Bond Market – Post Mortem Notes
by Julien B. Booth
April 10, 2020
I hope this notes finds you safe and healthy.
The note below is my attempt to summarize what has happened to the bond+income markets over the past 5+ weeks.
What has happened…
Covid 19 has morphed from Healthcare to Financial to outright Liquidity crisis. Covid 19 is a 100 year event.
A Systematic shutdown began cascading across every sector of the markets/economy and by March 19-20 the entire bond market system was at risk.
During March 19-20 the bond market suffered a historic route of approx. -18%. A dislocation not seen since the 1930s.
Federal Reserve stepped in March 24th with UNLIMITED QE ($creation) to support investment grade bond market.
Federal Reserve action in late March put a floor under the bond market as the Federal Reserve is specifically buying Investment Grade and “some” Municipal Bonds.
Other credit sensitive and municipal bond sectors continued falling. (update 4.9.20 – Fed has now stepped into to support most all bond markets)
Relevance to investors..
Bonds are generally sleepy and relatively in-active trading. A liquidity crisis from leveraged investors, broker sold products, and ETFs forced sales into this market (late March).
We saw spreads on every type of bond widen beyond 3 standard deviations (an incredibly remote probability) as liquidity was sole focus.
Variable rate notes, subordinated bonds, mortgage, and hybrid bonds are a smaller part of corporate capitalization and therefore generally lag their bond peers due to less trading volume.
Forced sales here were also exacerbating the price declines.
Our portfolios primary exposure is to very large financials; we have avoided cyclicals, energy and similar due to poor credit metrics in a slowing economic environment.
There was little value in 2%/annum corporate bonds for 5 years. At one point 10+ years of returns were gone in the corporate bond market.
Financials have been the most regulated group for past 8+ years and have large leverage ratios and capital/cash buffers. The Federal Reserve also stands behind the banking system for liquidity needs.
We have intentionally gravitated portfolios to large and liquid financial names. The banks did not cause this crisis.
portfolios generally have yields in excess of 6.75%. The variable rate securities allowed portfolios to perform very well in 2019 and compensated for assuming investment risk. The underlying bonds and notes are solid.
The market capitalizations of our holdings are that of large capitalization companies – most in excess of $10 Billion.
These are household names: Bank of America, JP Morgan, MetLife etc. These companies can survive and the larger will be the net winners.
Barring unforeseen negative events bonds will perform and pay accordingly. There has been stabilization in the variable rate market and we are seeing pricing firming in reality.
On statements created on EVAL data (pricing estimates), prices can often differ by 5-10 pts. We have seen “real world” prices differ from statement prices by 10+ points (also never seen event)
Net, net, only 13 trading days have passed since the market dislocations. Because of bonds sleepy nature (dislike of drama) it will take more time for things to normalize.
Bonds and Notes are solid and money-good in bond parlance.
Portfolios are adequately compensating (yields) for the risk assumed.
Credit quality is our specialty – Sixty Guilders was created in 2008-2009.
Portfolio cash flow will allow for far better re-investment returns
We encourage investors to be patient and allow pricing to normalize in the bond market.