July 2013 Monthly Commentary

Longer term interest rates rose in July as the yield curve continued to steepen, albeit at a slower pace than witnessed in May and June.  For the period, the yield-to-maturity of the 10-year note rose 10 basis points to finish the month at 2.58%.  The ETF related spread widening that occurred in June and was described in the last monthly update began to reverse, but the improvement has been inconsistent.  High quality investment-grade corporate bonds have retraced most of the spread widening, while lower-rated investment grade and sub-investment grade bonds have retraced only a fraction of the move.  Municipal bonds, on the other hand, continue to trade at the wide end of the spread range reflecting investors continued confusion as to the implications of the bankruptcy filing of Detroit, Michigan.  Because of that confusion, investors have been net sellers of muni bonds in fear that other issuers would follow the bankruptcy course of action.  While the municipal bonds held in the fund have suffered from “baby and the bathwater” type spread widening, our rigorous credit analysis leads us to conclude that the spread widening is not warranted for those issues and that the price action will improve in time, serving as an alpha generator for investors.

We mentioned on several occasions during the second quarter that anecdotal evidence of economic activity didn’t seem to jibe with Wall Street economists forecast for growth.  Consensus estimates among the large brokerage firms handicapped annualized GDP growth for the period at a paltry 0.5%, warning that the economy was nearing “stall speed.”  When the growth report was released in late July, investors were pleasantly surprised to learn that the first estimate of economic activity advanced at a 1.70% rate.  Moreover, that rate is likely to be revised to as high as 2.3% when the impact of the trade deficit is ultimately factored in.  The June trade report was also a pleasant surprise, as the deficit registered $34.2 billion, falling approximately $10 Billion from the prior month.  Driving the improvement was a record dollar amount of U.S. goods and services sold to foreign buyers.  Impressively, exports increased by $5 billion while U.S. citizens imported $5 Billion less foreign goods and services.  With economic activity in the second quarter registering more than four times what had been estimated, a tapering of bond purchases in September now seems a certainty.