Doubleline Capital - December 2013 Commentary

8/13/2019 Doubleline Capital - December 2013 Commentary

1/20333S.GrandAve.,18thFloor||LosAngeles,CA90071||(213)633820

QuarterlyCommentary

December2013

333S.GrandAve.,18thFloor||LosAngeles,CA90071||(213)633820


2/20

QuarterlyCommentary

12/31/

Overview

2013 was a pivotal year for fixed income markets,

endingwithanannouncementfromtheFederalOpen

MarketCommittee

(FOMC)

of

amuch

anticipated

cut

in its Quantitative Easing (QE) programs. One of the

topicsofconcernwastheplummetingunemployment

rateamidstafallingproportionofthepopulationwho

areeitherworking,orlookingforwork.

Also creating concern for central bankers were the

continually low levels of inflation. Both realized

measures of inflation, such as the Consumer Price

Index (CPI) and the Personal Consumption

Expenditures (PCE) Index, and anticipated future

levels of inflation by market participants, such as

forward breakeven rates on inflationindexed

securities, remain low. Ultimately, however, the

decision to contract purchases by $10 billion per

month ($5 billion each of U.S. Treasury (UST) and

AgencyMortgageBackedSecurities(MBS)purchases)

wasdeemedthemostprudentdirectionbythevoting

membersoftheFOMC.UpwardrevisionstoRealGDP

for the third quarter showing 4.1% growth received

after thedecision from theFOMC wouldserve to at

least partially substantiate this decision. Nonfarm

QuarterlyCommentary

payroll growth of only 74,000 in December th

lowestsuchgrowthsince2011suggestssomethin

tothe

contrary.

As

Janet

Yellen

takes

the

helm

of

th

Federal Reserve effective February 1, her ability t

navigate this still nascent recovery will be close

monitored.

Domestic equity markets closed the year wit

strength,justastheybegan.Aftergaining10%durin

thefirst

quarter

of

the

year,

the

final

quarter

of

201

saw nearly identical growth in the S&P 500 Inde

Following theopposite trend,domestic fixed incom

marketsasmeasuredby theBarclaysU.S.Aggregat

Bond Index nearly mirrored the 0.12% declin

experiencedduringthefirstquarteroftheyearwith

declineof0.14%duringthefourthquarter. Whileth

index finished the year down 2.0% (the first year

0

50

100

150

200

250

300

350

Jan13 Feb13 Mar13 Apr13 May13 Jun13 Jul13 Aug13 Sep13 Oct13 Nov13 Dec1

NetPayrollAdditions(000's)

NonfarmPrivatePayrollsNetChange

BLS ADP

Source:BureauofLabor Statistics, Bloomberg,ADP

LastBLS=74K

LastADP=238K

10.00%

8.00%

6.00%

4.00%

2.00%

0.00%

2.00%

4.00%

6.00%

8.00%QuarteroverQuarter(QoQ)RealGDPGrowthEstimates

Advance

Second

Third

Latest

Source:BureauofEconomicAnalysis, Bloomberg

Q32013Growth =4.1%

52.0%

54.0%

56.0%

58.0%

60.0%

62.0%

64.0%

66.0%

68.0%

1/1/1948

1/1/1951

1/1/1954

1/1/1957

1/1/1960

1/1/1963

1/1/1966

1/1/1969

1/1/1972

1/1/1975

1/1/1978

1/1/1981

1/1/1984

1/1/1987

1/1/1990

1/1/1993

1/1/1996

1/1/1999

1/1/2002

1/1/2005

1/1/2008

1/1/2011

U.S.LaborForceParticipationRate

Source:BureauofLaborStatistics, Bloomberg

12/31/2013:62.8%


3/20

QuarterlyCommentary

12/31/

declinesince1999),mostofthemovementhappened

during the relatively sharp rise in benchmark rates

which spooked fixed income markets broadly during

thesecondquarter.TenyearUSTrates increased42

basispoints(bps)duringthequarter,andfinishedthe

month at 3.02%. The 10year rate at December

monthend is the highest such monthly close since

June2011.

QuarterlyCommentary


4/20

QuarterlyCommentary

12/31/

EmergingMarketsFixedIncome

In Emerging Markets Fixed Income (EMFI), all three

sectors of the markets; the external sovereign,

corporatedebt

and

local

currency

bonds,

represented

bytheJPMorganEmergingMarketBondIndexGlobal

Diversified (EMBI), the JP Morgan Corporate

Emerging Markets Bond Index Broad Diversified

(CEMBI)and the JPMorganGovernmentBond Index

Emerging Markets Broad Diversified (GBIEM)

respectively, posted mixed returns for the month of

Decemberandnegativereturnsfortheyear2013.

Developed markets saw uneven economic progress

over the course of 2013. The eurozone, which has

been mired in recession and stubbornly high

unemployment rates, in March 2013 saw the

European Union (EU) approve the bailout of yet

another member nation struggling with a banking

crisis,Cyprus.Thiswasthefirstinstanceofabailin

provision requiring uninsured depositors accounts

above 100,000 to partake in losses. The eurozone

continuedtostruggleduringthefirsthalfof2013:th

manufacturing sector contracted every mont

throughJune.

In

contrast,

the

latter

half

of

2013

sa

moderate expansion in the sector every mont

Servicerelatedindustrieswereclosebehind,withth

sector expanding every month from August onwar

TheEuropeanCentralBank(ECB)hasprovenkeent

combatdeflationarypressuresinthemonetaryunio

it made a surprise 25 bps cut to the benchma

refinancing rate in November and said it wou

support eurozonewide banks with as much liquidi

as necessary until mid2015. The ECBs hand ma

have been forced by October data showing inflatio

atjust 0.7% in October, well below the 2% level

targets.

