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Fixed Income. Broken Dreams.28 August 2013
War Room
HiddenLevers War Room
Open Q + A
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Presentation deck
Product UpdatesScenario Updates
I. Market Volatility Update- Middle East Troubles- Debt Ceiling + Obamacare
II. Macro Overview – Taper Coming?
III. Fixed Income Broken
IV. Winners + Losers in Rising Rates
War Room
HiddenLevers
MARKET VOLATILITY UPDATE
Middle East Troubles
SyriaEgypt2013
Oil = 110
Syria conflict hurts Iran progress
Oil near2 year highs
US attack = risk off
Oil rally temporarysource: HiddenLevers, US Energy Information AdministrationInitial Reaction = 3 month time frame
Initial reaction
Gulf War 1991
Iraq Invasion2003
RightNow
VIX + 18% + 50% + 30 %
S & P - 6% -7.2% + 3
Oil + 100% + 66% + 13%
sources: HiddenLevers, Washington Post
Arab Spring 2011
Remember the good old
days Bob?
Middle East Troubles
Oil = 113
source: HiddenLevers
Watch out for biased research on Obamacare
Debt Ceiling + Obamacare
GOP divided on idea of using Government shutdown to defund Obamacare
But House Majority Leader has suggested using Debt Ceiling negotiations to defund Obamacare – does this put default back on the table?
Default is much bigger than Shutdown
Egypt = priced in
govt shutdown = sick
Syria = NOT priced in
debt ceiling breach = dead
Market Volatility – Recap
MACRO OVERVIEW – TAPER COMING?HiddenLevers
Macro Overview – Housing + Mortgage Rates
Housing starts and home prices both rising since early 2012
100bp rise in mortgage rates – impact on home sales just beginning
source: HiddenLevers
Macro Overview – Employment + CPI
Housing starts and home prices both rising since early 2012
100bp rise in mortgage rates – impact on home sales just beginning
source: HiddenLevers
Macro Overview – From the Horse’s Mouth
Fed Speak Translation
…as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee's 2 percent longer-run goal…
No rate hikes
anytime soon
“And if the subsequent data continued to confirm this pattern of ongoing economic improvement and normalizing inflation, we expected to continue to reduce the pace of purchases in measured steps through the first half of next year, ending them around midyear. At that point, if the economy had evolved along the lines we anticipated, the recovery would have gained further momentum, unemployment would be in the vicinity of 7 percent, and inflation would be moving toward our 2 percent objective.”
- Ben Bernanke, 7/17/2013
If economy holds up,
start taper in Sep ’13, and finish
by mid-2014 I’m pretty sure he means it Wilbur.
The Long View – where are we on rates?
Long-term (30yr) US interest rates have varied from 2% to 14%.
Even with 10yr at 4% we will be below long-term average interest rates.
This provides significant room for tapering as economy recovers.
~6% long term average for 30 year treasury
HiddenLevers
FIXED INCOME BROKEN – CRISIS LOOMING?
Puerto Rico is close to needing
a bailout
Muni Bond Crisis – Scary Anecdotes
Cook County, IL debt
downgraded
Muni bond sell off looks like
Lehman
Illinois pensions completely
underfunded
Harrisburg PA insolvent,
selling assets
Detroit files for bankruptcy,$18b owed
source: Bloomberg, Marketwatch, WSJ
Muni Bond Crisis – Reassuring Data
$3.7 trillion
$6.68billion
$189billion
$746million
70%
California’s last debt sale Bond market no longer views CA as distressed credit. Credit rating has been raised twice in 2013.
US municipal bond market
Amount of bonds cities + states have sold in 2013only 10 percent off last year’s pace
Marketshare of muni bonds held by Individual Investors
source: Journal Gazette, WSJ, Forbes, Reuters
Total defaults for first half 2013, including Detroit$6.4 billion of this is Detroit. 280 million of defaults otherwise.
