Tax-Exempt Strategies: Q3 2024
Opportunities in the Midst of a Painful Sell-Off
Since August 7, 2020, the 10-year US Treasury Yield has increased 1.9%, a staggering jump while bond price sensitivity was at all-time highs.
We recommend holding positions in short-term government debt like US Treasury Bills, whose rates are highly correlated to the Fed Funds rate.
The difference between US high-yield corporate rates and comparable Treasury benchmarks is 1.92% below its 10-year average, signaling that the market is comfortable with credit risk.
The global bond market has resumed its longest and deepest pullback in 40 years. Since August 7, 2020, the 10-year US Treasury Yield1 has increased 1.9%, a staggering jump at a time when bond price sensitivity was at all-time highs.
Over this time frame, the Bloomberg US Aggregate Bond Index2 was down 8.7% peak-to-trough before rallying modestly by 1.0% to end the quarter. The next largest pullback occurred in 1994 when the Federal Reserve surprised markets with unexpected rate hikes, not dissimilar to the abrupt, hawkish shift of the current Federal Open Market Committee.
Despite the damage done by rising rates, strong sell-offs are typically followed by strong recoveries, and yields on high grade bonds are the highest in nearly four years. On average, after bottoming, bonds3 rally 14.7% over the next 12 months and recover losses in just over 100 days.
Outperformance should continue in leveraged loans4 and collateralized loan obligations (CLOs)5, which benefit from very low interest rate exposure. These markets were defensive over Q1, falling just 0.10% and 0.20%, respectively. The biggest losses came from emerging market debt6, which fell between 9.0%-10.0% as the flight-to-quality resulting from the war in Ukraine caused an exodus from sovereign and corporate credit.
We continue to recommend asset classes with low interest rate sensitivity, primarily leveraged loans, CLOs and short-term US high yield corporate bonds. We also recommend holding positions in short-term government debt like US Treasury Bills, which have rates that are highly correlated to the Federal Funds rate. During Federal Reserve tightening cycles, these investments offer attractive yields with minimal market risk.
Our recommendation to tilt toward high-yield assets is underpinned by a strong credit environment. Dollar-weighted default rates7 have fallen to 0.21% in the US and remain low in Europe at 0.53%, a sign that contagion from geopolitical events remains contained. Further, the difference between US high-yield corporate rates8 and comparable Treasury benchmarks is 1.92% below its 20-year average, signaling that the market is comfortable with credit risk.
Important Disclosures
Important Information
Any opinions, projections, forecasts and forward-looking statements presented herein are valid as of the date of this document and are subject to change.
The information presented does not involve the rendering of personalized investment, financial, legal or tax advice. This presentation is not an offer to buy or sell, or a solicitation of any offer to buy or sell any of the securities mentioned herein.
Certain statements contained herein may constitute projections, forecasts and other forward-looking statements, which do not reflect actual results and are based primarily upon a hypothetical set of assumptions applied to certain historical financial information. Certain information has been provided by third-party sources and, although believed to be reliable, it has not been independently verified and its accuracy or completeness cannot be guaranteed.
Concentrating assets in a particular industry, sector of the economy, or markets may increase volatility because the investment will be more susceptible to the impact of market, economic, regulatory, and other factors affecting that industry or sector compared with a more broadly diversified asset allocation.
Private investments often engage in leveraging and other speculative investment practices that may increase the risk of investment loss, can be highly illiquid, are not required to provide periodic pricing or valuation information to investors, and may involve complex tax structures and delays in distributing important tax information.
Alternative investments are speculative, entail substantial risks, offer limited or no liquidity, and are not suitable for all investors. These investments have limited transparency to the funds’ investments and may involve leverage which magnifies both losses and gains, including the risk of loss of the entire investment. Alternative investments have varying and lengthy lockup provisions. Please see the Offering Memorandum for more complete information regarding the Fund’s investment objectives, risks, fees and other expenses.
Investments in below-investment-grade debt securities, which are usually called “high-yield” or “junk bonds,” are typically in weaker financial health and such securities can be harder to value and sell, and their prices can be more volatile than more highly rated securities. While these securities generally have higher rates of interest, they also involve greater risk of default than do securities of a higher-quality rating.
There are inherent risks with equity investing. These risks include, but are not limited to, stock market, manager or investment style. Stock markets tend to move in cycles, with periods of rising prices and periods of falling prices. Investing in international markets carries risks such as currency fluctuation, regulatory risks, and economic and political instability. Emerging markets involve heightened risks related to the same factors, as well as increased volatility, lower trading volume and less liquidity. Emerging markets can have greater custodial and operational risks and less developed legal and accounting systems than developed markets.
There are inherent risks with fixed-income investing. These risks may include interest rate, call, credit, market, inflation, government policy, liquidity or junk bond. When interest rates rise, bond prices fall. This risk is heightened with investments in longer-duration fixed-income securities and during periods when prevailing interest rates are low or negative. The yields and market values of municipal securities may be more affected by changes in tax rates and policies than similar income-bearing taxable securities. Certain investors’ incomes may be subject to the Federal Alternative Minimum Tax (AMT), and taxable gains are also possible. Investments in below-investment-grade debt securities, which are usually called “high yield” or “junk bonds,” are typically in weaker financial health and such securities can be harder to value and sell, and their prices can be more volatile than more highly rated securities. While these securities generally have higher rates of interest, they also involve greater risk of default than do securities of a higher-quality rating.
