3Q2011 Market Commentary
Clinton Investment Management
By Andrew Clinton
December 13, 2011
Clinton Investment Management PSN Ranking Announcement
We recently mailed to all of our readers, clients, and friends an announcement regarding our composite performance rankings on an inception-to-date (ITD) basis. We are very proud to have outperformed more than 90% of the over 100 managers that make up the PSN Municipal Bond Managers Universe during what has been one of the most challenging investment environments of our time. Since the strategy’s inception on May 31, 2007 until June 30, 2011 we achieved, on behalf of our clients, annual returns of 6.09% and 5.49% on a gross-of-fee and net-of-fee basis respectively. As of 09/30/2011 we continue to rank solidly in the top 10% of the PSN Municipal Bond Manager Universe on an ITD basis. When one considers the fact that a meaningful portion of the return our clients have enjoyed is tax-free, the taxable equivalent returns we have generated are significantly higher still.
3Q2011 Market Commentary
The US credit rating was downgraded by S&P during the third quarter to AA1 from AAA. A flight to quality ensued as investors attempted to preserve principle in an uncertain environment in which even the largest economy in the world experienced credit deterioration. Moody’s and Fitch placed the US rating on Watch for possible downgrade as well. Ongoing uncertainty, tied to the Euro region’s struggle to find a cure for the contagion spreading from Greek insolvency, caused wild gyrations in global equity markets. Investors sought the safety of US Treasury bonds as the US dollar benefited from fears surrounding a potential collapse of the grand experiment that is the European Union. Actions by the Federal Reserve remain the primary, if not the only, source of economic stimulus for the US economy and perhaps the world. Mr. Bernanke and his colleagues at the Fed did not disappoint over the past few months. The Fed indicated it would undertake “Operation Twist”. This strategy is a rarely used tool meant to bring down long-term interest rates. The strategy itself is fairly straight forward. The Fed would sell roughly $400 billion of the short- term positions it currently holds. It would then buy long- term Treasury bonds with the proceeds. Doing so significantly increases the demand for securities in the long-end of the curve which ultimately should reduce the supply of bonds and thereby push prices higher and yields lower. The Fed also took the unprecedented step of specifically stating that it would be maintaining the current low level of short-term interest rates for at least two years. In so doing, the Fed removed much of the uncertainty that had plagued the market relating to specific timing of when the Fed would begin raising short-term interest rates. These Fed actions were truly extraordinary and speak directly to the degree of Fed concern regarding the very weak state of the US economic recovery. The US unemployment rate remains stubbornly high while GDP growth remains stubbornly low.
The Fed’s strategy has largely been successful thus far. Long-term Treasury yields have fallen by over 100 basis points or 1.00% over the past six months. Given the dramatic drop in yields, Treasury bonds have provided some of the highest returns of any asset class on a year-to-date basis. The Barclay’s Capital Treasury Index is up over +8.75% as of 11/30/11 while the 25+ year area of the curve is higher by +29.54% over the same period.
Municipal bonds also benefited from the corresponding drop in rates. Municipal bond yields did not experience the same degree of price appreciation of corresponding Treasury Bonds however. Municipal bonds have therefore cheapened materially relative to taxable Treasuries. Higher demand for safe secure investments and attractive taxable equivalent yields offered in the municipal bond market increased demand for municipal bonds more broadly as the new issue calendar began to swell. Continued positive news on the credit front also benefited the municipal bond market as the dire predictions regarding the potential for cascading municipal defaults have faded. Municipal bond default rates have actually fallen year over year. That is not to say that state and local governments are not without their challenges. Rather, more difficult choices lie ahead. Further cuts to services, and ultimately state and local government jobs, are all but certain.
We believe, however, that there are clear signs of credit stabilization in select municipal issuers across the country. Higher tax collections and declines in unemployment rates in 36 out of the 50 states are two important indications that better days are ahead for the US economy and municipalities more specifically. We also believe economic growth will remain subdued due to ongoing gridlock in Washington, the 2012 Presidential election, continued cuts in government jobs, and stubbornly high unemployment. This will likely serve to depress consumer and business confidence for the foreseeable future. We continue to believe that essential services sectors, and issuers of bonds with dedicated revenue streams, offer the best risk-adjusted return potential going forward.
As we look toward year-end, we endeavor to seek out the best means for adding meaningful value to our client portfolios. We expect municipal bond new issue supply to dissipate as we approach the New Year. As it does, we expect technical conditions to improve materially. We also believe that the roughly $20 billion in anticipated January reinvestment will pull demand for municipal bonds forward into December. We have extended our client durations modestly in an effort to capitalize on what we believe could be a period of solid outperformance for the municipal bond market. In addition the strength of the credit and quantitative research we employ on behalf of our clients affords us the ability to determine those issues that offer the most attractive risk-adjusted returns. This is imperative during what we expect to be an extended period of low interest rates. We endeavor to seek ways to diminish volatility and or risk in each of our client portfolios. Please be sure to contact us should you have any questions regarding the above commentary or the municipal bond market in general.
Disclosure
*ITD - 05/31/2007 through 09/30/2011
**Criteria: The PSN universes were created using the information collected through the PSN investment manager questionnaire and use only gross of fee returns. The PSN/Informa content is intended for use by qualified investment professionals. The The Barclays Capital US Treasuries TR Index is an unmanaged index of public obligations of the U.S. Treasury with a remaining maturity of one year or more. Please consult with an investment professional before making any investment using content or implied content from any investment manager. Past performance may not be indicative of future results. It should not be assumed that the future performance of any specific investment or investment strategy will be profitable. 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 made reference to directly or indirectly in this newsletter (article), will be profitable, equal any corresponding indicated historical performance level(s), or be suitable for your portfolio. Due to various factors, including changing market conditions, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this newsletter (article) serves as the receipt of, or as a substitute for, personalized investment advice from Clinton Investment Management, LLC. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. A copy of our current written disclosure statement discussing our advisory services and fees is available for review upon request.
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