Insight | October 2, 2023
Muzinich Weekly Market Comment - October 2nd 2023
Weekly Update: Fair Value
As September came to a close, it occurred to us that history may conclude that 2023 has mostly just reinforced September’s reputation as a fairly miserable month for total return investors. Ever optimistic, we note that the S&P 500 closed down -9.34% in 2022 and is likely to drawdown only half that much this September. Meanwhile, European high yield has a chance to break through the seasonal negative energy and eke out a small positive total return—breaking a negative run of four years in a row which was capped by last year’s heavy drawdown of -3.99%1. Other outliers for the month include oil, generating close to a +10% total return for the month. The catalyst for rising oil prices last week was US crude oil inventories, which fell -4.1% for the week; lower inventory levels have only occurred twice over the last 10-years. At the other end of the spectrum, the long ends of government bond curves aggressively steepened over the month; 30-year yields in both the US and Germany rose by 30 basis points (bps), which was 25bps more than their respective 2-year yields. The US 30-year locked in a monthly loss greater than -13%2.
In the US, rising yields have been attributed to the central bank’s “higher for longer” stance, the no-hard-landing economic outlook, rising federal deficits, fading conviction that the inflation target can be achieved, quantitative tightening, Japanese and Chinese economic policy, and the cost of the negative carry from curve inversion positioning. However, this doesn’t answer the question on everyone’s lips: are government yields finally cheap?
Taking the US 10-year yield as our reference point, the simplest approach might be to examine the long-term average yield. Using data from 1790, the average yield is 4.5%3. A risk-reward approach would suggest that the 10-year yield must equal nominal growth—if the 10-year yield is greater than nominal growth, it might be advantageous to invest in 10-year bonds rather than in the economy, which would push the yield lower until equilibrium is reached. This relationship has worked well since the late 1960’s (see Chart of the Week). The average nominal growth over the last ten years has been 4.6%3. However, if we look forward and use the economic projections from the Federal Open Market Committee for 2024 and the long-term, the 10-year yield should be at 4.0% and heading towards 3.8% in the long-run4. Nevertheless, this approach assumes no risk premium for government stability and fiscal responsibility, something that is being questioned by investors as debt to GDP (Gross Domestic Product) approaches 100%, uncertainty surrounding the 2024 election mounts, and the US government came very close to a potential shutdown on October 1st. Unfortunately, factoring in this variability is not straightforward, but we would suggest adding an extra 50bps to yield, leaving the fair value for the US 10-year at 4.5%.
Chart of the Week: US 10-Year Yields
Source: Global Financial Data (GFD), Deutsche Bank, as of 26th September 2023. For illustrative purposes only.
1.The ICE BofA Euro High Yield Index (HE00) tracks the performance of EUR dominated below investment grade corporate debt publicly issued in the euro domestic or eurobond markets.
2.The ICE BofA 30 Year US Treasury Constant Maturity STRIPS Index (S030) tracks the performance of a single synthetic US Treasury STRIP purchased at the beginning of the month, held for one month, and then sold at the end of the month with the proceeds rolled into a new instrument.
3.Global Financial Data (GFD), Deutsche Bank, as of 26th September 2023
4.The Federal Open Market Committee (FOMC) Summary of Economic Projections, 20th September, 2023
Past performance is not a reliable indicator of current or future results.
Index performance is for illustrative purposes only. You cannot invest directly in the index.
The value of investments and the income from them may fall as well as rise and is not guaranteed. Investors may not get back the full amount invested.
This material is not intended to be relied upon as a forecast, research, or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed by Muzinich & Co. are as of 29th September 2023 and may change without notice. All data figures are from Bloomberg as of 29th September 2023, unless otherwise stated.
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