Weekly Commentary | March 10, 2019

Believe it or not but the Nasdaq had its first weekly decline since the week of Christmas.  Global equities across the board performed poorly all 5 trading days of the week.  Small caps fared the worst dropping over 4% but remain up 13% for the year.  

  • S&P:  -1.24%

  • DJIA:  -1.70%

  • Nasdaq:  -2.46%

  • Russell 2000:  -4.23%

  • EAFE:  -1.94%

The major news item of the week was the second central bank pivot of the last 3 months.  The European Central Bank announced plans to add additional stimulus as they slashed their forecasts for growth for 2019 to just 1.1% from 1.7%.   

The other major news on the week was the slowdown in the pace of hiring in February with just 20K jobs added.  Clearly, this looks like a fluke and likely to be revised higher.  In addition, January was an abnormally large job gain number and the two months averaged together still amounts to over 180K.  The unemployment rate fell to 3.8%.  

Interest rates fell every day last week from 2.76% ending the week down around 2.62%, the lowest since January 4th, in response to weak data and the ECB announcement.  Muni bonds rallied as well.  Meanwhile, credit spreads widened across all maturities and credit sectors.

The VIX popped back above 16 reversing the downward trend it had been on for some time.  

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JPM US macro outlook – consolidating for now before resuming the rally by the spring – the SPX has entered a period of digestion for the time being but the YTD rally likely is only taking a pause (instead of concluding) and a sustainable break above 2800 remains probable. This consolidation phase should confine to the SPX (approximately) within the ~2750-2800 band (w/some brief and mild overshoots in both directions). o Why a consolidation is occurring right now - this market requires digestion after spiking ~20% trough-to-peak over the last two months and after fully absorbing the big tree YTD fundamental tailwinds (earnings, the Fed, and China trade), the SPX has run out of reasons (for now) to rally further. Valuations aren’t cheap and the SPX doesn’t seem comfortable paying north of ~16x right now and this is why ~2800 is proving to be a tough ceiling (based on the ~$172 2019 EPS consensus). The ~2800ish level has been resistance going back to Oct and Nov (and keep in mind the ’19 EPS consensus was ~$178 at that time). Renewed GE anxieties (sparked by the CEO’s presentation at JPM’s ATI conf. on Tues 3/5) are having macro implications for the market as they resuscitate the “fallen angel”/HY worries from Dec. The stock market is being forced to digest an enormous amount of paper and the pipeline going forward is huge (the SPX is actually holding up well considering all this supply). The USD spike (exacerbated by Draghi and the ECB on Thurs) is incredibly unhelpful for equities (as it creates a growing EPS headwind). Finally, there just aren’t many major macro catalysts for a few more weeks (FOMC on 3/20 and the possible Trump-Xi signing ceremony on 3/27).

Closed-End Fund Analysis

Distribution Increase

PGIM High Yield (ISD):  Monthly distribution increased by 17.6% to $0.010 from $0.085.

PGIM Global High Yield (GHY):  Monthly distribution increased by 21.2% to 0.10 from $0.0825.  

Distribution Decrease

N/A

Fund Name Change

Dreyfus is changing the name on all their funds to reflect their parent company Bank of NY/Mellon.  Mellon purchased Dreyfus way back in 1993 and they obviously think the Bank of NY/Mellon brand is stronger.  

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Commentary

From a NAV perspective, munis did well this week with the average fund seeing a 0.52% increase in value.  This was driven by the flight to safety as investors piled into treasuries and other safe assets (like munis) pushing down the yields.  

Taxable munis actually led the way with a nearly 1% gain on the week PLUS a drop in price sending discounts wider by over 1.2%.  There are only three funds in the space now so movements can be exacerbated.  Still, BBN saw its price rise by only one cent but the NAV jumped 21 cents.  GBAB was another with a nicely rising NAV- however, its price fell be nearly 20 cents.  Hence GBAB being a top 5 NAV mover but a bottom 5 price mover.  The space remains a bit overvalued.  

MHI, PPT, and WEA were all top movers in the Core on the week.  Investors are starting to realize the value in PPT helping to drive up the price.  MHI saw renewed interest (though we don't own any) from the move towards munis.  WEA was one we've discussed on the chat frequently in the last two weeks.  As I noted there, I really want to see a strong value with the discount closer to -9%.  They did recently announce their next three months of distibutions.

