Corporate Bonds Remain Resilient

Corporate Bonds image5/17/11: In the markets, as in life, there are no guarantees but everyone is entitled to their opinion. Here’s my opinion on the financial markets today.

Some relative calm overseas contributed to gains in U.S. stock futures early this morning.  However, as the open approached and market participants digested the latest earnings news from a major retailer and a prominent technology company (along with economic data on housing starts and industrial production), gains evaporated.  Some dollar strength also weighed on the open and put modest pressure on commodities.  European markets were mixed, with bank weakness being offset by some gain in miners.  Meanwhile, the Nikkei inched higher, helped by a weaker yen, while the Hang Seng moved slightly lower.  Oil prices are down again this morning, to near $97, as are key metals, while agricultural prices are higher.

Looking back at Monday, the week started off on a down note thanks to Greece headlines and tepid economic data.  More specifically, Greece requested another round of bailout funds, while the New York manufacturing survey showed more of a slowdown in activity in that region than had been anticipated.  At the sector level, disappointing results from a major home improvement retailer and weakness in Internet retailers weighed on Consumer Discretionary, while Technology was dragged down by a more than 2% drop in earnings from a major sector player.  As has been the case for much of the past several months, defensives continued to demonstrate market leadership as Utilities, Health Care and Consumer Staples all finished around unchanged despite the market declines.  Crude fell more than two dollars to near $97 and gasoline tumbled nearly 5% as fears of refining disruptions from flooding abated.  Other big commodity movers yesterday included corn and wheat, which were solidly higher, and silver, which lost more than 2%.

Around our financial planning firm this morning, we were discussing four items that we thought would be of particular interest to our readers:

  1. Budget season is proceeding smoothly for the states. Texas, Connecticut and Florida became the most recent states to pass new budgets.  Budget gaps have been closed primarily through spending cuts, although Connecticut chose to include a significant tax hike.  Twelve states have now passed new budgets for the upcoming fiscal year (which starts July 1st for most states) and California remains the only major state that has yet to pass a budget.
  2. And speaking of the states and their financials, municipal outperformance extended last week. Municipal bond prices increased last week despite an unchanged Treasury market.  A low supply environment and overall bond market strength have been the two main drivers.  Credit fundamentals continue to improve as well.  S&P upgraded three states (Nebraska, Wyoming and Louisiana), two of which were moved to AAA, and also revised Tennessee’s AA+ to “positive outlook.”  California reported that revenues are running $2.5 billion ahead of expectations on a year-to-date basis.  In addition, the MCDX, the municipal credit default swap (CDS) index, which allows institutional municipal investors to hedge against broad-based municipal default risks, is at its narrowest spread level since October of 2009, suggesting fading credit quality fears.House
  3. Housing in the United States continues to struggle. Despite some fundamental positives for the housing market, it is essentially still haunted by an oversupply of unsold existing homes, which is keeping a lid on both prices and new home construction.  Both housing starts and building permits (a component of the index of leading economic indicators) plunged in April.  The message here is that other than a scattering of “fill-in” housing construction across the nation, there is no economic reason to build a new home given the oversupply of existing homes for sale.  The market will get news on existing home sales (and inventories of unsold home) for April on Thursday.
  4. Corporate bonds remain resilient. Stock and commodity volatility has done little to impact corporate bonds, both investment-grade and high-yield.  Valuations have been very stable, with only minor weakness in investment-grade corporate bonds.  A strong earnings season continues to support corporate debt, and high-yield bonds benefited from another decline in the default rate to 2.3% at the end of April from 2.6% in March.  Moody’s continues to forecast a 1.5% year-end default rate.

As always, email me here with your questions or comments.  I love to hear from you and thoroughly enjoy the “intellectual debate” with our clients and friends that these opinions generate.

Greg Powell, CIMA
Wealth Consultant

Note: The opinions voiced in this material are for general information and are not intended to be specific advice. Any indices such as the S & P 500 can’t be invested into directly. Past performance is no assurance of a future result.

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