John Mousseau to speak at MoneyShow – Tuesday, February 16, 2021 – 2pm to 4pm

jOHN Mousseau - MoneyShowTuesday, February 16, 2021 – 2:00 pm to 4:00 pm EST Bond Markets through the Pandemic, the Election, and into 2021* Focus: BONDS

John Mousseau, president, CEO, and director of fixed income with Cumberland Advisors, has over 30 years of investment management experience. During this in-depth course, Mr. Mousseau will discuss the bond markets thru 2020 and the volatility that they experienced through the pandemic, as well as the effects of various government programs on the bond market and offer a look at bond markets in the new administration.

Bond Markets March – April 2020

  • The pandemic rears its head: US Treasuries – plunging yields, US corporates – widening spreads, US tax free bonds – unprecedented fund redemptions.
  • The Fed and the Treasury to the rescue: CARES act and Fed programs

Bond Markets Summer Through the Election

  • Markets are repaired even while pandemic rages
  • Ratings hang in there
  • The state of despair index
  • Markets sensing the election
  • Blue wave

Bond Markets Heading into 2021

  • Government spending
  • Inflation
  • Taxation and legislation
  • Historical yields

Cumberland Advisor’s CEO & Head of Fixed-income, John Mousseau, provides you with a look at long-term generational bond markets and examines whether we have gone through an inflection point to help you manage your risk, safeguard your fixed-income investments, and reach realistic financial goals.

*Tickets are $139 per person at the MoneyShow website. Can’t make it to the live course? You can always watch it and other events on demand at a later date.

Register here: https://online.moneyshow.com


Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

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Los Angeles Has Been Hammered by Covid. But Its Muni Bonds Are Holding On. Here’s Why.

Excerpt from:

Los Angeles Has Been Hammered by Covid. But Its Muni Bonds Are Holding On. Here’s Why.

By Stephen Kleege – Barron’s – Jan. 15, 2021

CA-In-The-News-John-R-Mousseau-Universal

Moody’s Investors Service in the midst of the first Covid surge in April revised its outlook on the Los Angeles’ Aa2 rating to stable from positive. The city’s $2.6 billion in debt outstanding includes $585 million of general obligation bonds. It issued $1.8 billion of short term tax and revenue anticipation notes to bolster liquidity early in the fiscal year.

Moody’s cited the city’s large and diverse economy, strong management, and relatively modest debt burden.

Investors have stood by the city’s debt. Based on analysis by Ice Data Services, the price of a Municipal Corp. of Los Angeles lease revenue bond maturing in 2037 has risen to $122.427 on Jan. 14, from $120.51 at the beginning of 2020.

“I don’t really see L.A. bonds trading much cheaper than the general market,” says John Mousseau, head of fixed income at Cumberland Advisors. “This is why cities have reserves and why bonds have debt-service reserve funds—for those times. No doubt federal aid will help postinauguration.”

Read the full story at Barron’s (paywall): https://www.barrons.com/articles/los-angeles-has-been-hammered-by-covid-but-its-muni-bonds-are-holding-on-heres-why-51610717943


Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

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Cumberland Advisors Market Commentary – The Blue Wave and the Bond Markets

The Democratic Party won both Senate seats in Georgia on Tuesday, January 5th. Our own math had a split decision, with each party capturing a Senate seat; but with the sweep the Democrats will now control the White House, the House of Representatives, and the Senate, where a 50-50 split will now be broken by Vice President Kamala Harris.

What does this mean for the bond markets?

For overall interest rates, higher and a reversion to the mean. The charts below show the 10-year and 30-year US Treasury yields. They have been climbing since the early fall, anticipating a Biden victory; but now with the confirmation of a Democratic Senate, we have seen a distinct move up. We do not believe that this is a Taper Tantrum redux. We do believe that it is a reversion to the mean. It is important to remember that the 10-year and 30-year US Treasury yields were 1.9% and 2.4%, respectively, at the beginning of 2020 before the pandemic began.

Part of this rise in yields reflects the market’s starting to discount more stimulus and a greater amount of government spending. Clearly, this type of stimulus will up the expectation of inflation down the road.

The chart of the 10-year breakeven inflation rate measures the difference in yields between 10-year Inflation-Indexed treasury bond and the nominal 10-year treasury bond. If average inflation is BELOW the breakeven rate over 10 years, an investor is better in a nominal bond; and if it is above the breakeven rate, an investor is better in the inflation-indexed bond. We use breakeven inflation rates as a measure of inflation EXPECTATIONS. Clearly those inflation expectations are RISING with the blue wave and expectations are now above 2%. It is important to remember that this doesn’t mean that inflation necessarily rises. The best bond-buying opportunities in the past have materialized when bond markets sell off because of FEARS of inflation, but we don’t get outright inflation.

We do expect to see CORE inflation begin to rise. As you can see, core CPI is well off the bottom that we saw in the spring with early pandemic fears in full force, but it is well below the 2 percent plus that was trending before the pandemic. In other words, interest rates STILL have a long way to go to generate a positive spread over the rate of inflation. But we do believe that we will see inflation start to rise as the economy gets to a new normal with a vaccinated populace and a Congress that is much more predisposed to spending in general and to aid state and local governments as well as individuals.

What about munis?

The change in the Senate is beneficial to tax-free munis on several fronts.

First, municipalities will be getting more aid and getting it faster under a Democratic Congress with a Democratic White House. Certainly, many municipalities will benefit from this additional aid, though as we have mentioned in the past, most municipal entities – even troubled issuers like Illinois and New Jersey – have had access to the bond market and have been issuing debt this year. This anticipated assistance will also help, eventually, more pandemically affected issuers such as airports, transit systems, conventions centers, colleges and healthcare systems.