One fund that continues to look interesting is the EV Tax-Managed Global Fund (EXG) which was the lowest z-score on the list below at -2.0.  The fund cut the distribution at the start of the year and the discount has been widening ever since.  It is now well below the 1-, 3-, and 5- year discount averages.  For those looking for global equity exposure with tax efficiency, this is a good fund to look at.  Beware, it does have larger than average technology exposure.  

Lastly, Eagle Point Credit Company (ECC), a CLO fund, reported its monthly NAV last week.  The value of the underlying assets rose by 10.6% to $13.71 leaving the premium at 22.8%.  The price is down to $16.83, from a peak this year of $17.50 set on February 22nd.  The price is following the broader markets anticipating the NAV movements, which are only reported about a week following month-end.  To me, this fund appears overvalued still at +22%.  The average premium is right around 11%.  In addition, with markets being down so far in March, if the NAV were to print right now, it would likely be down low-single digits meaning the premium is actually somewhere in the mid-to-high 20s%.

As we noted in Friday's trade alert the two Prudential closed-end funds (Prudential Asset Management was renamed to PGIM last year) made a change in their investment policy and shifted their names.  PGIM Short Duration High Yield (ISD) and PGIM Global Short Duration High Yield (GHY) were renamed without the 'short duration'.  PGIM High Yield (ISDand PGIM Global High Yield (GHY). 

In addition, they increased the distributions by 17.6% and 21.2%, respectively.  

PGIM also removed the restriction on how much CCC-rated debt they can hold.  Previously, they could only only 10% in the lowest rated credit quality level.  That limit was completely removed.  

The new distribution yields will be 8.51% for ISD and 8.63% for GHY based on closing prices on Thursday.  

ISD:

GHY:

Concluding Thoughts on PGIM:

The company is doing two things here:  1) they are allowing them to get junkier in terms of their holdings.  Clearly the funds have been penalized for not having a competitive distribution rate primarily because they focus on the highest quality non-investment grade holdings.  By removing the cap, they can increase the distribution and perhaps close the large discounts.  The question is whether this is a good time in the cycle to be adding CCC-rated debt.        2)  They are adding duration by removing the "short duration" from the names of both funds.  At this point in the cycle, it is probably a good thing to add some duration.

All in all, I do think ISD is worth a look for a short-term trade.  The shares trade at a 12.4% discount to NAV which isn't as attractive as it was before the trade alert but still fairly wide compared to most of the peers. 

PIMCO Annuals

PIMCO released their semi-annual reports a couple of weeks ago.  We spent some time going through them but there wasn't much new to glean from them.  

Net investment income was steady for the six month period in the back half of 2018.  PCI did slightly better than PDI with NII of $1.01 ($2.02 run rate) for the six months, compared to $1.95 for the fiscal year 2018 ending in June 2018.  PDI generated NII of $1.34 ($2.68 run-rate) compared to $2.95 in FY2018.  In other words, PCI is doing slightly better than the prior trend while PDI is slightly below.

PCI had net realized/unrealized gain (loss) were negative for the year with a loss of $1.02.  PDI lost $1.34.  These are the largest losses since FY 2016, the last time high yield saw a significant decline.

In going through the holdings, there was nothing much new that needs to be noted.  It is still primarily non-agency MBS with another chunk in asset backed securities.  

Now, on the to juicier part:  their interest rate swaps and hedging.  It is interesting that they've actually lost money on hedging- at least on their unrealized portions.  Given the jump in coverage for PCI in January, it could be that they liquidated some swaps that did have sizable gains.  

Right now, it is difficult to tell what exactly is going on.  

It appears that they've offset some of the hedges to higher rates that they have put on.  

All-in-all, nothing material in terms of changes.  I'm going to try and get more color on their hedges and what they are trying to accomplish there.  The fact sheet from December 31 states that they were short the long end of the curve but "continue to see duration as a source of diversification and will continue to scale exposure into changing valuations and macroeconomic developments."

Statistics

First, the stats on the Core funds showing the top and bottom 5 price movers, NAV movers, highest premiums, largest discounts, highest and lowest yields, and z-scores.

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First, the stats on the Core funds showing the top and bottom 5 price movers, NAV movers, highest premiums, largest discounts, highest and lowest yields, and z-scores.

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