Muni Bond Crisis – Comparisons
Lehman comparisonsirresponsible
Fall in Munis tied to
treasuries
US 10y yieldsup 70% since
01/May
Munis held ground better
than US Treasuries
Muni bond yields up 30% since 01/May
Munis index -5%
US Treasury FundsDreyfus -15%T. Rowe Price -15%
Moving together since July
source: HiddenLevers, Marketwatch
“Lehman moment”
Maybe I should have dropped aLehman bomb?
Meredith Whitney
Muni Bond Crisis – Scenarios
BadNormal
Interest Rate risk
UglyDramatic rise
in defaults
1994 Bond Exodus – Massacre
- $1.5 Trillion global bond market losses- yields spiked 275 basis points in 6 months- long term treasuries lost over 10% in 1994- current lower rates = losses would be greater
8.0%
5.25%
50% rise
1994 Bond Exodus – Historical Scenario
• 1994 bond crash was mainly an interest rate and bond market phenomenon, did not have negative economic impacts
• Stock market impacts were very mild, though volatility rose
• Unemployment dropped, GDP growth increased, and CPI was stable during this period
1994 Bond Exodus – Precipitated by Fed?
Greenspan’s Fed hiked the Federal Funds Rate 6 consecutive times – from 3.5% to 6% in a one year timespan. He then reversed course and cut rates for the most of the next 2 years.
1994 Bond Exodus – No Stock Exodus
What happens to stocks after the Fed begins to tighten policy?
Average 1Y S&P Return post-tightening:
1965: S&P -12.2% 1972: S&P 4.8% 1987: S&P -6.2%
1994: S&P -4.6%
1.5%
New Bond Exodus? – Bond + Equity Outflows
date equities bonds2/28/2011 11,628 9,0633/31/2011 2,132 12,9784/30/2011 6,348 13,9695/31/2011 -4,208 19,6556/30/2011 -22,200 13,7257/31/2011 -31,654 9,8288/31/2011 -28,113 -4,1329/30/2011 -12,555 9,782
10/31/2011 -20,687 11,99211/30/2011 -18,547 19,07712/31/2011 -29,345 9,800
1/31/2012 -593 26,5262/29/2012 1,500 34,7153/31/2012 -10,157 30,8544/30/2012 -6,563 24,7345/31/2012 -8,692 19,0136/30/2012 -6,370 16,3887/31/2012 -9,262 25,0748/31/2012 -18,288 31,6259/30/2012 -24,446 29,174
10/31/2012 -16,418 34,51711/30/2012 -23,169 23,73412/31/2012 -30,666 7,250
1/31/2013 37,737 32,8012/28/2013 14,131 20,2833/31/2013 14,812 16,1444/30/2013 4,320 12,0555/31/2013 5,342 12,1966/30/2013 -58 -60,471
Weekly Net New Cash Flow(dollar figures in millions)
date equities bonds
7/2/2013 180 -6,284
7/10/2013 7,556 -8,141
7/17/2013 3,653 -3,251
7/24/2013 4,209 2,159
7/31/2013 713 -6,970
8/7/2013 3,411 -2,090
8/14/2013 1,498 -3,908
8/21/2013 1,332 -11,149
At MI6 we call that a smoking gun
source: ICI Trends in Mutual Fund Investing
Bond outflows haven’t stopped
Regular bond inflows until
mid-2013
June 2013 the reckoning
(dollar figures in millions)
More likely Fed Taper than great
rotation
WINNERS + LOSERS IN RISING RATESHiddenLevers
How to control duration? Shorten maturities Increase yield Hold to maturity Floating rate issues
Higher yield considerations Increased credit risk Higher correlation to
stocks
Rising Rates: Duration and Rate Risk
Rising Rates: Impact by Bond Maturity
What’s the impact of 150bp rise in 10y yields?
• -2.7% for short duration funds
• -20% for 20+ year maturities
• Average impact of -10% across maturities
LoserMortgage
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Rising Rates: Equities
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Rising Rates – Try Correlations Screener
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