Second, there is no question that income tax rates will eventually rise. However, we believe that the new administration will WAIT until the economy is on a better footing before raising taxes.

Below is a chart showing Treasury yields, AAA muni yields, taxable equivalent yields at the present top rate of 37%, and what taxable equivalent rates would yield at a top rate of 40%. If muni yields are higher than the AAA yields depicted, then those taxable equivalent yields would be higher as well. The higher overall yields in general will be partially offset by the countervailing force of higher tax rates in the muni market.

Third, we expect the Biden Administration to eventually roll back the SALT provisions of the 2017 tax bill.  To remind folks, the SALT provisions CAPPED the deductibility of state income taxes and local property taxes to $10,000 on a federal tax return. This cap has proved very onerous to citizens in high-tax states such as New York, New Jersey, and California. The rollback will have several effects. It will provide a support for housing markets in the high-tax states as the economy swings back to normal. It also means states that impose high property taxes or high income taxes would start to see a slowdown in the migration of high-income taxpayers to lower tax states. For the last three years, we have seen the shifts in population, say from Silicon Valley to Austin, Texas, or from Long Island, New York, to West Palm Beach, Florida. In other words, the states that have been economic losers over the past three years (New York, New Jersey, Illinois, California, etc.) should see the exodus of their residents to the economic winners (Florida, Nevada, Texas, Georgia, etc.) slow down. There is no question in our view that there is a political aspect to SALT as well, and that is that red (Republican) states have become more blue due to SALT as voters from Democratic states have moved to the more traditional red states. We think Georgia is a perfect example of this in both the presidential election as well as this week’s Senate races.

Fourth, we also expect an infrastructure bill from the Biden administration. This legislation never materialized during the Trump administration, and we feel an infrastructure initiative will help municipalities as well. The mechanics of it remain to be determined, but we know that the types of projects needed include roads, bridges, tunnels, dams, etc. Given the current economic situation, you won’t see projects like new runways at airports or new dorms at state universities, the way we did with the Build America Bonds program.

We deplore the chaos that we witnessed in Washington on Wednesday and pray for cooperation as the nation transitions to a new administration. We do think the transition to higher interest rates – reflecting both the economic recovery as well as the higher level of stimulus – is already under way. Therefore, we are more defensively positioned in total-return bond accounts than we were last summer.

Good luck to everyone in 2021.

John R. Mousseau, CFA
President, Chief Executive Officer & Director of Fixed Income
Email | Bio


Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

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Cumberland Advisors Market Commentary – The Long Strange Trip of the Muni Market in 2020

CA-Market-Commentary - The Long Strange Trip of the Muni Market in 2020 - Mousseau
Sometimes the light’s all shinin’ on me
Other times I can barely see
Lately it occurs to me
What a long strange trip it’s been
“Truckin,” by the Grateful Dead
(Lyrics by Robert Hunter)

 

Those great lines from a great song sum up the 2020 investment year in general and particularly in munis, as we look at the markets before the pandemic, in the middle of the March collapse, and now as we near the end of the year.




Source: Bloomberg

 

We can see how low US Treasury rates and municipal bond rates had both fallen at the end of 2019. A lot of the drop in rates was due to US rates “catching up” with those in Europe and Japan. We see very low tax-free to Treasury yield ratios. It’s important to remember that these are AAA yields, and most of the state general-obligation paper in muni markets yields more than this.

By mid-March we see s the full-blown turmoil in the muni market. But remember, this turmoil was not limited to just tax-free bonds; corporate bonds, stocks, oil – all were plummeting. This was a liquidity event, not a credit event, as we have previously written. The chart below shows the bond fund outflows, which were unprecedented.

The bond fund outflows of March followed the downdraft in oil prices caused by the onset of the pandemic, which caused the sharp sell-off in the stock market.

 

This grab for liquidity produced what we saw in March, with Treasury yields falling precipitously and yields on munis, as well as other instruments, moving significantly higher. The yield ratios seen in the March 20th chart are unparalleled for muni cheapness. We saw AA and AAA state general-obligation bonds with maturities less than four years yielding 10 times as much as Treasurys (3.0% vs. 0.3%). In 35-plus years of managing bond portfolios, this author had never seen that anomaly until this year.

As we know, the cheapness didn’t last long. Private money moved into the space abandoned by the bond funds, and it happened in a fairly short period of time. The rebound at the end of March was one of the most vigorous muni rallies ever witnessed. By the end of the month, muni bond yields, while still cheap to Treasurys, had closed two-thirds of the gap. Clearly, there was little issuance in March and indeed for the next month plus, as most issuers took a wait-and-see attitude to issuing bonds until the storm settled down.

The balance of the year saw continued improvement in the muni market. The CARES Act of March helped state and local governments, and the Municipal Liquidity Facility of the Federal Reserve provided a $500 billion vehicle through which issuers could sell short-term notes directly to the Fed. The fact is, however, that few issuers took advantage of this facility, as the Fed’s terms were somewhat arduous and issuers had to prove they could not adequately access the market. The lack of use points out the liquidity of the overall muni market, as well as the fact that issuers could get bank loans at better terms. But it’s very important to remember that the very fact that the Fed set up the facility was a big factor in the market’s returning to normal. The message of the Federal Reserve to the bond markets was “WE HAVE YOUR BACK.”

As we close the year, we can look at the chart and see that the muni market is essentially cured from a functionality standpoint. Muni yields across the board are significantly lower than they were at the start of the year, and in the short end they are MUCH LOWER. Compared to the end of March, when the muni market had righted itself, overall yields are also much lower, particularly in the shorter end of the yield curve, reflecting the lowering of short-term interest rates by the Fed in March and the return of liquidity to the market in general and the short-term market in particular.