Asia too, witnessed policymakers attempt to figh

deflationary pressures. China, where investors ha

feared weak growth could slow the global recover

posted

growth

that

was

the

slowest

since

the

Asiafinancial crisis of 19971998. This weak growth fe

throughtocommoditymarketsand ledmanyasset

such as precious metals, to post extremely wea

performance for 2013. Commoditylinked exporter

suchasAndeannationsinLatinAmerica(LatAm),sa

exceedingly weak exports on the back of China

cooling growth. Still, the new administration o

President Xi Jinping that took over in Marc

underlined

that

it

would

support

moderate

growtwhile also focusing on shrinking an excessive cred

bubble.Thegovernmentpublicallystateditwouldd

what was necessary to support 7.5% econom

growth in 2013, and this appears to be the like

target for 2014. The Chinese government has mad

clamping down on excessive lending, especially

propertymarkets,akeypolicyoutoffearofacred

QuarterlyCommentary

Tickers December

Return

4Q2013

Return

2013

Return

YTM Sp read

EMBI JPGCCOMP 0.51% 1.53% 5.25% 5.88% 308

CEMBI JBCDCOMP 0.17% 1.96% 0.60% 5.69% 311

GBIEM JGENBDUU 0.09% 0.73% 7.26% 6.79% N/A

Source:JPMorgan

(Pastperformanceisnoguaranteeoffutureresults.)

8.0%

6.0%

4.0%

2.0%

0.0%

2.0%

4.0%

6.0%

Dec12 Feb13 Apr13 Jun13 Aug13 Oct13 Dec13

JPMorganEmergingMarketsBondIndex

Performance12/31/2012through12/31/2013

EMBI

CEMBI

GBIEM

Source:JPMorgan


5/20

QuarterlyCommentary

12/31/

bubble forming. Twice during the year, the central

bankallowedforovernightlendingratestoskyrocket

in order to illustrate to banks, especially smallto

medium

sized

ones,

that

it

was

serious

about

preempting a bubble. The new administration also

made battling widespread corruption one of its top

priorities. InJapan,PrimeMinisterShinzoAbebegan

to implement his socalled three arrow policies to

unlock growth: explicit 2% inflation targeting,use of

monetary QE (similar to the Fed), and widespread

publicandprivatesectoreconomicreforms.Investors

welcomed Abenomics, with the countrys equities

risingover

50%

and

the

yen

falling

approximately

17%

in2013.

In EMFI, the impact of tapering was felt across the

asset class, particularly amongst those countries

running twin deficits with weak growth prospects. A

number of countries, whose debt had otherwise

enjoyed strong performance in the lowrate

environment implemented by the Fed, now saw

waninginvestor

support

due

to

alack

of

meaningful

fiscalandeconomicreforms.CountriessuchasSouth

Africa, India, Indonesia, Ukraine, and Venezuela all

saw largespikes involatilitywithin foreignexchange

and debt markets, particularly over the summer as

investors braced for Septembers expected taper.

Venezuela, which had performed strongly in 2012

despite a lack of marketfriendly policies under its

populistPresidentHugoChavez,sawitsdebtmarkets

sharplyreversecoursein2013.Followingthedeathof

thecharismaticChavezinMarch,hisnarrowlyelected

successor Nicolas Maduro has pursued a hardline

policy stance, with widespread asset seizure and

command pricesetting. India struggled over the

summerwithmisstepsby itscentralbankanda lack

of clear communication of its policy to combat FX

volatility,thoughtheselectionofanewcentralbank

governordidhelpcalmmarketssomewhatintoyea

end. South Africa struggled for much of 2013 am

fallingcommoditypricesandwidespreadstrikesini

critical

revenue

driving

mining

sector,

while

PresideJacob Zuma saw support ebb from breakawa

factionsofhisparty.

Sociopolitical unrest proved to be a theme acro

manyemergingmarketeconomies in2013 touchin

to varying degrees: Egypt, South Africa, Braz

Venezuela, Turkey, Ukraine, and Thailand, amon

others. Public anger at the perceived conservativ

Islamisttilt

of

leaders

in

both

Egypt

and

Turkey

sa

largescalepublicprotestsandclasheswithpolicefo

much of the spring. The protests and widesprea

clashes in Egypt eventually brought down th

relatively new government of Mohammed Morsi a

the military intervened on the side of antiIslami

protestors and imposed martial law as it wound u

outlawing Morsis Muslim Brotherhood part

Sporadic violence between the military and Islami

protestors/fighterscontinues.

Turkeys

protests

wer

sparked by the planned bulldozing of a public par

butswelledwithsecular,middleclassfigurescomin

outinangeratperceivedauthoritariantendencieso

PrimeMinisterRecepErdogans Islamistrulingpart

Though dying down somewhat toward late 201

following violent crackdowns, protests reignited

Decemberamidamajorcorruptioninvestigationth

continuestosweepthroughErdogansgovernment.

NotallEMmarketswitnessedturmoilin2013:Mexic

saw a series of major reforms tied to its revenu

criticalstateoilmonopolypassinto law,asPresiden

Enrique Pea Nieto seeks to boost flagging growt

whileColombia,wrackedbydecadesofcivilwar,sa

crucialprogressmadeinpeacetalksbetweenMarxi

rebelsandthegovernment inNovember,whichma

QuarterlyCommentary


6/20

QuarterlyCommentary

12/31/

pavethewayforthemainrebelgrouptolaydownits

armsandinsteadenterpolitics.

