The Yield Curve Flattens: The market appears to believe low inflation and slow growth in a still leveraged society will keep interest rates down for an extended period of time.
Europe Is Still a Mess: Interest rates continue to fall in Europe causing the euro to drop in value against the dollar.
Taxable and Tax-Free Markets: It was a volatile quarter marked by selloffs in July and September in taxable bonds, and a quiet quarter in the municipal markets.
Two and five year rates have risen as the economy is improving and the front end of the yield curve anticipates a future rate hike. However, 10 and 30 year interest rates continue to decline causing the yield curve to flatten. I don’t believe the market response is what the Fed had anticipated. The Fed is model driven and the bond market is not. The Fed would like to see a steep yield curve. However, the market appears to believe low inflation and slow growth in a still leveraged society will keep interest rates down for an extended period of time.
QE: “Gone with the Wind”
The Fed continued to pair back on QE II, reducing bond purchases again, and it is believed QE will be wound down to zero by October or November. And the market’s response to this is?
Frankly, my dear Janet, I don’t give a damn about higher long term rates.
Europe Is Still a Mess
Here is a snapshot of global interest rates at the end of the third quarter 2014:
|5 year||10 year|
Mario Draghi’s Day Off
Not shown on this global interest rate chart is that German two year rates are negative. Europe is suffering from deflationary pressures and stagnant growth in the periphery countries of the euro. Mario Draghi is trying to begin a QE program in Europe that can replicate the results the U.S. Federal Reserve has produced. The result of his efforts has been that interest rates continue to fall in Europe causing the euro to drop in value against the dollar.
Central banks response to slowing economic conditions has been to debase their currency, which in theory increases exports. Will it take the euro reaching parity with the dollar to start an economic recovery?
The Taxable Portfolios
The U.S. Dollar Index bottomed on July 1st and began a 12 week move up. The result was increased bond market volatility in high yield bonds. A high yield sell-off in July was followed by a snap-back rally in August. Another round of high yield selling occurred in September, breaking the July lows to end the quarter.
The higher dollar has caused commodity prices to drop across the board. Oil, copper, nickel, iron ore — all are down. Energy and material bond holdings were down sharply. We are monitoring the energy holdings and looking to increase our allocation to healthcare in the upcoming quarter.
The Tax Free Portfolios
It was another quiet quarter in the municipal market, volatility wise. We have been shortening our stated maturities in the portfolio and concentrating on 4% coupons from 5 to 20 years. In our opinion, 5% coupon bonds with short calls in the 2017-2019 range, which we had bought in the past, don’t seem to present any value. Therefore we will continue to look for value in the 4% coupon structure.
On the macro front, news from Puerto Rico has been quiet and bonds have seemed to find equilibrium. If stocks close higher in the fourth quarter and for the year, the next sell off may be tax selling as investors look to harvest losses in 2014.
The Dow Jones Industrial Average is a stock market index that shows how 30 large publicly owned companies based in the U.S. have traded during a standard trading session in the stock market.
The MSCI EAFE Index is a free float-adjusted market capitalization index that is designed to measure the equity market performers of developed markets outside the U.S. and Canada.
The MSCI Emerging Markets Index is a freefloat-adjusted market capitalization index that is designed to measure equity market performance in the global emerging markets.
The Russell 3000® Index measures the performance of the 3,000 largest U.S. companies based on total market capitalization, which represents approximately 98% of the investable U.S. equity market.
The Barclays U.S. Government and Credit Bond Index measures the performance of U.S. dollar denominated U.S. Treasuries, government-related, and investment grade U.S. corporate securities that have a remaining maturity of greater than 1 year. In addition, the securities have $250 million or more of outstanding face value, and must be fixed rate and non-convertible.
The Barclays U.S. Corporate High-Yield Index covers the USD-denominated, non-investment grade, fixed-rate, taxable corporate bond market. Securities are classified as high-yield if the middle rating of Moody’s, Fitch, and S&P is Ba1/BB+/BB+ or below.