Municipal credit has been resilient through the pandemic. Yes, there have been some downgrades, and there will be more. But the most salient feature of high-grade municipal bonds has shone through in 2020, and that is the fact that municipal issuers enjoy a monopoly on taxing power and the provision of essential services. And as we have seen in this past year, the larger infrastructure-type issuers enjoy broad institutional support from both the investing public and Congress. And just as important, even issuers with structural problems, such as New Jersey and Illinois, still have broad municipal market access, albeit at higher yields than the market.

To say all this is not to discount the fact that state and local governments will need some further help. As we write this, they were not included in the latest stimulus bill, which the president has finally signed. But they will benefit in a secondary sense from the spending by individuals and by corporations able to take advantage of another round of PPP. We think that the new Congress in 2021 will add another bill that addresses direct aid to state and local governments. There is still plenty of distress out there.

Earlier this month we showed you our Cumberland State of Despair Index, which combines COVID-19 infection rates with unemployment rates by state (https://www.cumber.com/cumberland-advisors-market-commentary-the-cumberland-state-of-despair-index/).

The index charts show the COVID infection rates and U-3 unemployment for each state for September 24 and November 23 and then the combined results for the “state of despair” on those dates. One stark result: The State of Hawaii registered very high in the Despair Index because, while the state has a low COVID infection rate, its unemployment rate (no tourism) has skyrocketed, and the economy has suffered greatly. It is still suffering but less intensely now on the jobs front, with the unemployment rate having dropped 4% from Sept. 24 to Nov. 23. There is no doubt that vaccines should help both measures of despair to go lower over time, and we pray that the overall Despair Index will downshift as we move into 2021. In December we have seen Rhode Island and New Jersey move into the top five, and of course it is no surprise that the two states have had to endure more lockdowns this month. We will update these Despair Index charts regularly.

As we enter 2021, we are very focused on the January 5th Senate runoffs in Georgia. A Democratic victory in both races puts that party in control of both houses of Congress, along with a new Democratic administration led by President-elect Biden. Our view is that this outcome would lead to more spending – in greater amounts and on a faster pace than if the Republicans hold the Senate, which they can do with a Republican outcome in either race. We think bond market participants will start to discount increased spending, and perhaps a higher inflation rate, and that may cause yields to rise. We believe this will happen even with a Republican Senate, although at a slower pace. We think President-elect Biden still has good relationships with Senators who were in office when he was a Senator more than 12 years ago, and those relationships should foster some measure of greater cooperation, in any case. We think we’ll see rates back to where they were at the end of last year; but certainly, halfway between where they were then and where they are now is a reasonable approximation of where we think yields will be mid-year.

The long strange trip of 2020 will hopefully give way to a better trip in 2021, with some degree of normalcy. We wish all of you pleasant holidays and best wishes for next year. The American economy has shown its great resilience and its ability to come back from other crises, and we believe it will do so this time, too. We hope that we will soon be doing some meetings in person and flying for some business as well as for fun, and that stadiums and hotels will be full. Happy Holidays!

John R. Mousseau, CFA
President, Chief Executive Officer & Director of Fixed Income
Email | Bio

Originally sent via email to subscribers: Check it out.


Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

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Cumberland Advisors Market Commentary – The Cumberland State of Despair Index

Half a century ago, Arthur Okun was an American economist who served on the President’s Council of Economic Advisers as chairman and before that was a professor at Yale University. Among Dr. Okun’s many contributions to the field of economics, one of the most memorable is the Okun “misery index.” This index summed the seasonally adjusted unemployment rate with the inflation rate and was meant to reflect the economic as well as the social cost that soaring levels of both inflation and unemployment were imposing on the economy. And in the late 1970s, with both measures at double-digit levels, the nation was indeed feeling that misery.

Market Commentary - Cumberland Advisors - The Cumberland State of Despair Index (Mousseau & Healy + Patterson)

In 2020, we face twin challenges again: unemployment brought on by the pandemic and the very real health issues caused by COVID-19 infections. We have tried to capture the despair caused by these challenges on a state-by-state basis by combining a state’s unemployment rate and its current COVID positive test rate. We are going to take our State of Despair Index and apply it as a variable in our credit-scoring model, as well. A couple of shout-outs are called for here. We would like to thank Dr. Steve Green, professor of economics at Baylor University. In a conversation, Steve and I were discussing the late Arthur Okun, his misery index, and his output-gap index of the 1970s; and out of this discussion came the State of Despair Index. We also want to thank Ms. Jane Mousseau of Group SJR in New York for her contribution of the “State of Despair Index” name.

 

On the chart above we list of all the states (and Puerto Rico) with COVID positive test rates and unemployment rates (standard U3) by state as of November 23. The states are listed in order of the positive test rates, with the highest at left. Not surprisingly, the leaders in the positive test category at this point are the ones in the news of late – North Dakota, South Dakota, and Wisconsin. The positive test rankings would have looked different just a couple of months ago. Here they are for September 24.

 

Back in September, the unemployment rates were much less consistent by state, and COVID positivity rates were much lower, as the second wave had not really started at that point. The highest positivity rates were in Louisiana, Mississippi, Florida, and Alabama. One consistent fact is that Vermont and Maine had very low positive test rates both then and now. Maine was very restrictive about who could enter the state through the summer and insisted on two-week quarantining for anyone entering the state from a “watch list” state.

