U.S. equities ended on a sour note on Friday with the Dow, Nasdaq, and S&P 500 registering declines of 2.5 percent, 3.1 percent, and 2.9 percent respectively. After staging a nice week long move to the upside, the risk trade once again came off the table as investors reassess the outlook for a sustainable economic recovery and the prospects for a double dip. While history suggests the odds of a double dip are negligible, the economic data in the past 4-6 weeks invariably points to a slowdown in the recovery. Most experts believe this slowdown naturally occurs after the early stages of a recovery and that sustainable growth will inevitably pick up. Unfortunately given how steep this recession was, investors remain jittery as to how robust the recovery actually is.
Concurrent with the sell-off in equities and risk trade unwind, U.S. treasuries once again caught a bid last week pushing the yield on the 10-year below 3.00% once again to 2.94%, while the 30-year yield declined below 4.00% to a 3.95%. In addition, the 2-year treasury yield declined to its lowest on record at .56% as the insatiable appetite for treasuries continues. In my opinion, the reality is setting in that deflation is clearly a concern, driving our yields lower. In fact, Friday’s Consumer Price Index month over month change was negative for the third consecutive month, a signal that prices are falling. Consequently, pay attention to Fed Chairman Bernanke’s semi-annual report card on monetary policy and the economy on Wednesday. He is expected to confirm the economy is recovering, albeit at a slower pace. In fact, some experts are speculating that the Fed might undergo another round of quantitative easing (purchasing treasury and mbs securities), to spur economic growth and inflate asset prices.
On the fixed income front, the story hasn’t changed. MBS prices continue to trade at new record highs on lack of supply and the aforementioned speculation that the Fed might step back in as a buyer. As it is extremely challenging to purchase mbs at current levels, we continue to have clients take gains. For those that need collateral, we favor one time callable agencies including one time call-one time step up structures as a defensive play. We also continue to like both tax-exempt and taxable munis across the curve given historically wide spreads to treasuries. Remember to focus on the cleanest credits as security selection in critical in the muni market.