Financial asset prices continued trending higher on the back of the Federal Reserve’s plan to provide liquidity and free reserves to financial markets. As news became available of an agreement in principal between the U.S and China on Phase One of their trade deal, market participants displayed another rush of optimism. Certainly, as this year concludes the start of 2020 should produce a lot of market moving headlines. All 3 domestic indexes (Dow Jones, S&P 500 and NASDAQ) produced positive returns between 2-3%. Additionally, it should be noted that gold, for the first time in 3 months appreciated in value and the precious metal looks to continue their run higher in 2020.
We continue to think that over the next 6 months fixed income still represents a good asset class. We recognize that interest rates for the benchmark 10-year US Treasury continue to increase and are currently approaching 2%. This development will continue to put downside pressure on longer dated bonds. Separately, the OAS (option adjusted spread) of the S&P 500 Investment Grade Bond Index is sitting around 95 basis points. Without getting to technical, the OAS is an important metric because it is the spread between interest rates of the US Treasury (risk free rate) and another fixed income instrument, like a bond, over a similar time frame.
What we are comparing here is the difference in interest rates of the US Treasury and a basket of different investment grade bonds. If the spread is low, as it is now, that means that market participants have been willing to take on more risk for less reward. Simply put there is not much more room for interest rates to tighten. Therefore, we continue to have a focus on short-term and/or low duration bonds.
At this point you might be asking why we are bullish on fixed income investments if the two variables we just talked about are negative. Fundamentally, in the near term there seems to be very strong tailwinds at work. First, street inventory is at 12-month lows and projected to remain flat. Street inventory is the amount of bonds for sale in the secondary market. In the primary market, new issuance is projected to decline 5-10% in 2020 as businesses focus on cutting costs and managing their existing credit as debt levels at the corporate level are abnormally high.
In previous letters, we have discussed the growing demand for the new issuances of creditworthy borrowers. The demand is still very high and we believe this supply /demand imbalance will be beneficial in the short term time frame. For example, just three weeks ago, there was $10 Billion worth of demand for the non-Investment Grade bond in Twitter. The company’s debut bond was only $600 million in size and was issued under 4%. We do believe staying in higher quality names within the fixed income space still provides value as long as the duration is managed. With the last letter of the year, we wanted to discuss several topics regarding the upcoming tax season.
First of all, as with years past, we encourage you not to file your taxes in January or February as Fidelity will undoubtedly issue 1099s and some investment partnerships will issue K-1’s over the first few months of the new year and possibly into March. As witnessed in the past, the process of getting these notices out to us has been mixed at best. We share your frustration with tax season but suggest you exercise patience in filing in order to allow for any 1099 corrections.
Secondly, The House and Senate have passed legislation known as the Secure Act that will have ramifications on our soon-to-be or current retirees. Beginning next year, the required minimum distribution (RMD) age will be moved to 72 from 70 ½. We applaud this measure as it allows a little extra time for generating returns and eliminates the confusion dealing with half a year. Building on this, Congress is extending an individual’s ability to make IRA contributions to their 72nd year. The reality of today’s world is more people are working into their 70s than ever before, so we believe this measure to be long overdue. Finally, for folks with inherited IRA’s, Congress will now require beneficiaries of inherited IRA’s to take all distributions within 10 years of receiving the IRA. This compares poorly with the previous legislation where a beneficiary could stretch out distributions over their lifetime.
Please review the following updates from some of the existing positions that we manage:
SunTrust Bank Junior Subordinated (Trust Preferred)— (CUSIP: 89832Q778): SunTrust Bank completed their merger BB&T Bank on December 9th. The newly combined company is named Truist Financial Corporation. On the announcement of the closing of the merger, Moody’s and S&P upgraded the Issuer Credit Rating causing our position’s credit rating to move higher within the existing investment grade levels. The Issuer Credit Rating of Truist Financial was graded by Moody’s to be A3, while receiving an A- from S&P. We continue to like the position for existing holders.
Aspen Insurance Holdings Series C Preferred Stock— (Ticker: AHL-C): The property and casualty insurer continues to operate well post the Apollo Global merger. Shares of our preferred stock increased 3% since their most recent capital raise in early August. Our investment grade preferred stock was helped because Aspen’s August capital raise was another preferred stock that they were able to issue at 5.625%. This newly issued preferred coupon is lower than our coupon rate (5.95%) which caused a repricing upward for our preferred. Total return for the investment is around +20%.
The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon.
All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.
Graham Capital Wealth Management, LLC (“Graham”) is a registered investment advisor. Advisory services are only offered to clients or prospective clients where Graham and its representatives are properly licensed or exempt from licensure.