In the two charts above we see the State of Despair Index (which, again, combines the COVID positive test rate with the unemployment rate) for November 23 and September 24. The State of Despair Index displays a large range, from a high in Nevada at 16.92% to a low in Vermont at 4.85%. The leaders on this list are not surprising: Both Nevada and Hawaii are dependent on tourism, and COVID has devastated that industry. The next two leading states are not as obvious. Illinois, a large state, is certainly dominated by Chicago; and Rhode Island, a small state, saw a pickup in COVID infections this fall, centered around its colleges.

The five leaders in the Despair Index have decidedly different makeups in their component scores for November 23:

Nevada – 4.42% positive test rate and 12.50% unemployment = 16.92% despair

Hawaii – 1.21% positive test rate and 15.00% unemployment = 16.21% despair

Illinois – 5.24% positive test rate and 10.40% unemployment = 15.64% despair

Rhode Island – 4.77% positive test rate and 10.50% unemployment = 15.27% despair.

North Dakota – 9.63% positive test rate and 4.40% unemployment = 14.03% despair.

Two months ago, the Despair Index was a little different. The five leading states then were these:

Nevada – 2.51% positive test rate and 13.30% unemployment = 15.81% despair.

Rhode Island – 2.29% positive test rate and 12.90% unemployment = 15.19% despair.

New York – 2.33% positive test rate and 12.50% unemployment = 14.83% despair.

Hawaii – 0.84% positive test rate and 13.00% unemployment = 13.84% despair.

New Jersey – 2.27% positive test rate and 11.10% unemployment = 13.37% despair.

So, we have the consistent Despair Index leader, Nevada, with second-highest unemployment and a moderate positive test rate. Hawaii has by far the highest unemployment rate and third-lowest positive test rate in the nation. Hawaii, with its low positivity rate, has borne a disproportionate share of the despair, as few people are visiting there from other states or countries due to travel restrictions. That situation should change as the vaccine makes its way into the general populace.

Two members of the top five in the September 24 Despair Index, New York and New Jersey, have now moved to 8th and 37th respectively. The bad news is that we now have many more states above the 10% despair threshold than we had two months ago.

State Charts

Starting in the early months of this year, we charted the Despair Index for five states, with a broad geographic mix: California, Florida, Illinois, New York, and South Dakota. All of the graphs show a similar pattern, with a sharp upswing in COVID in the early months of the pandemic, March and April, then a drop as we got to the latter part of the summer, and then a rise again in the past few months, with South Dakota picking up strongly in October and November because of its upsurge in COVID infections.

Clearly, the introduction of vaccines will shift the Despair Index downward. What we do not know is the velocity of this shift. There is no doubt that we will first see the shift downward as COVID cases decline, and then we would expect unemployment to follow.

COVID has now been described by many, including the credit rating agencies, as a social risk (social as in ESG – environmental, social, and governance) that needs to be evaluated. For example, the shutdown of non-COVID services at a hospital, or reduced demand for those services due to fear, results in less revenue in the face of increased costs for safety equipment, processes, and procedures.

The pandemic has accelerated all sorts of changes – changes, for instance, in telecommuting and telehealth, raising the need for greater broadband capabilities and cybersecurity. The pandemic has also revealed and widened disparities between high-income and low-income jobs, with higher-income earners mostly able to keep working from home and many low-income earners, such as hotel and restaurant workers, losing their jobs. The affordability of basics like food and healthcare then becomes a critical issue.

Municipal employees – teachers, healthcare and social-service safety-net workers – are all on the front lines of fighting the virus, and municipalities are bearing the cost while at the same time enduring reduced revenues.

The Despair Index will be used to adjust our credit scores, with a negative adjustment if the index is above the median value. The components of the index, unemployment and COVID positive test rates, will also be considered. A high Despair Index adjusted score relative to the average rating agency rating will trigger a review of that credit, so that we can stay ahead of negative rating actions. And in addition, we are also looking at the diversion between the unemployment rate and the COVID rate.  Hawaii is a perfect example with a small infection rate (for reasons of distance and density clearly) but soaring unemployment as their economy, so dependent on tourism, has borne the brunt of the shutdowns, slowdowns and lack of travel in the other 49 states.  On the other side are the Dakotas, where their unemployment is low and current infection rates high.  Their economies are focused on agriculture, food processing and technology, all areas in demand during COVID and the infection rate spiking has been more recent.  Clearly the concern is that the health issues don’t resolve and spill into slower economies.  So, it bears watching. And, unemployment is probably understated. The U6 measure of unemployment which includes part time workers as well as underemployed workers would clearly be higher across all states.

For Cumberland, the State of Despair Index is a work in progress, and it is our fervent hope that it is a less relevant part of our quantitative analysis down the road which will mean a drop in both infection rates as well as unemployment and a return to whatever the new normal would be. But as with all things regarding municipal credit, the Cumberland State of Despair Index is dynamic, not static.

John R. Mousseau, CFA
President, Chief Executive Officer & Director of Fixed Income
Email | Bio

Patricia Healy, CFA
Senior Vice President of Research and Portfolio Manager
Email | Bio

Tom Patterson
Fixed Income Research Assistant


Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

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Cumberland Advisors Market Commentary – Wave Bye to Blue Wave – Bonds

Though we are still sorting out last night’s election, the so-called “blue wave” of a Democratic sweep of the White House, Senate, and House of Representatives didn’t happen.

Market Commentary - Cumberland Advisors - Wave Bye to Blue Wave – Bonds

At this hour, the White House is still not decided; it appears the Senate will NOT switch and will stay Republican; and the Republicans made a few gains in the House, but it will remain in Democratic control.

