Though the month of July was a mixed bag in terms of news, fixed income markets outperformed as spreads tightened across corporates, financials and sovereign bonds. On the negative front, worries about the recovery escalated as US GDP growth slowed and consumer confidence slipped as concerns over jobs and wages intensified. News on the housing front was also weak as U.S. homebuilders turned more pessimistic than expected and housing starts fell suggesting that the housing market will take longer to recover than expected. Ben Bernanke’s comments that the economic outlook remains “unusually uncertain” also reinforced the view of a slowdown in U.S. economic growth.
The market absorbed several broadly positive events prior to the publication of the stress tests for European banks on July 23:
- The Dodd-Frank financial reforms bill in the US was signed into law by President Obama
- Goldman settled with the SEC for less than expected with respect to charges of fraud
- BP finally made progress to stop the flow of oil from its leaking well in the Gulf of Mexico
In addition, banks also benefited from the news (post stress tests) that Europe’s Basel Committee on Banking Supervision will pursue softer rules than anticipated and will not fully phase them in until 2018. The important news in July, however, was the publication of stress test results for European banks, which sought to remove any doubts about the overall viability of the European banking system.
The bank stress tests in Europe were anticlimactic with only seven “fails” and were accompanied by better than expected transparency on sovereign exposures in the banking books as well as assumptions used in the stress tests. The improved sentiment across European banks and financials has led to a decrease in systemic risk, tighter sovereign spreads (higher relative prices) and lower borrowing costs across European securities. The increased transparency that came with the examination resulted in a fairly positive reaction in the credit markets as European bank solvency worries eased.
Many closed-end funds (CEFs) trade at premiums and thus seem expensive. A good number of commodity, low duration, investment grade, and mortgage CEFs have risen on both an absolute and relative scale in relation to their projected values. Their high dividend payments (yields) help maintain them at these seemingly stretched levels and may continue to prop them for a long time. None-the-less, investors remain in a cautious frame of mind and will be quick to recoil from risk at the slightest suggestion of financial trouble anywhere on the globe.
Michael Ashley Schulman, CFA
Hollencrest Capital Management