All investing is subject to risk, including the possible loss of the money you invest. As with any investment strategy, there is no guarantee that investment objectives will be met, and investors may lose money. Diversification does not ensure a profit or protect against a loss in a declining market. Past performance is no guarantee of future performance.
Indices are unmanaged, and one cannot invest directly in an index. Index returns do not reflect a deduction for fees or expenses.
Alternative investments are speculative, entail substantial risks, offer limited or no liquidity and are not suitable for all investors. These investments have limited transparency to the funds’ investments and may involve leverage which magnifies both losses and gains, including the risk of loss of the entire investment. Alternative investments have varying and lengthy lockup provisions.
This material is available to advisory and sub-advised clients, as well as financial professionals working with City National Rochdale, a registered investment advisor and a wholly-owned subsidiary of City National Bank. City National Bank provides investment management services through its sub-advisory relationship with City National Rochdale.
Index Definitions
S&P 500 Index: The S&P 500 Index, or Standard & Poor’s 500 Index, is a market-capitalization-weighted index of 500 leading publicly traded companies in the U.S. It is not an exact list of the top 500 U.S. companies by market cap because there are other criteria that the index includes.
CNR Proprietary Quality Ranking: City National Rochdale Proprietary Quality Ranking is the weighted average sum of securities held in the strategy versus the S&P 500 at the sector level using the below footnoted formula.
City National Rochdale Proprietary Quality Ranking formula: 40% Dupont Quality (return on equity adjusted by debt levels), 15% Earnings Stability (volatility of earnings), 15% Revenue Stability (volatility of revenue), 15% Cash Earnings Quality (cash flow vs. net income of company) 15% Balance Sheet Quality (fundamental strength of balance sheet). *Source: City National Rochdale proprietary ranking system utilizing MSCI and FactSet data. **Rank is a percentile ranking approach whereby 100 is the highest possible score and 1 is the lowest. The City National Rochdale Core compares the weighted average holdings of the strategy to the companies in the S&P 500 on a sector basis.
DuPont Quality: DuPont analysis is a framework for analyzing fundamental performance originally popularized by the DuPont Corporation, now widely used to compare the operational efficiency of two similar firms. DuPont analysis is a useful technique used to decompose the different drivers of return on equity (ROE).
Earnings Stability: Earnings stability is a measure of how consistently those earnings have been generated over time. Stable earnings growth typically occurs in industries where growth has a more predictable pattern.
Revenue Stability: Recurring revenue is the portion of a company’s revenue that is expected to continue in the future. Unlike one-off sales, these revenues are predictable, stable and can be counted on to occur at regular intervals going forward with a relatively high degree of certainty.
Cash Earnings Quality: Cash earnings are the residual profits after cash expenses are subtracted from cash revenues.
Balance Sheet Quality: A financial statement that reports a company’s assets, liabilities and shareholder's equity at a specific point in time, and provides a basis for computing rates of return and evaluating its capital structure.
Bloomberg Barclays US Aggregate Bond Index (LBUSTRUU): The Bloomberg Aggregate Bond Index or “the Agg” is a broad-based fixed-income index used by bond traders and the managers of mutual funds and exchange-traded funds (ETFs) as a benchmark to measure their relative performance.
GT2 Govt, GT3 Govt, GT5 Govt, GT10 Govt, GT30 Govt: US Government Treasury Yields
DXY Index: The U.S. dollar index (USDX) is a measure of the value of the U.S. dollar relative to the value of a basket of currencies of the majority of the U.S.’s most significant trading partners.
Dow Jones U.S. Select Dividend Index (DJDVP): The Dow Jones U.S. Select Dividend Index looks to target 100 dividend paying stocks screened for factors that include the dividend growth rate, the dividend payout ratio and the trading volume. The components are then weighted by the dividend yield.
P/E Ratio: The price-to-earnings ratio (P/E ratio) is the ratio for valuing a company that measures its current share price relative to its earnings per share (EPS).
The Commodity Research Bureau (CRB) Index acts as a representative indicator of today’s global commodity markets. It measures the aggregated price direction of various commodity sectors. The MSCI indexes are market cap-weighted indexes, which means stocks are weighted according to their market capitalization — calculated as stock price multiplied by the total number of shares outstanding.
Dividend Stock: A stock dividend is a dividend payment to shareholders that is made in shares instead of cash.
Quality Ranking: City National Rochdale Proprietary Quality Ranking is the weighted average sum of securities held in the strategy versus the S&P 500 at the sector level using the below footnoted formula.
City National Rochdale Proprietary Quality Ranking formula: 40% Dupont Quality (return on equity adjusted by debt levels), 15% Earnings Stability (v volatility of earnings), 15% Revenue Stability (volatility of revenue), 15% Cash Earnings Quality (cash flow vs. net income of company) 15% Balance Sheet Quality (fundamental strength of balance sheet).
*Source: City National Rochdale proprietary ranking system utilizing MSCI and FactSet data. **Rank is a percentile ranking approach whereby 100 is the highest possible score and 1 is the lowest. The Ci ty National Rochdale Core compares the weighted average holdings of the strategy to the companies in the S&P 500 on a sector basis. As of September 30, 2022.
Non-deposit investment Products are: • not FDIC insured • not Bank guaranteed • may lose value
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