The graph below shows the intraday yield of the 10-year US government bond. You can see yields rising from October 15th to the 23rd.  This was “prime time” for the blue wave conversation’s entering the bond market. The logic was simple. A Democratic triumvirate of White House, Senate, and House would produce more spending, social programs, and a higher level of inflation expectations. During this period of rising yields, we witnessed a large increase in the number of “short” positions in US Treasury 10-year bond futures – betting that bond prices would continue to decline and yields to rise.

We see yields begin to decline on October 23rd. Why? The second presidential debate sowed doubts in the presidential election results and the blue wave in general. Yields began to decline as the Treasury shorts were removed. This trend lasted until near the end of October, when some of the swing state polling continued to show a lead for former Vice-President Biden. So, yields began to rise again until we hit election week.The drop in yields since the beginning of the week represents what will be a divided Congress regardless of who is President. In other words, spending programs will be harder to come by.

Some quick thoughts – and a lot of crosscurrents – follow.

Municipal bonds aren’t hurt as much as they are not helped. A second stimulus bill that would include additional aid for state and local governments will be harder to come by with the House and Senate in control of different parties.

The higher income taxes that we assume will be coming under either Biden or Trump would come faster under Biden but are less likely with a divided Congress. So a boost in the marginal tax rate, which would help muni bonds at the margin, is probably off the table for now.

On the positive front we have noted how much muni supply is down. Below is the chart of the Bond Buyer visible supply, which is the near-term calendar of municipal bonds plus what is in dealers’ hands. Issuers rushed to market to beat the election, remembering the bond market volatility of four years ago. So, for now, there is VERY LITTLE issuance and a large reinvestment period of December and January looming.

So, as we sit here and wait for some resolution to the elections, a few thoughts:• Interest rates, both intermediate and longer, will be slower to rise; but as the economy improves and we get to a vaccine, we should see higher rates no matter who is finally elected President. Thus caution is needed on durations and maturities.

• Munis should be fine. Though they will probably not get a tax-increase boost right away, from a demand/supply standpoint they are in very good shape.

• Muni credit will continue to be important and is anything but static. Without a second stimulus bill, we may see some additional actions from the Federal Reserve to shore up markets if needed. We also expect further jawboning from the Fed to Congress on the importance of additional stimulus.

We will keep readers up to speed.

John R. Mousseau, CFA
President, Chief Executive Officer & Director of Fixed Income
Email | Bio



Cumberland Advisors Market Commentary – Muni Bonds Turn Toward the Election

With the presidential election a month away, we start to mull over what the bond market might look like post-election day.

Market Commentary - Cumberland Advisors - (Mousseau)

While most polls have Vice-President Biden ahead by 6–7% points, we know the race has the potential to be much closer, since the 50 individual states decide the election by virtue of voting by state through the Electoral College.

Here’s a quick view of the markets at the start of the quarter and the end of the quarter.



Source: Bloomberg

 

As you can see, there was very little movement during the quarter. The 10-year and 30-year Treasuries were up 3 basis points during the quarter, and 10-year and 30-year AAA tax-free munis were down 7 and 8 basis points respectively, so we saw a decline in the muni-to-Treasury yield ratios during the quarter.  This trend is also a function of the overall market’s feeling better about muni credit the further we move away from the pandemic days of last spring.

Bond volatility in general has crept lower. As we can see below (courtesy of Bianco Research), bond market volatility has dropped precipitously since the upheaval of March 2nd.

 

One thing 2016 taught us is that an unexpected result can change the status quo very fast. Below is a chart of the Bond Buyer Index after the 2016 election. The sharp rise in longer muni rates was caused by expectations of cut taxes, infrastructure spending, and inflationary pressures. All of these concerns helped spur bond fund redemptions and higher yields, presenting, as we know from past experience, a buying opportunity.

 

There are a few assumptions we are making if there is a Biden win after November 3rd.

Higher taxes. The former vice president has not been shy about saying that he will raise taxes on the wealthy. And given the current deficit, which has grown since the onset of COVID-19, there is a good case to be made that marginal federal tax rates may rise at some point even if President Trump is reelected. Here is a yield chart of AAA munis from last week.

Source: Bloomberg

 

We take the existing AAA yield curve and calculate the taxable equivalent yield of the current top federal marginal tax rate of 37%, and then we boost that rate to the old (pre-2017) tax rate of 39.6% and then 41% and 43%. For longer municipal bonds the bump up in taxable equivalent yields is the greatest at the highest coupon levels. And even now, many bonds trade at rates much higher than the AAA curve. For example, many muni bonds are yielding 2–2.25%. A 2% tax-free yield has the taxable equivalents of 3.17, 3.31, 3.39, and 3.51 at the above tax rates. These taxable equivalent yields are SIGNIFICANTLY higher than taxable alternatives are. A higher marginal rate should also flatten the muni yield curve over time as the demand for longer-dated paper increases because of the benefits it provides on a taxable equivalent yield.

The offset to that calculation is that clarity of knowing who the next president is may provide a platform for some higher interest rates at the margin. The chart below shows the difference between 10-year Treasury bond CORE inflation, as measured by the Consumer Price Index less food and energy.

 

We have been at negative REAL yields for a while. But, as in 2016 when Brexit forced the bond market to negative real yields, the resolution of the politics could change expectations to higher levels of spending and potential inflation. We feel this will be potentially true if the US Senate goes Republican and the Democrats have the White House, House of Representatives, and the Senate all in the same camp. More fiscal stimulus, more deficits, and an immediate infrastructure program are all strong possibilities if we get the Blue Wave that sweeps the White House, House, and Senate all into the Democratic column.  We think markets will take notice and start to price in this potential— possibly before election day. Of course, there are lots of issues between now and then– the health of the president and Mrs. Trump, the uncertainty of future debates, and the uncertainty surrounding many swing states in the election.

How do we prepare for this?

