DoubleLine Q1 Letter
Overview
Record cold temperatures across a broad swath of the U.S. led to disappointing economic data to begin the first quarter of 2014. This posed another opportunity to question the ‘escape velocity’ of the recovery, particularly on the back of data showing Gross Domestic Product (GDP) growth during the second half of 2013 was the strongest such growth in a decade. The poor data spooked equity markets to the tune of a 3.5% fall in the S&P 500 Index on a total return basis, and 10?year U.S. Treasury (UST) yields fell 38 basis points (bps).
Since January, however, something of a sea change occurred, as most investors ascribed the poor data purely to weather related issues. With “tapering” of its Quantitative Easing (QE) program in full swing, investors subsequently began focusing on when the Federal Reserve (the Fed) would eventually raise rates. This sentiment was largely fueled by an un unemployment rate that was quickly approaching the Fed’s previously stated target of 6.5% (a target which has since been discarded), the belief that the budget agreement reached in December would reduce much of the fiscal drag seen in 2013, and inflation measures that were slowly inching higher into the end of 2013. Hawkish sentiment also was expressed in Fed Chair Janet Yellen’s first press conference after the Federal Open Market Committee (FOMC) meeting on March 19th. When asked to clarify the timing on plans to keep the federal funds rate near zero for a “considerable time”, Fed Chair Yellen replied that it “probably means […] around six months.” This was decidedly a shorter timeline than most market participants had anticipated. Subsequent comments from the Fed have attempted to walk back this hawkish view.
The pickup in intermediate rates offered a contrast to the growing commentary on ‘secular stagnation’,
continued elevated levels of the long?term unemployed, and levels of inflation that are historically quite low. Data from the eurozone suggested inflation of only 0.5% in the latest print, and more momentum seems to be gaining towards their own version of QE. For its own part, the most recent Core Personal Consumption Expenditures (PCE) data in the U.S. was only 1.1%, which is hardly consistent with a robust economy some five years into the recovery. If the rest of the year is anything like the first quarter, markets should continue to be reactive largely in anticipation of any movement from the Fed.
Emerging Markets Fixed Income
Markets continued to rebound from a late January selloff during March, as risk assets broadly moved higher. Credit markets were supported by relatively more robust economic data out of the U.S. and strong technical support as investors deployed cash that had been held on the sidelines, especially favoring Emerging Markets Fixed Income (EMFI). Though benchmark UST yields rose by 7 basis points (bps) to 2.72% this month, hard currency EM sovereign debt saw its spread compress by 23 bps. Other risk assets including equities and agricultural commodities such as corn and wheat rallied, while precious metals and copper sold off. For the quarter, EM bonds as represented by the JPM Emerging Markets Bond Index Global Diversified (EMBI), returned 3.73%, the bulk of which performance came in the month of February. EM sovereign bonds outperformed both EM corporates and local bonds in this period.
Abroad, the eurozone economy remained largely sluggish: the Consumer Price Index (CPI)¹, year?over? year (YoY) estimate for March was reported at 0.5%, slightly below expectations. Retail sales were reported as unexpectedly increasing month?over? month (MoM) for February. China, whose growth prospects have weighed on commodities and many emerging market economies linked to natural resources, announced YoY exports shrank by 18.1% in February, versus a 7.5% expected increase. The official Purchasing Managers Index (PMI)² for March showed only slight expansion in the manufacturing sector, while HSBC’s private PMI showed further contraction in the sector than February. Headlines continue around the frothy local debt market and the number of bad loans being written off: the five biggest quasi?sovereign banks wrote off $10.5 billion of nonperforming loans in 2013, 2.5 times the number of bad loans transferred off their books the year prior.
March was a volatile month in Europe, the Middle East, and Africa (EMEA): early in the month Russia occupied and ultimately annexed the Crimea province of Ukraine sending both nations’ debt and currencies plunging amid escalating geopolitical tensions and fear of heavy sanctions on Russia from the West. Though Russian troops remain amassed on Ukraine’s eastern border, outright war did not erupt and a stalemate appears to have emerged. Furthermore, sanctions from the U.S. were narrowly targeted to individuals and a bank tied to Russian President Putin’s administration. Markets reacted positively to the lack of a worst?case?scenario outcome, and both nations’ debt and currencies rallied into month?end.
