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“Bonds are back” is the refrain on business cable shows largely sponsored by many money management firms. Expect more of this approach, especially as we enter 2023 and accounts attempt to rebalance.

Not Matching Expectations

December 20th, 2022 by Kurt L. Smith
  • In the hustle and bustle of the season, we would expect no less in a bull, bull, bull world. Our experience matches our expectations. Such is not the case with the financial markets.

    While we are a couple weeks away from posting final 2022 results, the bull, bull, bull world has failed to deliver results. Depending on your yardstick of choice, you might categorize the results as poor, bad, or even horrific. Yet we cannot blame investors for not trying: the rally in both stocks and bonds from October to early December appeared to have legs…until it did not.

    There is a reason for this expectation/performance mismatch, and it is not inflation. The reason is the bull market is over. And while stock investors may continue to believe they have seen this movie before, bond investors are surprisingly acting the same way.

    Nowhere is the bull, bull, bull world more apparent than in the world of bonds. One example is in spreads. In writing about the treasury market, Jeff Sommer at the New York Times says “this has been an awful year for U.S. bonds — so bad that 2022 may end up as the worst calendar year in history.” Maybe that explains how Idaho Housing sold its 4.384% taxable municipal at 11 basis points below treasury yields (higher priced) last week (per Bloomberg). The bond is not a treasury! Idaho Housing bonds due six months later sold to the spread of seven basis points. Yeehaw! A lack of spread to treasuries is very bull, bull, bull.

    Such lack of spread may explain how several classes of bonds like municipals and corporates will probably outperform treasuries for 2022. So, we should buy more? Bloomberg’s Martin Z. Braun reported on December 13th just that. “Despite the worst route in forty years, investors plowed a record $27.86 billion into municipal bond ETF’s (Exchange Traded Funds) this year.”

    In my opinion, there is no better place to look for bull, bull, bull than in the bond portfolios across Wall Street. Tens of trillions of dollars are invested in these portfolios built during the bull market, for the bull market. It does not matter whether the fund is actively managed, like PIMCO, or passively managed, like Vanguard, these funds were built for a bull that is now over.

    Money management is based on the premise of scalability. What is good for $1 million should be good for $1 billion. One might call it the economies of scale in the arms race of money management. Now that the biggest firms manage trillions of dollars, with fixed income usually the largest portion, these firms and their funds were well positioned in the bull market but now turning their portfolio around is like trying to quickly turn an oil tanker. Not only impossible but why even try?

    The easier strategy for money managers is to continue full speed ahead. First, you do not have to admit you blew 2022 and second, you can advertise your higher yields. “Bonds are back” is the refrain on business cable shows largely sponsored by many money management firms. Expect more of this approach, especially as we enter 2023 and accounts attempt to rebalance.

    Speaking of rebalancing, the Wall Street Journal recently reported Blackstone’s Real Estate Investment Trust (BREIT) would limit redemptions. Getting out while the getting out is good works, until it does not. This is another area where experience is not matching expectations. In a bull market liquidity is not an issue. When liquidity disappears, it may not be a bull market any longer. We should heed this example as perhaps the dead canary in our coal mine.

    For investors who continue to hold bond investments in funds of any type, I implore you to do otherwise. I have worked bond math for decades and the bond math of “making up” your 2022 losses does not add up. But, as I discussed earlier, the lack of spread in the bond markets also means prices are higher spread bonds such as municipals and corporates. This condition will not continue indefinitely. Rather as more investors determine bond funds are not for them, the closer the funds become to having a Blackstone moment. Investors are better served by moving on while they have the chance and while relative prices are high.

    City of Rockwall, TX

    Combination Tax and Revenue Certificates, Series 2023

    Aa2 Moody Underlying AA+ S&P Underlying

    Due 8/1   Dated 1/1/23 Maturity 8/1/42

    $35,990,000 Sold

    Years   Maturity           Coupon      Yield*

    1         2023             5.00%           2.83%

    2         2024             5.00%           2.68%

    3         2025             5.00%           2.63%

    4         2026             5.00%           2.64%

    5         2027             5.00%           2.67%

    6         2028             5.00%           2.71%

    7         2029             5.00%           2.73%

    8         2030             5.00%           2.76%

    9         2031             5.00%           2.79%

    10          2032          5.00%           2.82%

    11          2033**       5.00%           2.90%

    12          2034**        5.00%           3.05%

    13          2035**        5.00%           3.23%

    14          2036**        5.00%           3.39%

    15          2037**        4.00%           3.72%

    16          2038**       4.00%           3.88%

    17          2039**       4.00%           3.95%

    18          2040**       4.00%           4.00%

    19          2041**       4.00%           4.06%

    20          2042**       4.00%           4.08%

    *Yield to Worst (Call or Maturity) ** Call 8/1/32

    Source: Bloomberg

    This is an example of a new issue priced the week of 12/19/22

    Prices, yields and availability subject to change


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