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Performance Matters

January 6th, 2025 by Kurt L. Smith

It is the new year and with optimism gripping the financial world ebullience is everywhere. Contagion? Evidently because everyone is excited for the new year, the new administration, new tax laws, less regulation…a veritable Shangri-La here at home.

Unfortunately, the bond market failed to get the message. Or perhaps it did; just think about how bad the bond market would be if there was not a contagion of optimism?

The scorecard for 2024 is now out and bonds were not the place to be. Not just compared to the one-two punch of stocks for the second straight year, but as a standalone asset class. Bonds should yield something, particularly when people are buying them left and right because, hey, they now yield something.

The results say otherwise. For the year, the Bloomberg US Treasury Index clocked in with a +0.58% gain for the year (all prices and yields per Bloomberg).  If we add Corporate Bonds and Mortgages to the mix, the Bloomberg US Aggregate Bond Index finished up 1.25% for the year while the Bloomberg Municipal Bond Index, a highflyer almost year all year as we discussed in the October 28th letter when up 9.81%, finished up a mere 1.05% for the year.

Longtime readers know this is not a new phenomenon. Performance figures in a bond bear market are difficult because the wind (the trend towards lower interest rates) is no longer at your back but instead buffet you in the face (as the trend is toward higher interest rates). It has been almost five years since the bond bear market began in March 2020. In now appears we are almost halfway through what is shaping up as a lost decade of bond market performance.

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Come On In

December 6th, 2024 by Kurt L. Smith

One of the sales pitches for buying bonds (albeit an effective one) these past few years has been to buy bonds because now they earn you something. But while everyone knows 3% or 4% is greater than 1% or 2%, it is hardly a reason to do something silly.

The fact that interest rates were once near zero and now they are not should give you pause. Higher interest rates are not a recipe for bond investment performance. It was the trend toward lower interest rates over three decades that provided the wind in the bond bull market’s sails. With the new trend of higher interest rates, bond investors face headwinds that crimp performance.

Taking a longer-term perspective may help. The “higher” interest rates we now have are like where they were ten years ago. We buy a number of bonds issued ten or so years ago, so I am reminded daily. It also explains why the Bloomberg Municipal Bond Total Return Index for the past ten years is 2.73%. On December 2, 2014, the Index stood at 1064 and last week on November 29, 2024, it was 1355 (all prices and yields per Bloomberg). This Index covers the long-term tax-exempt bond market across four main sectors: state and local general obligation bonds, revenue bonds, insured bonds and prerefunded bonds.

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Bonds Reverse on News

October 28th, 2024 by Kurt L. Smith

The Federal Reserve’s September 18th rate cut was the news. This move followed excitement for the cut as three-month treasury bill yields moved from about 5.40% in July to 4.75% on the 18th. Six-month treasury bills moved from 5.30% to about 4.50% in the same time frame (all yields and prices per Bloomberg). The Fed merely followed the markets, as expected.

While the short-term interest rates have largely held in since the cut, longer term bonds have tanked. Sell on the news indeed! Our bellwether poster child, the US treasury bond 1.25% of May 15, 2050, sold at just over 56 on September 17th and below 50 today, October 25th. This is essentially the same level the bond traded at on October 24th, 2022.

It is difficult to make money in a bear market. The first step needed is to recognize that this is the trend. We reached this point years ago, back in 2020 when the bellwether sold at twice its current price, near par. Most investors have failed to recognize this first step. They have done what most investors have done: they held and/or doubled down. Unfortunately, with respect to bonds, they have not held bonds which have treated them well.

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Is This It?

September 25th, 2024 by Kurt L. Smith

For about eleven months now, bonds have traded higher in price and lower in yield in the most recent correction of the nascent bond bear market. From near 0% interest rates in 2020 to over 5% in 2023 in longer US treasury notes (below 0% to 5.50% for treasury bills), corrections are natural movements in how trends are developed.

While bond prices have rallied, we have also seen stocks hitting new highs as well. Even the Federal Reserve jumped on the bandwagon cutting rates this week to fulfill the promise made last month.

Yet for so much time, for so much work, the rebound in bonds looks pathetic. Most, if not all, of the rally occurred in the final nine weeks of last year. Our favorite long treasury bond, the 1.25% of May 15, 2050, traded at 43.25 on October 20th, 2023, and just over 55 on December 28th, weeks later. That’s a nice 27% gain for prescient traders, but a far cry from the 102 on August 6th, 2020 (all prices and yields per Bloomberg). This is what a bond bear market looks like.

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Fixin’ To

September 6th, 2024 by Kurt L. Smith

In late August we finally received the word from the mount on high. From his temporary perch at Jackson Hole, Federal Reserve Chairman Jerome Powell delivered his “time has come” speech. Treasury bills, the leader in all things short term, had obviously received advanced word as short-term interest rates broke to yearly lows.

Last month we noted treasury bills had fulfilled the requirements for a correction. We have long noted the key problem with corrections (like the problem with market tops) is it is tough to know how low low is (or how high high is). August brought us the strongest drop for yields in over a year as both three- and six-month bills hit new yearly lows. Chair Powell obviously noticed.

We are not treasury bill traders. Whether you are receiving a 2% taxable return on your cash in 2019 or 0% for the two years following the March 2020 beginning of the bond bear market, is not my primary concern. You would not have been happy then or even now when you are earning more. Selecting worthwhile municipal bonds is the key to your bond portfolio performance.