In

conjunction

with

the

selloff

in

EMFI

markets

following the first news of tapering in May was the

pace of outflows from both hard and local currency

funds totaling $39.8 billion from June to December.

For the calendar year, the emerging market debt

funds saw a net inflow of $10.3 billion, down

significantly from inflows of $97.5 billion in 2012.

Retail flows were particularly susceptible to taper

related headlines, such as strong economic data

releasesincluding

non

farm

payrolls.

Looking

forward

to2014,webelievethatmanyoftheseshorterterm

investors may have been flushed out of the asset

class, leaving stronger, longterm strategic buyers.

Strategic inflows from pension funds, insurance

companies, endowments, etc. totaled $26 billion in

2013, inline with prior years. Many crossover

investors, for whom emerging markets are not a

specialty,hadexposuretoonlythemostwellknown,

liquid

names:

when

outflows

spiked

from

May

through yearend, sovereign and local bond funds

sawcombinedoutflowsof$37billion,versusjust$1.7

billion leaving corporate debt since the end of May.

Furthermore, we feel that the selloff for much of

2013 left many fundamentally sound corporate

credits trading at attractive levels simply due to the

excessivefearoftaperingandratesrapidlyrising.

Weexpectdebtissuance,whichhadpickedupinthe

fourthquarter2013after trailingoff in thesummer,

tocontinueatleastthroughthefirstquarter2014,as

thereremainsasolidpipelineofnewissuancewaiting

tocometothemarket.

QuarterlyCommentary


7/20

QuarterlyCommentary

12/31/

GlobalDevelopedCredit

Although total returns for corporate credit in 2013

failed to match the spectacular results posted in

2012,

the

year

logged

respectable

performance

despite a meaningful rise in UST rates. The total

returnoftheBarclaysU.S.CreditIndexwas2.01%in

2013,farshortofthetotalreturnof9.39%postedin

2012. However, investment grade corporate bonds

posted an excess return over UST of 2.26% for the

year. Investment grade corporate bond spreads

tightened by 20 bps during 2013 led by financial

institutionswhichtightenedby46bps. TheBarclays

U.S. Corporate High Yield Index returned 7.44% in

2013,lessthanhalfofthe15.81%theIndexgainedin

2012. Excess returnspostedbyhighyieldcorporate

bonds came in at 9.23% for 2013. High yield bond

spreads tightenedby129bpsduring theyear ledby

industrialswhichtightenedby137bps. TheBarclays

U.S. High Yield Loan Index returned 5.39% in 2013

withtheassetclasscontinuingtoenjoystrong levels

of

demand

from

investors.

Gross

fixed

rate

investment grade supply in 2013 of $1.106 trillion

essentiallymatchedthe$1.086trillionissuedin2012.

The primary high yield market priced $325 billion in

2013, slightly lower than the $345 billion priced in

2012whichstillholdstherecordforannualhighyield

issuance.

Within the investment grade universe during 201

the greatest excess returns were posted by Gamin

(+6.94%); Airlines (+6.28%); Supermarkets (+6.01%

Life Insurance (+5.76%); and Building Materia

(+5.55%). Theworstperformingsectorsonarelativ

basis were Media/Cable (+17 bps); Foreign Agencie

(+19 bps); Wireless Telecommunications (+40 bps

Supranationals (+43 bps); and Metals (+50 bps

Higher

quality

issues

(those

bonds

rated

single

A

obetter) materially underperformed their lower rate

counterparts given the continued predilection o

investors to trade down the risk curve to reach fo

yield. The topperforminghighyieldsectors in201

were Consumer Products (+10.35%); Technolog

(+10.22%); Building Materials (+8.74%); Pape

(+8.05%); and Gaming (+7.37%). The wor

performing sectors of 2013 were Pipelines (+2.12%

Media/Cable(+3.58%);

Wireless

Telecommunication

(+6.04%); Retailers (+7.55%); and NonCaptiv

Finance (+9.08%). As was the case with investme

grade corporate credit, lower quality bond

outperformed their higher rated counterparts wit

Caarated credits returning 13.82% in 2013 versus

returnof7.27%forBratedcreditsand5.05%forB

QuarterlyCommentary

4.0%

3.0%

2.0%

1.0%

0.0%

1.0%

2.0%

3.0%

Jan

13

Feb

13

M

ar13

Apr13

M

ay13

Jun

13

Jul13

A

ug

13

S

ep

13

Oct

13

N

ov

13

D

ec

13

PerformanceofSelectBarclaysIndices

12/31/2012through12/31/2013

U.S.HighYield

U.S.Credit

U.S.Aggregate

Source:Barclays Live

0

20

40

60

80

100

120

140

160

180

BillionsofU.S.

Dollar

s

TotalFixedRateInvestmentGradeSupply

Source:BarclaysLive


8/20

QuarterlyCommentary

12/31/

ratedcredits.

Overall, default activity in 2013 was benign as both

default volume and the high yield default rate

reached

sixyear

lows.

According

to

JP

Morgan,

in

201329companiesdefaultedcomprising$18.9billion

in bonds and institutional loans. In comparison, 36

companies and $22.6 billion defaulted during 2012.

Notably, bond defaults were almost twice as

prevalentas loandefaults in2013with16bondonly

defaults versus only 9 loanonly defaults and 4

defaults in which the company had both bonds and

loansoutstanding.

Withrespecttofundflowsandinvestordemand,high

yield mutual funds experienced a net outflow of

assetsof$5.6billion in2013while loan fund inflows

totaled$62.9billionfortheyear.

