money following the quantitative easing policies of the world’s major central banks.  We believe it has no investment merits and is simply a speculative vehicle whose value is completely reliant on having someone else willing to pay the price.

This is a Fixed Income Commentary, so why all the focus on speculative activity in stocks and Bitcoin?  With short rates at the zero bound in the U.S. and negative in Europe and Japan, some investors are drawn to increasingly speculative behavior due to ultra-low borrowing costs, low opportunity cost, or a mentality that there is no alternative (TINA) since interest rates are relatively unappealing.  Our view is that fixed income securities — bonds and preferred stock — provide stability to balanced portfolios while generating some income, all while offering good liquidity should funds be needed for some other purpose.  It’s also possible this type of volatility and speculation in segments of the market could hasten the end of the ultra-easy policies, or at least some of them, due to these unintended consequences.

The other newsworthy story from January concerns the GDP report: the U.S. economy grew by 4.0% (annualized) in the fourth quarter of 2020.  Consumption growth, the biggest single driver of overall growth, slowed to only 2.5% annualized, likely due to the pandemic-related restrictions on activity late last year.  Some of the bright spots were business investment and residential investment spending, both of which we expect will continue to be decent sources of growth momentum in 2021.  GDP was still down by 2.5% relative to one year ago, but that’s a pretty remarkable achievement given the pandemic’s massive cost to society and the unprecedented measures taken to halt it.

We will end this month’s Commentary on a cautionary note: be very discriminating in allocating your hard-earned money to new “assets” or ideas made popular on wild rides up.  The wild rides down can be very painful indeed.