Quarterly Fund Commentary
Barry M. Ogden, CFA , CPA
Market Sector Update
- Interest rates ended the second quarter much lower than they started, but in a roller coaster fashion. Crude oil was in the $40-$50/barrel range for most of the quarter, helping to alleviate some of the panic seen in the first quarter in the equity and credit markets.
- The Federal Open Market Committee (FOMC) took a pass at a rate hike in late April. In May, several Federal Reserve Bank Presidents made comments suggesting a June rate hike was possible. The bond market took notice and sent yields higher in anticipation of a forthcoming rate hike. Fed Chair Janet Yellen joined that chorus in late May, suggesting a rate hike would probably be appropriate in the coming months.
- Thoughts of a June hike were erased when the May employment report showed a weak growth of just 38,000 jobs in the non-farm payrolls report. While it has generally been felt that job growth should slow as the economy reaches full employment, the May report was so weak that no one was certain whether it showed the end result of a strong labor market or cracks in a weakening labor market.
- The FOMC declined to raise rates in June partly because of the weak non-farm payroll numbers and partly because the polls were showing a relatively close vote on the “Brexit” referendum regarding whether the United Kingdom would leave the European Union. The “leave” vote on June 23 caused a huge flight-to-quality in sovereign developed markets, sending U.S. Treasuries to their lowest yields of the year. The quarter ended with U.S. Treasury yields across the curve 14 to 32 bps lower than three months earlier.
- The portfolio’s duration was pretty close to that of the benchmark entering the quarter and we lengthened it slightly during the quarter. Investment-grade corporate bond issuance set an all-time record in May, at $190.2 billion. We have continued to buy bonds in the primary market, but have been very selective and often withdraw from deals if spreads narrow greatly. Corporations have been steadily increasing their leverage in this low interest rate environment but often are not finding productive, revenue-generating uses for the new cash, which puts added strain on their balance sheets.
- In early June, when the polling on the Brexit vote started looking like “leave” was a very possible outcome, we sold our dollar-denominated European bank debt, feeling the risk of owning it was too great. Given the outcome of the vote and spread widening in the sector, our decision to sell proved to be prudent.
- The slight barbell strategy begun in late 2014 remains in place, as we are slightly overweight the very front end of the curve, and have a small allocation to maturities beyond five years.
- We have been in a low interest rate environment for approximately eight years now. With no fiscal policy prescription in sight to help stimulate economic growth, the Federal Reserve has tried to do the economic heavy lifting with monetary policy. While some members of the FOMC would surely prefer to continue normalizing interest rates over the coming months and years, they will likely find this difficult, owing to factors such as negative interest rates in much of Europe and Japan, slowing in China, “Brexit” and our own possible domestic slowing.
- The final reading on first quarter gross domestic product (GDP) was 1.1%, and estimates for the second quarter are in the 2.5-3.0% range. Strong GDP growth would help give the FOMC the confidence that raising rates won’t destabilize the economy.
- There is no crystal ball and there is a tremendous amount of uncertainty in the world today. One thing that seems pretty certain is that if the FOMC is able to continue to engage in rate hikes, they will be very cautious and will not be hiking quickly. The Limited-Term Bond Fund should continue to do very well in this environment.
The opinions expressed in this commentary are those of the Fund's manager and are current through June 30, 2016. The manager's view is subject to change at any time based on market and other conditions, and no forecasts can be guaranteed.Past performance is not a guarantee of future results.
Risk factors. As with any fund, the value of the Fund's shares will change, and you could lose money on your investment. An investment in the Fund is not a bank deposit and is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Fixed income securities are subject to interest rate risk and, as such, the net asset value of the Fund may fall as interest rate rise. These and other risks are more fully described in the Fund's prospectus.
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