Aswemovetoward2014,it islikelythemarketswill

experience continued interest rate volatility with

movements in the Treasury curve reflecting both

underlyingeconomicfundamentalsaswellasfurther

expectations

for

Fed

tapering

of

the

QE

program.

Corporate credit spreads should continue to tighten

in line with fundamental economic improvement.

However, spread movements for corporate credit

could be a bumpy ride in 2014 as well with more

spreadvolatilitythanthatwitnessedin2013ascredit

investors balance what have become the competing

forcesoffundamentalconditionsintheU.S.economy

with the challenges faced by the Fed in

communicatingfurther

tapering

actions.

QuarterlyCommentary


9/20

QuarterlyCommentary

12/31/

further

although

we

believe

the

majority

of

thextensionhasalreadyoccurred. Ifratesweretoris

significantly, we would project the MBS duration t

extendabove6,butnotmuchmorethanthat. Ifth

scenario were to play out over the next 12 month

the MBS sector could outperform the TS

sector. How it performs relative to the Corporat

sector willdepend in largepart on whathappens t

U.S.InvestmentGradeCorporatespreadsduringth

timeperiod.

One of the major reasons why MBS experienc

duration extension during rising rate periods is th

expectation of decreasing prepayment speeds on

going forward basis. Prepayment speeds went u

marginally for the month of December. This sligh

increaseinspeedsbrokethestringofsixconsecutiv

decliningmonthsofprepaymentspeeds. Prepaymen

AgencyMortgageBackedSecurities

AgencyMBShadareturnof0.47%forthemonthof

December 2013, according to the Barclays U.S. MBS

Index.For

December,

10

year

UST

rates

rose

by

23

bps, and the MBS sector outperformed the U.S.

Treasury (TSY) sector but underperformed the U.S.

Investment Grade Corporate sector according to the

BarclaysU.S.AggregateBondIndex. Forthecalendar

year2013,10yearUSTratesroseby125bpsandthe

Barclays U.S. MBS Index had a return of 1.41% for

sameperiod.This12monthperformancewasbetter

thantheperformancesofboththeU.S.TSYandU.S.

InvestmentGradeCorporatesectorsaccordingtothe

Barclays U.S. Aggregate Bond Index. This is an

example of mortgages outperforming the other

components of the Indexwhen rates risemore than

100bps.

One of the major reasons for mortgage

outperformance in rising rate environments has

historically

been

due

to

the

shorter

duration

of

the

MBSsectorrelativetothoseoftheTSYandCorporate

sectors, according to the Barclays U.S. Aggregate

Bond Index.During therateriseof2013,durationof

Agency MBS extended from 3.18 years at the

beginningoftheyearto5.66yearsattheendofthe

year. This is the longest duration ever reported for

the sector. Should rates rise further, we would

expect the duration of the MBS sector to extend

QuarterlyCommentary

ConditionalPrepaymentRates(CPR)

2013 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

FannieMae(FNMA) 27.8 24.4 24.4 24.0 25.1 22.7 20.5 16.2 12.2 11.5 10.4 10.6

FreddieMac(FHLMC) 28.2 26.0 25.9 25.3 25.5 23.4 21.5 17.1 13.1 12.0 10.8 11.1

GinnieMae(GNMA) 23.3 21.9 21.8 23.0 22.2 19.4 18.2 14.9 12.2 12.1 11.2 11.2

BarclaysCapitalU.S.

MBSIndex 10/31/2013 11/29/2013 12/31/2013 Change

AverageDollarPrice 104.60 103.68 102.91 0.77

Duration 5.26 5.56 5.62 0.06

BarclaysCapitalU.S.

IndexReturns 10/31/2013 11/29/2013 12/31/2013

U.S.Aggregate 0.81% 0.37% 0.57%

U.S.MBS 0.68% 0.62% 0.47%

U.S.Corporate 1.44% 0.27% 0.25%

U.S.Treasury 0.48% 0.33% 0.91%

source:eMBS,BarclaysCapital

0.00

1,000.00

2,000.00

3,000.00

4,000.00

5,000.00

6,000.00

7,000.00

12/31/10

2/28/11

4/30/11

6/30/11

8/31/11

10/31/11

12/31/11

2/29/12

4/30/12

6/30/12

8/31/12

10/31/12

12/31/12

2/28/13

4/30/13

6/30/13

8/31/13

10/31/13

MortgageBankersAssociationRefinanceIndex

Source:MortgageBankersAssociationviaBloomberg


10/20

QuarterlyCommentary

12/31/

would mean no more QE program 12months fro

now. Assumingthisscenarioplaysout,wewouldno

expect any widening of MBS. As in most market

MBS

performance

will

depend

on

both

the

supply

andemand for securities. Currently, the Fed is th

biggest player on the demand side and therefore i

actions are very important; however, there a

changes on the supply side of mortgages that hav

experienced even greater change than the Fe

tapering. Lastsummer,grossissuanceofAgencyMB

was approximately $150 billion per month. As rate

have risen, this number has come dow

significantly.

In

fact,

Decembers

number

was

$7billion,sothegross issuanceofAgencyMBS isdow

approximately $75 billion permonth from where

waslastsummer.

speedsdecreasedby60%over2013andAgencyMBS

experienced their slowest speeds since December

2008, which was in the middle of the subprime

housing

crisis.

We

are

already

in

an

environment

whereprepaymentspeedsareata5yearlow.

Future prepayment speeds will depend partly on

what happens to interest rates. A secondary factor

couldbeachangeinthegovernmentsinvolvementin

the mortgage process. Currently, the Home

Affordable Refinance Program (HARP) 2.0 is the

government program with one of the largest affects

on

prepayment

speeds.

