Morning Note | Oct 18, 2022
Good Morning!
Futures are up sharply with the S&P slated to open up nearly 2.0% after a strong move on Monday. Bond yields are up across the curve with commodities mostly lower. The 10-yr yield is back above 4.0%. Fedspeak starts today with Kashkari and Bostic possibly giving headlines. We have data on industrial production and the housing index today. China delayed its third quarter GDP data. Â
Yesterday, the markets gained momentum throughout the day and earnings results trickled in. The market is now trading on the notion that third quarter earnings will be terrible so anything not awful will be a positive. Growth is still very weak overall as the bar was set pretty low.
… In the end, we expect to be heading into a period of low growth and high inflation, which the Fed also projected at their most recent meeting. In this environment we believe it is good idea to become a little more defensive and consider positioning portfolios to include investments that may benefit during times of increased inflation and have the potential to perform better during higher volatility.
Bond yields have been the driver of market direction. Elevated bond yields have been a forceful headwind for stocks, as it raises borrowing costs and increases the discount rate on future cash flows. As yields have experienced volatility, so have stocks, in an almost inverse relationship, that is, when yields fall, stocks rise, and vice versa.
Now we have earnings taking over. From mid-June to mid-August, earnings came in relatively strong, producing a 500-point rally or about 13%. We could see a repeat of that even for the third quarter. To me, this is a classic bear market rally. Let's see how far it has to run but just don't fight the Fed. This jump in asset prices is not what the Fed wants so they will fight it every step of the way. Â
The recession is all but certain with the inversion at record levels as well as a hard landing. We think the market correction is NOT over but a bottom is not that far off into the future - probably the end of this year or first quarter of next. The market bottom is closer than the economic bottom since the market bottoms and turns before a recession is over. Typically, as the chart below shows, the bond market moves toward a positive slope long before a recession is over. Â
We are beginning to see things start to break globally, even at this stage of the cycle. Other central banks, including both Japan and England’s, have had to intervene in their sovereign and currency markets because the size and speed of Fed tightening has broken the order in markets.  The question is, when do these events cause contagion that may eventually cause the Federal Reserve to pivot - or at least pause the push for higher rates.
If you haven't read the Weekly Commentary from Nuveen, we highly suggest you do.  www.nuveen.com/en-us/insights/investment-outlook/cio-weekly-commentary?
CEF NAVs were mostly higher on the day but lagged the overall rally in the equity markets. High yield was up 0.6%, loans up 0.2%, preferreds up 0.4%, and munis up 0.2%. Discounts were mostly wider again. We are approaching levels in discounts not seen outside of a few distinct economic situations and crisis. Â
Muni CEF discounts are now in their 94th percentile (meaning they've only been wider 6% of the time over the last 25 years). Taxable bond CEFs are in the 92nd percentile. However, as we have been saying ad nauseum, we would resist the desire to buy here.
In fact, Merrill Lynch's CEF report came out recently echoing our stance. They stated:
This is something we've been saying since August. But we would change that to waiting for NAVs to turn higher in a sustained way. For that, we need to see high-yield spreads blow out further in order to change the risk-reward to the upside. Â
Members have asked for my best ideas in the taxable space and they have not changed all that much. Â
1)Â First Trust Inter Dur Pref & Inc (FPF)
2)Â Invesco Sr Income (VVR)
3)Â C&S Tax- Adv Pref Sec & Inc (PTA)
4)Â PIMCO Access Income (PAXS)
5)Â Western Asset Div Inc (WDI)
6)Â Apollo Tactical Income (AIF)
7)Â Angel Oak Dynamic Income (FINS)
8)Â Invesco High Income 2023, 2024 (IHIT), (IHTA)
Would add.....
7)Â Western Asset Global Corp Def Opp (GDO)
But again, be careful here as NAVs are still falling. While you can make smart swap decisions, we would be cautious getting too heavy into CEFs at this point. Â
Have a good day!
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Like this post
I don't understand the quote on "Don't chase duration" seems contradictory, and then they throw in yield at the bottom. Strange paragraph to me, I dont understand.
I am adding to my duration because I want to lock in good yields before we go into a recession and yields drop.