We start to take some profits on bonds bought during the sell-off in March; we start to let matured bonds lie fallow in some short-term paper for a month or so; and we do the same with called bonds. In other words, we try to dampen down the duration or price risk of the portfolios at the margin.

On the credit side of things, we remain vigilant. Though municipal governments could use another stimulus package, the economy’s opening up – even as we start to reach a COVID vaccine – is crucial.  There is no question that the opening of the economy on the state and local level is just as important as any stimulus. The pace of increased economic activity is key here. We have seen some downgrades to municipal issuers; and this, of course, is to be expected. But the changes have been anything but a free fall in ratings, and that is because most municipal governments were in fairly good shape entering the pandemic.

An election with a clear winner, if that is what unfolds, will be a harbinger of higher rates down the road and will start to get interest rates back into the positive REAL category, where they have spent most of their time historically.

John R. Mousseau, CFA
President, Chief Executive Officer & Director of Fixed Income
Email | Bio

 


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Cumberland Advisors Market Commentary – Cumberland Responds to Barron’s

Three of us have collaborated on this discussion. Our views are pretty much aligned. We think Congress is hobbling an economic recovery by delaying the funding related to COVID-19 and now, additionally, funding related to the wildfires. We think many municipal entities are under extreme stress. And federal help is needed now, or these entities will have to reduce staff, swelling the ranks of the unemployed across the nation and reducing municipal services at the very time that demands for those services are at record levels.

We will identify the author of each part of this collaborative effort.

Cumberland Advisors Market Commentary - Cumberland Responds to Barron's
David R. Kotok writes:

Barron’s has described the $1 trillion funding gap in US states and local governments. Much of that gap is created by or worsened by COVID-19. See “Cities and States Are Facing a $1 Trillion Budget Mess. There Will Be More Trouble Ahead.” Barron’s, https://www.barrons.com/articles/cities-and-states-are-facing-horrific-budget-holes-there-will-be-more-trouble-ahead-51598638702.

So what can be done and how to do it are now key policy questions.

Here are the general outlines of a proposal. The federal government can use its guarantee to back up to a $1 trillion municipal issuance. That would enable worldwide purchases, just as the US federal guarantee enables mortgage lenders like Fannie Mae to issue debt for global market purchases. The federal guarantee also allows the Federal Reserve to purchase such debt and to maintain orderly markets in it.

The debt can be issued by states and their agencies with the guarantee. The debt can be of the self-liquidating type; thus, it is eventually paid back by the states and doesn’t permanently increase the federal deficit. The US Treasury can set rules and the use of funds purposes description. That purpose of issuance can be well-defined (infrastructure, public health, water-sewer, etc.) or left to states’ discretion. Debt type can be inflation-indexed or conventional or zero-coupon or sinking-fund or floating-rate or a mix. The self-liquidating structure is typical in municipal bond issuance and there is no reason to change it. Maturity length can be out to 30 years or even longer. There already is a mature market for long-term Munis.

With the issue, credit pressure on states and their regional and local subdivisions will be buffered, and they will be able to advance and finance the many services that COVID-19 and post-COVID-19 economic recovery will require. We believe the Barron’s estimate of $1 trillion is sufficient to close the funding gap and carry the recovery process for as long as the next two to three years and until the vaccine/treatment issue is resolved with some trust and clarity for the whole population.

We believe that if we want US business to recover and our nation to flourish again, we must get the 90,000 state and local political jurisdictions onto a stable funding platform. The longer we wait, the more difficult a business and economic recovery will be. Now is the time for action. Let me pass this discussion to my colleagues.

Here’s John R. Mousseau on muni markets.

The Barron’s cover story for August 31, 2020, “The Trillion Dollar Hole,” made some good points – the most important being the long-term track record of municipal credit. The article correctly noted that Arkansas was the only state to default on its debt in the Great Depression. What was missing was the fact that Arkansas went that route in order to aid local towns and cities that would have had a harder time recovering on their own, and the decision was made that the state could more easily recover its financial balance than these juridictions could on their own. By the way, Arkansas subsequently cured the default and paid everything it owed to bondholders.

This is not to say that challenges aren’t there for states. We know those – underfunded pension plans, insufficient rainy day funds in many states, and a number of states on the wrong side of “the Laffer curve,” where further tax increases (think combined state income taxes, state sales taxes, and local property taxes) result in a DROP in total revenue to the state, not an increase. For example, New Jersey has been experiencing this phenomenon for several years.

The key for a number of these municipalities and states, and for some troubled issuers is to cut spending to tread water through the remainder of the pandemic and to access the capital markets where available. As we saw with the State of Illinois, as well as with New York MTA in May, issuers may not like the rate that the market affords them, but access has still been robust. Both deals were multiple times oversubscribed; and today, four months later, these bonds still trade well more than 100 basis points lower in yield than they did when they came to market. For example, in May of this year, the State of Illinois (BBB-) had a deal where bonds in 2045 came to market at a 5.85% yield. Those bonds have recently traded at a 3.60% yield to a 10-year call. This happened when the general market had shifted down only about 45 basis points in yield. This is not to say that the market does not back off for more challenged credits. But the market has clearly embraced the federalism we have seen in the wake of the pandemic, whether that takes the form of the Treasury’s special vehicle or the Federal Reserve’s direct purchasing of notes (Illinois and MTA) or the yet-to-be-passed infrastructure program.

The course and tenor of municipal finance changes markedly with the broad distribution of an effective vaccine, though not right away; the changes will be a step function. High-grade credits are already back to pre-pandemic levels, and in the case of shorter-term yields they are well below pre-pandemic levels, because the Fed has cut short-term interest rates. We would expect a general narrowing of credit spreads as a vaccine begins to be accepted and administered nationwide. More-troubled credits such as convention centers, smaller colleges, student housing, airports, transit systems, and sales tax bonds in general should all start to move up on a relative basis.