HARP

2.0

is

experiencing

burnout,whichiswhathappensastimepassesand

the borrowers who qualify have already acted,

thereforeleavingfewereligibleborrowersthanthere

wereinthepast.Themortgagemarketisdealingwith

theconfirmationofMelWattas thenewdirectorof

Federal Housing Finance Agency (FHFA) as well,

replacing Ed DeMarco.The markets perception is

thatWattmaybemorefriendlytowardsborrowers

thanDeMarco,

which

could

lead

to

policy

decisions

thatcouldincreasetheprepaymentspeedsofcertain

mortgagesecurities.Thusfar,Watthasindicatedthat

he will postpone the previously announced increase

in fees across both Fannie Mae and Freddie Mac.

Watt officially takes the position on January 6,2014

and many investment professionals are closely

watching the decisions made by Watt and their

ramificationsonthefixedincomemarkets.

OnDecember18th,theFedannouncedthetaperingof

$10billionpermonthwithhalfofthetaperingbeing

inMBS.ThistakesthetotalamountofFedpurchases

to $75 billion per month, with $35 billion of that in

MBS (this doesnt include the reinvesting in MBS of

paydownsonoutstandingMBS,whichcanbeasmuch

as$1520billionpermonth). TheMBSmarketseems

tohavepricedina12monthtaperingprocesswhich

QuarterlyCommentary

3.00

3.50

4.00

4.50

5.00

5.50

12/31/10

1/31/11

2/28/11

3/31/11

4/30/11

5/31/11

6/30/11

7/31/11

8/31/11

9/30/11

10/31/11

11/30/11

12/31/11

1/31/12

2/29/12

3/31/12

4/30/12

5/31/12

6/30/12

7/31/12

8/31/12

9/30/12

10/31/12

11/30/12

12/31/12

1/31/13

2/28/13

3/31/13

4/30/13

5/31/13

6/30/13

7/31/13

8/31/13

9/30/13

10/31/13

1 1 / 3 0 / 1 3

FreddieMacCommitment Rate30 Year

Source:Bloomberg


11/20

QuarterlyCommentary

12/31/

debated throughout 2013. News of the recor

settlementbyJPMorgandominatedthemarketplac

Ocwen, the largest nonbank servicer, is the late

entity making the headlines in regards to mortgag

litigation. Ocwen will provide $2.1 billion o

foreclosure compensation and principal modificatio

forhomeownerswhoarebehindon theirpayment

The settlement is based on regulator claims th

Ocwen abused its handling of borrowers loans. W

willcontinuetomonitortheseeventsclosely.

NonAgencyMortgageBackedSecurities

Decembertradingvolumeexperiencedanuptickdue

to the liquidation of a large segment of INGs

portfolio

late

in

the

month.

The

ING

list

consisted

largely of payoption AdjustableRate Mortgage

(ARM)bondsandthus,thissectorofthemarketsaw

an almost threefold increase from November.

Despite thesize of the list and time in the year, the

list traded very well with bids coming from banks,

investment managers, hedge funds and insurance

companies.

Fundamentally, December remittance reports

showed mixed results. Prepay speeds on prime

collateral increased0.5ConditionalPrepaymentRate

(CPR) while AltA and subprime speeds decreased a

modest 0.5 CPR and 0.4 CPR, respectively. Rising

interest rates have been pressuring the fast prepay

speedsseenduringmuchofthesecondhalfof2013.

Liquidationsslowedforallsectorswiththeexception

of

subprime.

Average

Conditional

Default

Rates

(CDRs)decreasedby0.4forprimeand0.9CDRforAlt

A collateral while subprime, on average, saw

liquidations increase by 0.2 CDR. Loan modifications

slowed going into 2013 yearend with 1,947 loans

modified in December; 56% of all modified loans

were rate modifications, with the average mortgage

ratebeingreducedbyapproximately4%.Withsupply

still relatively low, technicals continued to put

pressure

on

yields

and

we

saw

a

slight

tightening

across all sectors. Prime finished the year trading

between 44.25%, AltA between 4.54.75%, and

subprimebetween55.5%.

On the political front, there was some concern on

whatchangeswouldbeimplementedwhenMelWatt

takesovertheDirectorshipoftheFHFA.Settlements

between mortgage issuers and investors were hotly

QuarterlyCommentary

30

35

40

45

50

55

60

65

70

75

80

6/30

/11

8/31

/11

10/31

/11

12/31

/11

2/29

/12

4/30

/12

6/30

/12

8/31

/12

10/31

/12

12/31

/12

2/28

/13

4/30

/13

6/30

/13

8/31

/13

10/31

/13

/

/

ABXPrices

ABX20062AAA

ABX20071AAA

Source:MarkItviaMorganStanley

86

89

92

95

98

101

104

107

110

113

6/30/11

8/31/11

10/31/11

12/31/11

2/29/12

4/30/12

6/30/12

8/31/12

10/31/12

12/31/12

2/28/13

4/30/13

6/30/13

8/31/13

10/31/13

PrimeXPrices

PrimeXFRM.1

PrimeXFRM.2

Source:MarkItviaMorgan Stanley


12/20

QuarterlyCommentary

12/31/

Our investment focus for the sector continues t

emphasize security selection. We continue to focu

onshorter

duration

assets,

including

securities

with

more storied basis, as our ability to drill down t

the collateral and borrower allows us to adequate

assess risk. Looking forward, our outlook for th

sector continues to remain cautious give

uncertaintiesinthemacroenvironment.

CommercialMortgageBackedSecurities

Newissuanceactivitykeptinvestorsbusythroughout

themonth of December, finishing the year with $79

billionin

total

issuance,

the

highest

since

2008.

