Fixed-Income Market Commentary Archive

November 2008

October Fixed-Income Review

• Extreme volatility in the bond market continued throughout the month of October. The startling events of September were not necessarily repeated or matched; however the fallout and aftereffects are there to be dealt with. I have said in the past that it takes a pretty hefty amount of discipline to manage money- even more so in times such as we are in now. This discipline combined with confidence and flexibility is needed in ample amounts to sort through it all and make trades that will eventually profit from the dislocations we are seeing on a daily basis. To paraphrase what one portfolio manager recently told us, it is a terrible environment out there and this is why everything is so ridiculously cheap.

  The way we see it, the only area of the fixed income market that is not cheap is conventional Treasuries. This leaves several other areas of the market that are though, and this is where opportunity lies. The actual trades we are making and the offerings available to us are too numerous to detail here, but suffice to say there are significant prospects out there to take advantage of. The corporate bond and the municipal market are chock full of securities that have been priced too cheaply in both relative and absolute terms. This is the outcome from the environment of tight credit, reluctant buyers and forced selling by the leveraged players in a desperate act to de-lever balance sheets and in some cases meet margin calls.

• The TIPS market (inflation linked) is turned upside down. I have written previously about how well the TIPS market was hanging in there for much of 2008. Then October happened. The sell-off has left TIPS bonds yielding more than conventional Treasuries at various spots along the on-the-run and off-the-run curves. Investors are downplaying the threat of inflation and recognizing that a deflationary period is a real possibility as the economy contracts. In theory, TIPS should yield less than conventional Treasuries because of the way their principal is adjusted for inflation. The investor in conventional bonds receives a yield premium because he is not insulated against inflation. One way we measure the attractiveness of TIPS is to measure the BEI spreads and they have collapsed. (BEI = break-even inflation: subtract the yield of the TIPS from the yield on the nominal and the number you are left with is the rate of annualized inflation necessary to break-even on your trade). This is just one more area where opportunity now lies.
• Last month I commented on the extraordinary rates that municipal money market funds were yielding and I suggested that you should enjoy them while they last - because they never do. I ran the same exercise on the last day of October and found dramatically different levels than one month ago. I reviewed the 7-day yields on 30 different funds (some national, some state specific) and came up with an average yield of just 1.27%. I say "just" because a month ago, during the height of the hysteria in the market, the average was an eye-popping 5.07%.

  There was a genuine snap-back in the broader municipal bond market too. Toward the middle of the month, buyers recognized exactly how cheap munis had become and came back to the market with force. The muni index returned 5.74% in just a 5-day span. That would be a great return for an entire year, let alone for just one week! The really good news is that there are still some very good bonds available at very attractive levels.

Christopher Keith
Fixed-Income Manager