Market Outlook
Barely a week into the New Year, the biggest market story so far has been the weather, starting with last weekend’s snowstorm in the Northeast and continuing with the deep freeze currently gripping the eastern half of the country. Here in Chicagoland, we had the dubious honor of experiencing the coldest day in almost 20 years yesterday: minus 16 degrees F, with wind chill factors down to minus 40.
The financial markets are also starting the year on a frigid note, although that will surely change over the course of this data-heavy week. The leadership transition at the Fed has been relatively smooth, as Janet Yellen’s confirmation as the new Chairperson went through without a hitch yesterday. Later in the week, market participants will try to glean some insight from the FOMC minutes regarding the future path of Fed bond purchases.
While Ms. Yellen’s dovish stance is well documented, the pace of Fed tapering efforts will now be dictated by economic data. Recent economic releases are pointing toward a much stronger-than- expected fourth quarter of 2013. The November trade balance, for instance, came out this morning at -$34.3 billion, after a revised -$39.3 billion in October, both much better than forecasts. The strong contribution from the trade sector should lead to upward revisions in Q4 GDP growth to around 3%.
Of course, the markets will be most focused on this week’s employment data, starting with the ADP survey tomorrow and ending with the December Non-Farm Payrolls report on Friday.
Longer-term Treasury yields have been unable to decisively cross into the next handle: after hitting a high of 3.03%, 10-year Treasuries have retreated back under the 3.00% mark, to about 2.96%, on the back of some modest profit-taking in the equities market. Likewise, the 30-year bond yield has remained firmly under the 4.00% mark, around a 3.90% at this writing.
The financial markets are also starting the year on a frigid note, although that will surely change over the course of this data-heavy week.
There will also be fresh Treasury supply to absorb this week, so some backup in yield levels should be expected as traders set up for the auctions as well as for the jobs number.
Having outperformed taxables during the final weeks of 2013, the municipal market is starting the New Year at somewhat unattractive ratios versus Treasuries, particularly in the intermediate maturities. In the 10 year part of the curve, for instance, the AAA MMD/Treasury ratio currently stands at 93%, closer to the bottom than to the top of its 91%-102% range for the past 12 months. The same can be said of the 30 year ratio, currently at 107%, compared to an average of 109% and a range of 105-116% over the past 12 months.
With a diminished relative value argument and without much new supply on this week’s calendar to spur price discovery (less than $2 billion), one would expect muni traders to adopt a wait-and-see attitude and take their cue from the Treasury market’s reaction to the upcoming spate of economic data releases.
The only new issue of note on the negotiated side will be a $240 million deal from University of Texas System Permanent University Fund. With a AAA rating from all three rating agencies, this issue shouldn’t have any problem getting placed.
Puerto Rico Back in the Headlines
What would the New Year be without more negative headlines on Puerto Rico?
Over the last few days, a couple of media articles confirmed what we’ve been saying all along: current demographic trends for Puerto Rico do not bode well for the Island’s economic future.
First, a report from US News documented the ongoing rapid decline of the Island’s population. According to the report, “the territory lost more than 36,000 people, or around 1 percent of its population from July 1, 2012, to July 1, 2013 – more than seven times the percentage decline in the next closest state, West Virginia, which lost 0.13 percent of its population (…) Puerto Rico’s population similarly fell by nearly 1 percent in both 2012 and 2011. By comparison, only one U.S. state has posted a population decline exceeding 1 percent since 2000: Louisiana, which lost nearly 6 percent of its population due to 2005’s Hurricane Katrina, according to data provided to U.S. News by William Frey, demographer at the Brookings Institution.”
Over the last few days, a couple of media articles confirmed what we’ve been saying all along: current demographic trends for Puerto Rico do not bode well for the Island’s economic future.
Another article in this morning’s Wall Street Journal focused on the exodus of young working-age Puerto Ricans to the mainland US in search of employment opportunities: “From 2000 to 2010, a net 288,000 people left for the U.S. mainland, according to the Puerto Rico Institute of Statistics. The pace has accelerated in the past few years as the economic situation has worsened, with a net loss of 54,000 migrants a year in 2011 and 2012 on an island of just over 3.6 million people. Preliminary data for early 2013 suggest the outflow is still strong.”
Needless to say, such grim statistics make it very easy for anyone and everyone to have an opinion on Puerto Rico’s credit, even without the proper historical perspective on the tax-exempt market. The latest example of fear-mongering by a muni market outsider (jokingly referred to on Twitter as a “muni tourist”) came from Forbes.com columnist Larry McDonald, who recently published an article titled: “Could a Puerto Rico Default Hammer the $3.7 Trillion U.S. Muni Bond Market in 2014?” Mr. McDonald’s article rehashes the same old bearish arguments about the Commonwealth but his motivations are certainly quite transparent: he’s looking at this as a potential trade for his clients. You can judge for yourself if Larry’s piece contains any new information or if he’s just trying to further depress the market on PR bonds.
It’s quite interesting to note that Mr. McDonald previously wrote another piece titled “Let Fear Be Your Friend in the Market.” In that article, he argues that market capitulation trades driven by fear should be viewed as opportunities: “Today’s losers will become tomorrow’s winners once again.” Who knows? Depending on how events will unfold over the next six months, that statement may well apply to Puerto Rico bonds this year.
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