Of

the

total, $52 billion were from conduits, representing

less than half of the 20052007 conduit issuance

average. Overall, the market sentiment remains

cautiously optimistic as investors generally added to

positions lower down the capital stack now that the

Fed has brought some clarity to concerns with the

taper. Webelieve thatsomeof thebroader themes

for 2014 are the improvement in Commercial Real

Estate(CRE)fundamentals,increaseinCMBSissuance

in 2014 and concerns with the continued

deteriorationofnewissuecreditqualityduetolooser

lendingstandards. ForDecember,spreadsralliedinto

yearend with legacy AAA and junior AAA CMBS

spreads tightening versus November. In the new

issuemarket,AAAspreadsendedthemonth45bps

tighterwhileBBBspreadsimprovedby1012bps. For

the

month,

the

CMBS

portion

of

the

Barclays

U.S.

AggregateBond Indexreturned 0.29% inDecember,

+0.53%forthefourthquarterandfinished+0.23%for

theyear.

The delinquency rate continued its decline in

December ending the month at 7.43% (23 bps). By

property type, the 30+ day delinquency rate for

multifamilydeclinedto10.86%(28bps),industrialto

10.46%(+2bps),officeto8.13%(33bps),lodgingto

7.91%(+19

bps),

and

retail

to

6.06%

(26bp).

During

themonthofDecember,93loanstotaling$1.3billion

weredisposedof,resultinginanaveragelossseverity

of 50.4%. We anticipate the delinquency rate to

declinefurtherin2014withthependingresolutionof

CW Capital liquidation of $2.5 billion of defaulted

loans, fewer expected delinquencies and higher

resolutionrates.

QuarterlyCommentary


13/20

QuarterlyCommentary

12/31/

TheBarclaysCapitalU.S.GovernmentIndexreturne

2.60%fortheyear. Itwasthefirstfullcalendaryea

negativereturn

since

2009.

The

2013

return

include

areturnof 0.69%forthefourthquarterand 0.87

forDecember.Thefullyearyieldrisewassharpestfo

intermediatematurities,with the7yearand10yea

points on the yield curve posting matching 127 bp

rises,followedby102bpsrisesforthe5yearand3

year maturities. Returns were more negative fo

longer maturities. For the full year the 2year not

return was +0.30%, worsening to 2.47% for the

year note, 7.81% for the10yearnote,and 15.03

forthe30yearnote.

TheTreasurymarketselloffgarneredthelionssha

ofinvestorsattentionin2013,butsomeotherfixed

incomesectorsespeciallythosewithlessliquidityo

longer duration suffered even larger losse

Treasury InflationProtected Securities (TIP

substantially

underperformed

conventionTreasuries through 2013, burdened by both lon

durationandpoorliquidity,pluslowrealizedinflatio

and falling inflation expectations. The Barclays U.

TIPS Index returned 8.61% for the year. Ta

exempt bonds fared better, boosted by improvin

creditfundamentalsandastrongperformanceinth

fourth quarter. The Barclays Municipal Bond Inde

returned 2.55% for the year, including a +0.32

returnfor

the

fourth

quarter.

The powerful fixedincome liquidation cycle th

began in early May 2013 brought most investo

positions into line with postQE Fed policy an

sustained economic growth. We expect the bon

marketwillfindbuyinginterestfromsometradition

investorgroups,suchaspensionfundsandinsuranc

U.S.GovernmentSecurities

TheUSTmarketfinishedatumultuousyearonaweak

note, as the 10year Treasury note yield rose from

late

October

through

November

and

December

to

finishtheyearatitshighclosingyieldof3.03%.

Asforayearinreview,theyearbeganquietlyasthe

10year yield started 2013 at 1.76%, only modestly

abovethealltime lowyieldset inJuly2012. Aftera

smallselloffthemarketralliedto1.63%onMay1st.

May 3rd proved to be a turning point, with the UST

market selling off on a strongerthanexpected

employment report. Market sentiment shifted

dramaticallyas a broad rangeof investors sought to

liquidate longheld positions and shed duration. The

changed psychology was reinforced in late May by

Fed Chairman Bernanke, who discussed for the first

time a timetable for winding down and ending the

Feds asset purchase program. In early September

the 10year note yield had risen to 2.99%. By then,

investors seemed more comfortable with their fixed

incomeexposure.TheFedhelpedcalmbearishfears

bynoting

that

financial

conditions

had

tightened

due

totheselloffandbyemphasizingthatahikeinshort

termrateswouldnotinevitablyfollowontheheelsof

the end of the asset purchase program. Weak

economic data, resolution of the federal

governmentsfiscalcrisisandanunexpecteddelayin

the onset of the Feds taper all contributed to a

rally through September and October, but that rally

couldretraceonly50bpsoftheearlier140bps sell

offbefore

reversing.

QuarterlyCommentary

11/29/2013 12/31/2013 Change

3month 0.06 0.07 0.01

6month 0.10 0.09 0.01

1year 0.12 0.11 0.01

2year 0.28 0.38 0.10

3year 0.55 0.77 0.22

5year 1.37 1.74 0.37

10year 2.75 3.03 0.28

30year 3.81 3.97 0.16

Source:Bloomberg

YieldCurve


14/20

QuarterlyCommentary

12/31/

companies, at 10year Treasury yields above 3.00%.

Higher yields could limit domestic economic growth.

While yields may rise modestly in 2014 we do not

expectarepeatof2013.