The Barclays 30-Year U.S. Treasury Bellwethers Index is a universe of Treasury bonds, and used as a benchmark against the market for long-term maturity fixed-income securities. The index assumes reinvestment of all distributions and interest payments.
The Barclays 10-Year U.S. Treasury Bellwethers Index is a universe of Treasury bonds, and used as a benchmark against the market for long-term maturity fixed-income securities. The index assumes reinvestment of all distributions and interest payments.
The Barclays 5-Year Municipal Bond Index is the 5 Year (4-6) component of the Municipal Bond index. It is a rules-based, market-value-weighted index engineered for the tax-exempt bond market. The index tracks general obligation bonds, revenue bonds, insured bonds, and pre-refunded bonds rated Baa3/BBB- or higher by at least two of the ratings agencies.
Index returns include the reinvestment of income and dividends. The returns for these unmanaged indexes do not include any transaction costs, management fees or other costs. It is not possible to make an investment directly in any index.
Morningstar is the largest independent research organization serving more than 5.2 million individual investors, 210,000 Financial Advisors, and 1,700 institutional clients around the world.
For each separate account with at least a three-year history, Morningstar calculates a Morningstar Rating™ based on a Morningstar Risk-Adjusted Return measure that accounts for variation in a separate account’s monthly performance, placing more emphasis on downward variations and rewarding consistent performance. The top 10% of separate accounts in each category receive 5 stars, the next 22.5% receive 4 stars, the next 35% receive 3 stars, the next 22.5% receive 2 stars and the bottom 10% receive 1 star. The Overall Morningstar Rating for a separate account is derived from a weighted average of the performance figures associated with its three-, five- and ten-year Morningstar Rating metrics.
© 2012 Morningstar, Inc. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information.
Past performance is not indicative of future results. This material is not financial advice or an offer to sell any product. Not every client’s account will have these exact characteristics. The actual characteristics with respect to any particular client account will vary based on a number of factors including but not limited to: (i) the size of the account; (ii) investment restrictions applicable to the account, if any; and (iii) market exigencies at the time of investment.
Clark Capital Management Group, Inc. reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs. The information provided in this report should not be considered a recommendation to purchase or sell any particular security, sector or industry. There is no assurance that any securities, sectors or industries discussed herein will be included in an account’s portfolio. Asset allocation will vary and the samples shown may not represent an account’s entire portfolio and in the aggregate may represent only a small percentage of an account’s portfolio holdings. It should not be assumed that any of the securities transactions, holdings or sectors discussed were or will prove to be profitable, or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance of the securities discussed herein.
The CBOE Volatility Index® (VIX®) is a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices and which shows the market’s expectation of 30-day volatility. It is constructed using the implied volatilities of a wide range of S&P 500 index options. This volatility is meant to be forward looking and is calculated from both calls and puts. The VIX is a widely used measure of market risk. The S&P 500 measures the performance of the 500 leading companies in leading industries of the U.S. economy, capturing 75% of U.S. equities. The Barclays Capital U.S. Aggregate Bond Index is a market capitalization-weighted index, meaning the securities in the index are weighted according to the market size of each bond type. Most U.S. traded investment grade bonds are represented. Municipal bonds, and Treasury Inflation-Protected Securities are excluded, due to tax treatment issues. The index includes Treasury securities, Government agency bonds, Mortgage-backed bonds, Corporate bonds, and a small amount of foreign bonds traded in U.S. The Barclays Capital Aggregate Bond Index is an intermediate term index.
The volatility (beta) of a client’s portfolio may be greater or less than its respective benchmark. It is not possible to invest in these indices.
Clark Capital Management Group, Inc. is an investment adviser registered with the U.S. Securities and Exchange Commission. Registration does not imply a certain level of skill or training. More information about Clark Capital’s advisory services and fees can be found in its Form ADV which is available upon request.