Also, many municipalities have seen their property tax base increase in value, with COVID-led demand for single-family homes continuing to push housing prices northward along with the pace of sales. So there is room for many local general-obligation bonds to soldier on or perhaps to have a higher tax base. In addition, municipalities are innovative in deriving new revenue sources. Think of a financial transaction tax going to New York City, or of states or counties extracting a “toll” on drones that traverse the airspace above their roads (which the municipalities control). The idea is that lower sales taxes in some areas can be replaced by usage taxes in other areas

We expect to see some creative financing, especially from larger issuers. We know that New Jersey advanced $7–$9 billion in financing. What if you were to sell an inflation-indexed 100-year bond, non-callable, such that the supplemental inflation payment was in the form of tax-exempt coupons. Then have the federal government back the principal of the bonds but the state or city be responsible for the coupon payments and supplemental inflation payments. With thirty-year US Treasury TIPS at a yield of -0.3%, even a troubled issuer like the State of NJ could get away with a real yield of 1–1.5%. For longer-view investors we think that would be attractive as an inflation hedge. It might appeal to pension funds that don’t need the tax exemption.

We know that many of the troubled credits out there (Illinois and New Jersey, even before the pandemic) have a LIQUIDITY issue (a need for cash to pay bills as normal collections are less from sales taxes, ridership revenue for transportation credits, etc.) but not an INSOLVENCY issue. That is an important distinction and one that contributes to the overall extremely good track record of municipal debt. Continued access to the capital markets, combined with realistic choices and belt tightening, should pave the way for better days for municipal issuers and for the market as the economy comes back.

Here’s Patty Healy on how a federal backing that raised $1 trillion would help the existing $4 trillion municipal finance sector to stabilize and would lower borrowing costs for most jurisdictions in the United States.

State and local municipalities received $150 billion in CARES Act funds, and the action was swift, delivering aid to the hardest-hit sectors and to states and large municipalities. Presumably, the state funds could be downstreamed to localities. The funds, however, were not without strings and could be used only for COVID-related expenses, not for revenue replacement, though revenues had plummeted dramatically. Other programs were designed to help businesses retain employees, and unemployment benefits were increased so that bills could be paid and some level of consumption could continue as the economy shut down to battle the pandemic.

Municipalities, which are on the forefront of addressing the pandemic, having seen a substantial drop in revenues, have had to cut budgets and personnel and in some cases reduce planned capital expenditures. Some may not even make the annual payments required to keep their pension funding levels from decreasing. If they don’t, pension funding becomes more expensive in the longer run – a vicious cycle that has caused the loss of financial flexibility for some and credit downgrades for others. Higher leverage and credit downgrades do increase borrowing costs.

According to the Bureau of Labor Statistics, state and local public employees make up approximately 13% of the American workforce, with municipalities alone employing nearly three million people nationwide. The Center on Budget and Policy Priorities noted that total nonfarm payroll employment (private plus government) fell by 22 million jobs in March and April, wiping out a decade of job growth. Despite job growth since then, including 1.0 million jobs added in August, private payroll employment remains 10.7 million jobs below its February level while state and local government payrolls remain 1.1 million jobs below their February level. The history of the financial crisis showed that the loss of municipal employment was a drag on the economy and lengthened time to recovery.

Congress has been dragging its feet in providing additional aid to municipalities, and many hope some aid will arrive shortly; otherwise, budget cuts will continue, services will be reduced, and the recovery will be slowed. The Center estimates that states, excluding local governments, need $555 billion, with the shortfall expected through fiscal 2022. If municipalities could plan on some aid, even phased-in aid; and if funds are not immediately available, at least budgets could take into consideration additional future aid and minimize the number of layoffs and service reductions.

Any mechanism to get needed funds to state and local governments – and soon – would help retain state and local public employees. A guarantee fund could be useful, lowering funding costs for municipalities close to the cost of Treasury bonds. The September 16, 30-year Treasury bond yielded 1.45% at the end of the day (Sept 16), while AAA-rated municipal bonds yielded 1.72%; the 10-year was at 0.67% compared with AAA yields of 1.16%. Shorter-term yields recognize the short-term risks that the market perceives in the municipal market. Debt repayment could be stretched out so that the additional debt-servicing burden would be minimal. Already a number of issuers are refinancing higher-cost debt and in the process reducing the amount of near-term maturities. They are also extending the final maturity of the bond, a move called “scoop and toss” in Muniland. While in good economic times scoop and toss is a signal of stress at a municipality that opts to do it, during an extreme situation it becomes a tool for the municipality to manage through the crisis.

Bottom line from our three authors: We are not in business-as-usual financial times. State and local governments need help, and the federal government has the ability to help them. The time for that action is now.

David R. Kotok
Chairman of the Board & Chief Investment Officer
Email | Bio


Virtual Event Thursday, Sept 24

Cumberland Advisors is an Annual Sponsor of

the Global Interdependence Center

GIC - Monetary Policy with James Bullard, Ph.D.

GIC’s next Executive Briefing will explore monetary policy with James Bullard, Ph.D., President & CEO of the Federal Reserve Bank of St. Louis. Join them Thurs, September 24 at 12:00 p.m. ET.
Complimentary registration: https://bit.ly/33DvgLX


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Inflation TIPS: Living On The Hedge

Rida Morwa quotes John R. Mousseau in a recent commentary, dated August 14, 2020 on Seeking Alpha

Cumberland Advisors John Mousseau

Excerpt follows:

There are two major risks of TIPS. The first is that the inflation rate it’s tied to is calculated by the CPI which is a government calculated index. While we are not in the conspiracy theory category, there’s always a risk that CPI could understate actual inflation and hence you would not get the real benefit of TIPS. CPI also weighs components of inflation in a way that may not be representative of your own circumstances, and hence even in case of an accurate calculation, you may still lose out.