QuarterlyCommentary


15/20

QuarterlyCommentary

12/31/

12.3%, respectively.The quarter was quite volati

for precious metals prices as the market initial

ralliedduring

the

U.S.

debt

ceiling

crisis,

followed

by

downward trend in the last two months of th

quarter. Chairman Bernanke announced the Fed

assetpurchaseprogramwouldbeginagradualdat

dependenttaper, leadingtoasharpselloff.Investo

continue to waiver between inflationary fears v

unintended consequences of the multitrillion dolla

balance sheets of central banks and potential re

yieldprospectsofinvestmentsinbonds. Ifrealyield

on other financial assets remain elevated and leve

of inflationremainnearalltime lows,goldandsilve

pricescouldhaveanotherbearishyearin2014.

For2013,theenergycomplexwasupover5%,drive

by increased demand and global tension. Quarter

energy prices were mixed with the SPGSCI Energ

Index returning 1.3%, refined products, natural ga

and

Brent

crude

posting

positive

returns,

and

Wcrude returning 4.4%.Increasing nonOPEC crud

production may continue to degrade the cartel

ability to control global oil supply. Over the last fe

years, new U.S. extraction technologies have led t

historically high production growth with mo

potential for 2014; this may lead to an increase

divergence in the price of WTI crude versus Bren

crude. The U.S. currently imports roughly 500,00

barrelsper

day

while

domestic

supply

is

forecast

t

increase over 1 million barrels per day in 201

Coupledwiththecurrentexportban,theU.S.mark

could see falling prices in 2014. Natural gas return

were positive on the quarter returning 12.5% o

strongerseasonaldemandforthewinterthusfar,th

strongperformanceallowednaturalgastogenerate

positive9.1%returnin2013.

Commodities

The Standard and Poors (S&P) Goldman Sachs

Commodity Excess Return Index (SPGSCI ER) ended

the

fourth

quarter

down

0.34%.

For

the

year,

the

Index suffered a small loss of 1.3%, though these

numbers do not tell the entire story. Of the five

sectors represented by the SPGSCI, only the energy

sector had positive returns for both the fourth

quarterand2013. Inflationaryfearswanedasyear

overyear(YoY)U.S.CPIhoverednear1%,alevelnot

seen since mid2010. This was exacerbated in the

fourthquarterby the Feds decision to implement a

gradual tapering of its large scale asset purchase

program, known as quantitative easing (QE). In the

developed world, preliminary forecasts showed that

Europewasfinallyekingfromthedepthsofrecession,

and the U.S. economy appeared to be gaining

momentum albeit at a slow rate. Unfortunately,

major commodity consumers such as China, Brazil

and Indiacontinue togrowatpacesslowerthan the

previous

decade,

which

could

put

a

damper

on

demandgrowthin2014.

Preciousmetalssufferedin2013returning29.8%for

the year. It was the first calendar year that gold

sufferedanegativereturnsince2000.Theweakness

continued throughout yearend with both gold and

silver giving back all of the positive returns they

reapedfrom

the

third

quarter

losing

9.5%

and

QuarterlyCommentary

0.34%

1.26%

9.67%

0.37%1.31%

6.71%

12.00%

10.00%

8.00%

6.00%

4.00%

2.00%

0.00%

2.00%

S&PGSCIE R E ner gy Pr ec ious

Metals

Industrials Livestock Agriculture

QuarterlyExcessReturnsofGSCSICommoditySectors

September30,2013 December31,2013

Source:Bloomberg, DoubleLine


16/20

QuarterlyCommentary

12/31/

stronger U.S. housing market and ameliorate

concernsregardingEMgrowth.

The

Livestock

sector

saw

a

modest

loss

of

1.3%

in

thfourthquarter.Withinthesector,hogsweretheon

loserforthequartergivingback5.8%duetothelo

impactofthethirdquartersporcinevirusoutbreak

the U.S. Fears of a supply shock due to pigle

mortality and quarantine conditions failed t

materialize leaving supply relatively unaffected. Th

spread between the performance of Live Cattle an

Feeder Cattle narrowed to 65 bps on the quarte

with

both

gaining

in

priceby

73

bps

and

138

bp

respectively. Ontheyearlivestocklost3.7%in201

goingforwardwatchforincreasedmeatconsumptio

from emerging markets that could drive deman

higherin2014.

The agricultural sector ended 2013 with a 6.7

return inthefourthquarter,cappingoffaweakyea

where18.1%was lost.Corncontinued itsslidedow

morethan

6.9%

in

the

fourth

quarter

on

increasin

inventory levels, stemming from larger acreage an

higher potential crop yields. Further weakne

stemmed from the Environmental Protectio

Agencys (EPAs) decision to reduce the ethan

mandate landing a particularly hard blow to cor

based suppliers contributing to a 2013 loss o

30.3%. Soybeanspostedapositive2.0%returninth

Chinese, Brazilian and Indian economic growth was

moderated this year putting a demand side damper

on

commodity

prices

in

2013,

for

the

year

they

returned12.9%. Onaquarterlybasis,industrialslost

0.4% on uncertainty concerning the next political

economic epoch in China. Going forward excess

inventories may lead to a demand driven market

where marginal cost of production will set prices,

potentially leading to downward price pressureover

the longer term. Copper inventory iscoming off all

time highs with the Chinese physical premium

increasingto

levels

not

seen

since

2009;

