WEEK ENDING 8/9/2024
- Diversification matters
- The market’s implied probabilities of future events are often wrong
- We’ll miss the 2024 Olympics – sure beats politics
A CITY DIFFERENT TAKE
The markets went from thinking the world was ending on Monday to spending the remainder of the week coming back down to earth. Such is the nature of volatile markets. We think investors should prepare for more volatility as November 5th approaches. This time, it all started in Japan. The Bank of Japan raised its target rate by 0.25%, causing the value of the yen to rise. The knock-on effect was for all those investors who borrowed in yen terms and invested in higher-yielding markets (leverage), to race for the doorway out all at once. This is the nature of leverage; investors will never know when they get caught with their pants down and their trades start losing money.
The U.S. fixed-income markets also panicked a bit before coming back to earth. The following table shows how future Fed rate cut expectations have moved over the week. We observed intra-day expectations of a Fed rate cut in September to have exceeded 200%.
Events like these remind investors that diversification among asset classes is the first rule of risk management. Next week, we will get the inflation readings for the first of July. Housing starts, capacity utilization, University of Michigan sentiment readings, and the weekly initial jobless claims should provide clues to the economy's strength or weakness.
CHANGES IN RATES
Treasury yields were higher on the week, and the week was volatile. Investors woke up to a significant bond rally and a large price decline for equities. It all started when the Bank of Japan raised the target interest rate by 0.25%. This caused a surge in the yen's value and much distress for all those investors who borrowed money in yen terms and invested in higher-yielding securities. Such is the nature of leverage trades; they are great when they work and terrible when they don’t. Most investors in such trades think they are smart enough to spot the turning points. Alas, most aren’t. City Different Investments knows our limitations and doesn’t engage in such trades.
Municipal yields were mostly higher last week. The municipal market easily digested a large new issue calendar, $16+B. The ratio table below highlights the relative differences.
Municipals, as measured as a ratio versus their Treasury equivalent maturities, were, for the most part, significantly lower over the week.
Corporate yields were significantly lower over the week.
THIS WEEK IN WASHINGTON
.png?width=1920&name=graphs%20in%20order%20(1).png)
The Kamala train kept on rolling. It picked up a new passenger, Gov. Tim Walz, the Veep pick, along with what seemed to be more momentum. JD Vance had a monopoly on all the Sunday talk shows—if you needed a break from politics, it’s a good thing the Olympics were still on. It seems both parties are in the mood to buy votes. Kamala Harris came out with a plan to exempt tips from taxes, copying the Trump suggestion. This prompted a new nickname the former president is trying out, “Copy Cat Kamala”. What do these guys have against cats?
The Trump campaign says foreign sources hacked it. It seems reminiscent of the Russians hacking Hillary’s emails in 2016.
Who else is going to miss the Olympics? Only four more years to Los Angeles…and another presidential election.
WHAT, ME WORRY ABOUT INFLATION?
The 5-year Breakeven Inflation Rate finished the week of August 9th at 2.24%, higher by 5 basis points from the close of August 2nd. The 10-year breakeven inflation rate finished the week at 2.10%, six basis points higher than the close of August 2nd .
MUNICIPAL CREDIT
As of August 9th, 10-year quality spreads (AAA vs. BBB) were 0.99%, six basis points higher than the August 2nd reading (based on our calculations). The long-term average is 1.70%.
Quality spreads in the taxable market are not attractive. They ended the week at 0.88%, five basis points higher. High-yield quality spreads were 22 basis points lower at 3.24%.
WHERE ARE FIXED-INCOME INVESTORS PUTTING THEIR CASH?
Money Market Flows (millions of dollars)
Most money market funds saw increased cash flows. No surprise, given last week’s volatility.
Mutual Fund Flows (millions of dollars)
Bond fund categories saw negative cash flows for the week reporting July 31.
ETF Fund Flows (millions of dollars)
ETF asset classes experienced increased cash flows overall.
SUPPLY OF NEW ISSUE MUNICIPAL BONDS
The supply of new issues will be about $6.8 billion this week.
CONCLUSION
This past week taught us the importance of asset class diversification in building a balanced portfolio. The municipal market easily handled a large new issue, calander, in a volatile week. Some pundits (those with their hair on fire) called for emergency Fed rate cuts between meetings. Thank goodness Jerome Powell and his colleagues ignored their Pollyannish cries. The sky was not falling; it was just the end of a favored leverage trade. It is painful for all involved and for those observing.
IMPORTANT DISCLOSURES
The information and statistics contained in this report have been obtained from sources we believe to be reliable but cannot be guaranteed. Any projections, market outlooks or estimates presented herein are forward-looking statements and are based upon certain assumptions. Other events that were not taken into account may occur and may significantly affect the returns or performance of these investments. Any projections, outlooks or assumptions should not be construed to be indicative of the actual events which will occur. These projections, market outlooks or estimates are subject to change without notice.
Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product or any non-investment related content, made reference to directly or indirectly herein will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions.
All indexes are unmanaged, and you cannot invest directly in an index. Index returns do not include fees or expenses. Actual portfolio returns may vary due to the timing of portfolio inception and/or investor-imposed restrictions or guidelines. Actual investor portfolio returns would be reduced by any applicable investment advisory fees and other expenses incurred in the management of an advisory account.
You should not assume that any discussion or information contained herein serves as the receipt of, or as a substitute for, personalized investment advice from City Different Investments. To the extent that a reader has any questions regarding the applicability above to his/her individual situation or any specific issue discussed, he/she is encouraged to consult with the professional advisor of his/her choosing. City Different Investments is neither a law firm nor a certified public accounting firm and no portion of this content should be construed as legal or accounting advice.
A copy of City Different Investments' current written disclosure statement discussing our advisory services and fees is available for review upon request.
Unless otherwise noted, City Different Investments is the source of information presented herein.
A description of the indices mentioned herein are available upon request.