The other big risk here is that current yields on TIPS are a bit ludicrous.

The auction went “pretty well,” according to Tom Simons, a money market economist at Jefferies in New York.

The direct bid was a little soft, which is not all that unusual in recent times,” he said, adding there was a strong take down on the indirect bid side. A rush into TIPS has pushed yields to near historic lows amid an uptick in inflation expectations. The 10-year TIPS yield was last at -0.881%. “With the amount of stimulus that’s out there, it’s hard to believe that there’s not some inflation that’s going to come out of this,” said John Mousseau, president and CEO of Cumberland Advisors. (Source: Reuters)

That was not a typo. The Negative 0.881% yield means that the first 0.881% of inflation gets you to nada. Of course if inflation does average 2% or 3% over the next 10 years you would still do far better than the 10-year bonds yielding under 0.55%. You need inflation to average 1.43% over 10 years to do identically well as the 10-year bond.

Read the full commentary at Seeking Alpha: https://seekingalpha.com/article/4368045-inflation-tips-living-on-hedge


Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites. Sign up for our FREE Cumberland Market Commentaries Cumberland Advisors Market Commentaries offer insights and analysis on upcoming, important economic issues that potentially impact global financial markets. Our team shares their thinking on global economic developments, market news and other factors that often influence investment opportunities and strategies.




Cumberland Advisors Market Commentary – Managing Hurricane Risk in a Bond Portfolio

The Northeast continues to clean up from Hurricane Isaias, which swept up the Atlantic coast to New York and parts of New England on Thursday.

Below is a slide from a presentation by our good friend Tom Doe, who heads up Municipal Market Advisors (http://www.mma-research.com). Tom’s firm does in-depth quantitative and qualitative research on the muni market, and we show the slide with their permission.

As you can see from the slide, hurricane season is upon us, and some observers think it could be the busiest storm season since 1851. The hurricane risk forecast is very high this year (some say the highest ever), and water temperatures in the Atlantic and Gulf are setting records. Not only that, but as we have witnessed, storms are lingering longer, traveling farther, and dropping more rain, causing major flood damage in addition to wind damage. It is not just the coastal regions that are impacted, either, as we have seen the Midwest and inland South also sustain more damage in recent years. States, municipalities, and first responders have been proactive in preparing; and now we have the added complications of the coronavirus pandemic and how to manage evacuations and sheltering while still maintaining social distancing and other safe practices.

At Cumberland we track hurricane cones of uncertainty five days before landfall to determine if any of our municipal bond holdings could be negatively affected by the storm, and we act early to exit those holdings that are in the path of a storm. We did this ahead of Hurricane Katrina in August of 2005, exiting many of our Gulf Coast holdings, and we have employed this strategy for many subsequent storms. The key is not to be precise meteorologists but to do smart risk assessment. In the case of Katrina this meant selling selected credits stretching along the Gulf of Mexico from Galveston, Texas, across the Louisiana, Mississippi, and Alabama shorelines, all the way to the Florida Panhandle.

The selection of credits to sell involves looking at exposure (read, close to the coast) and size (Galveston general-obligation bonds: sell; Harris County (Houston) toll roads: keep). The idea is that by being proactive, credits with potential exposure can be sold, and bonds with similar ratings in different geographic areas can be bought, thus not disturbing duration, yield, and maturity considerations in a portfolio but reducing event-specific risk. In the case of Katrina, none of the credits we sold were terribly affected, with the one major exception of New Orleans bonds (water, airport, etc.). Today these credits continue to be backed by vibrant municipal entities, but at the time the HEADLINE RISK post-Katrina rendered many of the bonds illiquid. Did they come back? Yes, but it took a while.

What have we learned since Katrina?

In 2005, we didn’t have the interactive maps and online meteorological tools we have now. We did it the old-fashioned way, with a list of credits, push pins, and a Rand McNally map of the Gulf. Katrina was the biggest hurricane to hit the US in a century. As a practice, if two bonds from a state were similar in yield, credit, maturity, etc., we opted for the bond away from the coast. All other things being equal, we would rather own the bond of Columbia, SC, that is backed by the University of South Carolina than a limited-tax general-obligation pledge from Beaufort, SC, which is right on the coast.

There’s no magic number, but 100 miles from a coast is a good place to draw the line. And the essentiality of a service also factors into judgments. A water or sewer bond covers the type of service that will have priority getting back online (thus earning debt service).

Fifteen years after Katrina, we feel we are in a much better position to manage through strong hurricanes because of our bond selection method. Does that mean we avoid coastal credits totally? No. Yield on a bond is still important; but, in our view, if we are to assume that larger geographical/meteorological risk, we need to get paid for it.

And as we enter the heart of hurricane season, we continue to be vigilant on credits from the Gulf to the Carolinas, and from the Middle Atlantic to New England. And for all the benefits that Google Maps brings to our work, we still have multiple copies of the Rand McNally atlas, for that day when a Cat 4 barrels down on us.

Stay safe and enjoy the rest of the summer.

John R. Mousseau, CFA
President, Chief Executive Officer & Director of Fixed Income
Email | Bio

Patricia Healy, CFA
Senior Vice President of Research and Portfolio Manager
Email | Bio

With contributions by Amy Raymond
Fixed Income Dept. Manager


Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

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