this

should

leadtowardsautilizationofexcesssupply. Withnew

multiyear project mines coming online the supply

surplus will likely continue for at least the next

several years providing limited upside to prices

without a large demand side catalyst. Potential

positiveshockstodemandin2014couldcomefroma

QuarterlyCommentary

1.28%

5.08%

29.79%

12.92%

3.66%

18.05%

35.00%

30.00%

25.00%

20.00%

15.00%

10.00%

5.00%

0.00%

5.00%

10.00%

S&PGSCIE R Ener gy Pr eci ous

Metals

Industrials Livestock Agriculture

YearlyExcessReturnsofGSCSICommoditySectors

December31,2012December31,2013


15.00%

12.50%

10.00%

7.50%

5.00%

2.50%

0.00%

2.50%

5.00%

7.50%

10.00%

12.50%15.00%

S&PGSCIER

NaturalGas

UnleadedGas

Zinc

BrentCrude

Lead

GasOil

HeatingOil

Soybeans

Cocoa

FeederCattle

Copper

LiveCattle

Nickel

WTICrude

Cotton

Aluminum

Coffee

LeanHogs

Corn

Gold

Sugar

Silver

Wheat

KansasWheat

QuarterlyExcessReturnsofGSCSICommoditySectors

September 30,2013December31,2013

Source: Bloomberg, DoubleLine

40.00%

35.00%

30.00%

25.00%

20.00%

15.00%

10.00%

5.00%

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

S&PGSCIER

Cocoa

Soybeans

NaturalGas

Cotton

BrentCrude

WTICrude

GasOil

UnleadedGas

HeatingOil

LeanHogs

FeederCattle

LiveCattle

Zinc

Copper

Lead

Sugar

Nickel

Aluminum

KansasWheat

Wheat

Gold

Corn

Coffee

l

YearlyExcessReturnsofGSCSICommodity Sectors

December31,2012December31,2013



17/20

QuarterlyCommentary

12/31/

fourth quarter finishing out a strong 2013 campaign

in which they returned 10.5% on supply concerns in

Brazil and crop yield concerns in the United States.

Wheatand

Kansas

Wheat

ended

the

year

on

adown

ticklosing12.3%and13.6%,respectivelyinthefourth

quarteranddown27.2%and26.2%,correspondingly,

ontheyear.

QuarterlyCommentary


18/20

QuarterlyCommentary

12/31/

U.S.Equities

InMayandJune,theprospectoftheFedtaperingits

QEpolicieshelped todrive the market down5%, its

greatestdeclineoftheyearalbeitamoderateone.By

midDecember,however,anticipationoftaperingwas

welldigested by the market and macroeconomic

fundamentals were looking stronger. By the time of

theFedsDecembermeeting,theyieldonthe10year

Treasury had already risen 1.27%, a 78% increase

from summer lows in 2013. Judging from the rise in

stock prices, the decline in unemployment, and the

overall more positive tone in macroeconomic data,

this increase in rates was easily absorbed by the

economy. Therefore, when the longanticipated

announcement of the taper occurred on December

18th, thestockmarketreactednotwith thealarmof

June,butbyrallyingthroughyearend. TheS&P500

Indexclosedtheyearatanalltimehigh,up32%for

theyear. Forthefourthmonthinarow,theS&P500

Index closed the monthhigher than it began,as the

S&P500Indexwasdowninonlytwomonthsin2013.

QuarterlyCommentary


19/20

QuarterlyCommentary

12/31/

pressure inthefourthquarteras investorsremaine

mixed on whether or not the broadbased reform

announcedby theChinesegovernment inNovembe

will set the stage for positive longterm growt

trajectoryorwill itcomeatathecostof lowersho

to medium term growth, which could unravel som

overzealous sectors of the economy. The Shangh

Composite Index was down 2.70% during the fourt

quarter.

Going

forward,

global

equity

markets

should

focus

oU.S.growth and the pace of Fed tapering. Europea

and Japanesemarketswillbemonitoring theaction

oftheECBandBOJ,asbothbanksarelikelytorema

highlyaccommodativein2014.EmergingMarketsw

be highly contingent on U.S. rates and a smoot

transitioninChina.

GlobalEquities

Global equity markets, as measured by the Morgan

StanleyCapital InternationalAllWorldCountry Index

(MSCI ACWI), performed well in fourth quarter, as

equitiesshruggedofftheannouncementofFedtaper

inDecemberandembracedthebetterthanexpected

economicdatathatwasreleasedovertheperiod.The

MSCIACWIreturned6.93%fortheperiod.

Europeanequitieswerepositiveinthefourthquarter

with Germany, Italy, and Spain the top performing

countries

with

the

Deutsche

Borse

AG

German

Stock

Index (DAX), Financial Times Stock Exchange Milano

Italia Borsa (FTSE MIB), and ndice Bursatil Espaol

(IBEX)up11.14%,8.79%,and7.95%,respectively.The

Cotation Assiste en Continu (CAC 40) and Financial

TimesStockExchange(FTSE100)werealsopositivein

the fourth quarter returning +3.68% and 4.44%,

respectively. European equities were supported in

part by an ECB that cut its key interest rate and

pledgedto

maintain

its

accommodative

stance

for

an

extendedperiod.Theeconomicdataoutoftheregion

also showed signs that the region was climbing its

wayoutofrecession.

Japanese equities performed extremely well in the

fourth quarter with the Nikkei +12.70%. Japanese

equities were supported by the weakness in the

Japanese Yen and the belief that the Bank of Japan

(BOJ)will

step

up

its

quantitative

easing

program

to

offset drag from fiscal reform. Emerging markets, as

measured by the MSCI Emerging Market Index,

underperformedDevelopedMarketsover theperiod

withtheindexonlyup1.54%.RisingratesintheU.S.

were a headwind to Emerging Market equities as

foreign investorspulledcapitaloutofcountrieswith

high external financing needs; e.g., Brazil, Indonesia,

and Turkey. Chinese equities were also under

QuarterlyCommentary


20/20

Documents

Doubleline Capital - December 2013 Commentary