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Change Appears At Hand

July 31st, 2024 by Kurt L. Smith

In April my letter examined whether the Federal Reserve would begin cutting rates. Optimism abounded as the ten-year treasury note yield fell from 5% to 3.88% (prices rose) in the fourth quarter of 2023 (all prices and yields per Bloomberg). By April such optimism had taken a hit as higher yields (lower prices) left the bond market correction hanging on by a thread.

Since October of last year, the treasury market has been in a correction. From near 0% (0.31%) in March 2020 to 5% on ten-year treasury notes, the market was due, if not overdue, for a correction. Short term treasury bills had seen a similar run from negative yields on the six-month treasury bill in March 2020 to 5.59% in August of last year, with most of the move happening in the preceding twenty months.

The bond market correction has not only hung in, but treasury bills (three months and six months) hit their lowest yield (highest price) in the correction last week, completing an A-B-C correction. Three-month bills moved from 5.51% on October 6th to 5.28% this week, while six-month bills went from 5.59% to 5.12%. A ten month correction of a twenty month move? One can make an argument that short term treasury bills next move from here is toward higher interest rates not lower.

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Managing Municipal Bond Portfolios

June 28th, 2024 by Kurt L. Smith

It seems we cannot get enough of municipal bonds, taxable or tax free. The deals keep coming, the orders overflow, and some even get filled. Shampoo, rinse and repeat.

More demand than supply should keep bond prices buoyant. Unfortunately, financial products do not work that way. Wall Street’s job is to supply more when demand is high, and Wall Street is doing exactly that by creating more and more bonds (debt) to keep up.

Demand is high so municipal bond deals are large as well, some well over a billion dollars. According to Joe Mysak, Bloomberg’s long-time resident municipal bond market expert, this week marked “the 27th deal of $1 billion or more, with overall borrowing accelerating at a torrid pace.” Amazingly, the municipal bond market remains around $4 trillion, the same as 2020, according to SIFMA website. Actual current figures are $4.1 trillion, the same as two years ago and barely higher than $3.9 trillion in 2019. So perhaps the $200 billion difference is due to larger deals! Shampoo, rinse and repeat as old bonds mature and they need to be replaced.

So how does one manage municipal bond portfolios? Largely they are managed with scale. This is where new deals like this month’s Eagle Mountain – Saginaw ISD featured bond comes into play. The best time, perhaps the only time, to buy a $5 million, $10 million, or $25 million piece is when they are first distributed. This is not new. The new issue market has been on the shampoo, rinse repeat treadmill for many years.

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Everyone (It Seems) Loves Municipals

May 29th, 2024 by Kurt L. Smith

After many months of expensive pricing relative to treasuries, municipal bond prices began to capitulate this week. Together with treasury price weakness, longer term municipal bond prices are breaking down with yields jumping upwards.

Last month we discussed that the bond market correction was hanging on by a thread. By mid-month it appeared the correction phase was intact as ten-year treasury yields moved from 4.73% on April 25th to 4.31% on May 16th (all prices and yields per Bloomberg). The spirited move saw some sympathy with two-year treasury notes (from 5% down to 4.70%), but just a few days later the two-year note is back to 4.95% on May 24th.

Remember, it is the shorter-term treasury yields that shape Federal Reserve policy, not the other way around. With short-term treasury bills and two-year notes at or near their highest yields for the year, this trend is not encouraging.

If there is such a thing in the bond market as everyone on one side of the boat, it is the duration trade. With yields on bonds at levels investors have not seen in years it seemed to make sense to buy some longer bonds to take advantage when the Federal Reserve lowers interest rates again. This could help explain bond prices rallying nicely in last year’s fourth quarter. Municipal bonds were trading about 75% of treasuries (ten-year maturity basis) to begin the move in October and later hit a record low of 57% in March, further amplifying municipal bonds bounce up in prices.

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High Flying Municipals

April 26th, 2024 by Kurt L. Smith

I continue to find worthwhile municipal bonds for clients despite the historically expensive pricing of generic municipal bonds. While treasury securities are at their highest yields (and lowest prices) in over five months, municipal bonds continue their relative pricing superiority.

Packages of municipal bonds, such as mutual funds and exchange traded funds (ETF’s), are priced high relative to their historical averages to treasury securities. Such high prices have helped their performance relative to other fixed income securities.

Today, the ten-year AAA municipal yield of 2.74% is but 59% of the 4.64% of the ten-year treasury note (all yields and prices per Bloomberg). As we have talked about recently, if such spread was even 70% (much less of a historical outlier), municipal yields would need to rise about fifty basis points to 3.25%. Lower actual yields mean municipal bond prices are priced higher, thus contributing to positive performance of late.

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Rate Cuts? Not So Fast (Obviously)

April 3rd, 2024 by Kurt L. Smith

Writing about market corrections is hardly exciting. Investors want to know where a market is going and when. The exciting part is when forward steps are being taken, not the times when the market takes a step back.

After almost forty years of making headway towards lower and lower yields, the market has reversed from 2020 to 2023 as yields rose from near zero to something substantial. Ten-year treasury note yields went from .31% March 9, 2020 to 5.02% on October 23, 2023 (yields and prices per Bloomberg). Shorter term yields, like three-month treasury bills, were negative in March 2020, rising to 5.51% last October 6th.

These were many steps forward in the new trend of higher yields and lower bond prices. But markets do not move in straight lines. A trending market needs to correct, taking a step, or maybe steps, back.

Here is the bad news. Corrections allow the trend to continue. From October 23rd to December 27th, the ten-year treasury yield fell from 5.02% to 3.78%. This correction generated a lot of excitement, particularly from those investors who own long term bonds at substantially higher prices purchased when rates were low. Lower yields boosted longer bond prices in the process.

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