February 8, 2021
Doug Drabik discusses fixed income market conditions and offers insight for bond investors.
Certain events or comments send the markets into action. It could be a recognized municipal expert forecasting a wave of municipal failures causing investors to panic and sell credits that never wind up defaulting. It could be economists predicting higher interest rates as they have at the beginning of nearly every year for decades. The forecast implores investors to shorten up (lower durations) and keep liquid in order to hold off on purchasing until the moment of higher rates. In actuality, interest rates have generally fallen for over 39 years. Duration should have been embraced instead of being lowered.
To further compound the issue, expectations do not need to come to fruition and the underlying fundamentals don’t necessarily need to reflect anticipation in order for investor sentiment to dominate market direction. If enough people believe in something or react to something, it can move markets. Look back no further than last week’s GameStop rally. A company that is struggling financially is moved to extreme market highs based on off balance sheet factors. Irrational behavior can last a lot longer than most investor’s solvency.
The medical pandemic of 2020 pushed us into a financial recession. The last four GDP year-over-year prints were 0.3%, -9.0%, -2.8%, and -2.5%. GDP measures the total final market value of the goods and services produced. The data release reveals the change in value, not the nominal dollar value. Since we had 3 negative prints, it is likely that the change in value will reflect a very positive number. Note the last couple of times we were in a recession, the following reflected a stronger GDP. A majority of the time, two years after a negative print, GDP YoY snapped back.
Many pundits are calling for higher inflation. PCE just went from 1.37% (Nov) to 1.45% (Dec). Higher inflation but not high inflation. We could have yet another higher print for January and still not have high inflation, yet if investor sentiment views this as a sign of runaway inflation to come, the market may react as such.
First, there is no guarantee that just because it happened before, that this time will follow suit. It stands to reason though, that when you have a very low number, the percent increase will be relatively large. Finally, be prepared. Market reactions are often irrational given the actual underlying data. If investors are emotionally swayed or convinced that a directional move is forthcoming, that snap reaction can carry market momentum for long periods of time.
Being prepared to take advantage of momentary emotional market moves may allow you to gain a little yield advantage when every extra basis point counts in this yield challenged environment. Market emotion has proven to be a worthy consideration in tandem with actual fundamentals. Be prepared to evaluate both.
To learn more about the risks and rewards of investing in fixed income, please access the Securities Industry and Financial Markets Association’s “Learn More” section of investinginbonds.com, FINRA’s “Smart Bond Investing” section of finra.org, and the Municipal Securities Rulemaking Board’s (MSRB) Electronic Municipal Market Access System (EMMA) “Education Center” section of emma.msrb.org.
The author of this material is a Trader in the Fixed Income Department of Raymond James & Associates (RJA), and is not an Analyst. Any opinions expressed may differ from opinions expressed by other departments of RJA, including our Equity Research Department, and are subject to change without notice. The data and information contained herein was obtained from sources considered to be reliable, but RJA does not guarantee its accuracy and/or completeness. Neither the information nor any opinions expressed constitute a solicitation for the purchase or sale of any security referred to herein. This material may include analysis of sectors, securities and/or derivatives that RJA may have positions, long or short, held proprietarily. RJA or its affiliates may execute transactions which may not be consistent with the report’s conclusions. RJA may also have performed investment banking services for the issuers of such securities. Investors should discuss the risks inherent in bonds with their Raymond James Financial Advisor. Risks include, but are not limited to, changes in interest rates, liquidity, credit quality, volatility, and duration. Past performance is no assurance of future results.
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