April 2015 Monthly Commentary
For most of the month, bonds traded at the high end of the price range as investors continued to fret that the muted Q1 economic activity might be the start of a trend rather than simply weather related. However, in the last few days of the month, those concerns abated with decidedly improved economic activity. While Q1 GDP growth registered an abysmal 0.2%, compared to Q4 2014, when measured versus the year ago quarter, the economy grew at a solid 3% pace. We believe the latter measure is more relevant, especially given the especially harsh winter endured for the second consecutive year. With that, bonds came under pressure during the final two days of the month, finishing at a loss for the period.
Investors continue to focus on the Federal Reserve for clues as to when the Open Market Committee will move to raise rates. All but the most dovish members have conceded that the current level of interest rates no longer makes sense. However, they also openly worry about the market volatility they expect to occur when they ultimately move to raise rates. Current consensus is that the Fed will wait until September to initially move, believing that the committee will want to ensure that Q1 weakness wasn’t anything more than weather related. We would argue that the Fed should look past that data and focus instead on the pattern of economic activity witnessed last year. Recall that the weak first quarter growth yielded to rapid economic expansion as the year progressed. As a result, the unemployment rate plunged from 6.6% to 5.6% for the year. At the current 200,000 new jobs per month run rate, the unemployment rate would likely drop to approximately 5% by September. The Fed should consider that the FOMC meeting concludes on September 17th, just nine trading sessions before October, the month most feared by equity investors. If they are concerned about destabilizing the market then they certainly don’t want to adjust policy in late September. The June meeting would make much more sense for a number of reasons. First, the capital markets have been suffering from heightened volatility recently, reacting to a mildly disappointing earnings season, crowded fixed income and currency trades, and confusion as to when and how the Fed is going to raise rates. If the Fed moves in June and presents a cogent path forward at the press conference, we believe that after initial volatility, markets would stabilize. Another consideration is that the Fed is not entirely certain if their intended plan to raise rates will be successful. As we’ve discussed on several occasions, the extraordinary amount of liquidity in the system render their traditional tools useless. Given those considerations, raising rates in June would seem to be more prudent than waiting until later this year. Of course, there are those that would argue that the economy is not strong enough to endure a rate rise. While that argument may have held water a few years ago, it no longer does. The zero interest rate policy distorts markets, penalizes savers, and encourages heightened risk appetite as investors reach for yield wherever it can be found. Despite the sensibility of a June rate hike, the odds of an early move are falling.
General Electric, one of the largest issuers of corporate debt, shocked the investment community in their April 10th announcement that they planned on selling the vast majority of their GE Capital assets and exit the sector over the next 24 months. They will retain financing units related to their Aviation, Energy, and Healthcare units, but that will represent a very small percentage of revenue. GE began the process last year when they spun off and sold a portion of their retail credit card business, renaming it Synchrony. In their latest move, the company sold their real estate assets and loan portfolio. In addition to the asset sales, the company announced that they had authorized the buyback of up to $50 Billion in GE stock in the secondary market. By exiting the finance business, the company will no longer be subject to the cost and reporting burden of being a significantly important financial institution (SIFI). Equally important, in exiting financial services, GE will lessen the volatility in their earnings. Under most circumstances, such a massive share buyback program would cause the price GE debt to fall, as the buyback would be interpreted as being at the expense of creditors. However, as industrial bonds trade at a significant premium to bank and finance debt, the move to 100% manufacturing resulted in a rally in both stock and bond prices.