doubleline capital - december 2013 commentary
TRANSCRIPT
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8/13/2019 Doubleline Capital - December 2013 Commentary
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QuarterlyCommentary
December2013
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QuarterlyCommentary
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Overview
2013 was a pivotal year for fixed income markets,
endingwithanannouncementfromtheFederalOpen
MarketCommittee
(FOMC)
of
amuch
anticipated
cut
in its Quantitative Easing (QE) programs. One of the
topicsofconcernwastheplummetingunemployment
rateamidstafallingproportionofthepopulationwho
areeitherworking,orlookingforwork.
Also creating concern for central bankers were the
continually low levels of inflation. Both realized
measures of inflation, such as the Consumer Price
Index (CPI) and the Personal Consumption
Expenditures (PCE) Index, and anticipated future
levels of inflation by market participants, such as
forward breakeven rates on inflationindexed
securities, remain low. Ultimately, however, the
decision to contract purchases by $10 billion per
month ($5 billion each of U.S. Treasury (UST) and
AgencyMortgageBackedSecurities(MBS)purchases)
wasdeemedthemostprudentdirectionbythevoting
membersoftheFOMC.UpwardrevisionstoRealGDP
for the third quarter showing 4.1% growth received
after thedecision from theFOMC wouldserve to at
least partially substantiate this decision. Nonfarm
QuarterlyCommentary
payroll growth of only 74,000 in December th
lowestsuchgrowthsince2011suggestssomethin
tothe
contrary.
As
Janet
Yellen
takes
the
helm
of
th
Federal Reserve effective February 1, her ability t
navigate this still nascent recovery will be close
monitored.
Domestic equity markets closed the year wit
strength,justastheybegan.Aftergaining10%durin
thefirst
quarter
of
the
year,
the
final
quarter
of
201
saw nearly identical growth in the S&P 500 Inde
Following theopposite trend,domestic fixed incom
marketsasmeasuredby theBarclaysU.S.Aggregat
Bond Index nearly mirrored the 0.12% declin
experiencedduringthefirstquarteroftheyearwith
declineof0.14%duringthefourthquarter. Whileth
index finished the year down 2.0% (the first year
0
50
100
150
200
250
300
350
Jan13 Feb13 Mar13 Apr13 May13 Jun13 Jul13 Aug13 Sep13 Oct13 Nov13 Dec1
NetPayrollAdditions(000's)
NonfarmPrivatePayrollsNetChange
BLS ADP
Source:BureauofLabor Statistics, Bloomberg,ADP
LastBLS=74K
LastADP=238K
10.00%
8.00%
6.00%
4.00%
2.00%
0.00%
2.00%
4.00%
6.00%
8.00%QuarteroverQuarter(QoQ)RealGDPGrowthEstimates
Advance
Second
Third
Latest
Source:BureauofEconomicAnalysis, Bloomberg
Q32013Growth =4.1%
52.0%
54.0%
56.0%
58.0%
60.0%
62.0%
64.0%
66.0%
68.0%
1/1/1948
1/1/1951
1/1/1954
1/1/1957
1/1/1960
1/1/1963
1/1/1966
1/1/1969
1/1/1972
1/1/1975
1/1/1978
1/1/1981
1/1/1984
1/1/1987
1/1/1990
1/1/1993
1/1/1996
1/1/1999
1/1/2002
1/1/2005
1/1/2008
1/1/2011
U.S.LaborForceParticipationRate
Source:BureauofLaborStatistics, Bloomberg
12/31/2013:62.8%
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declinesince1999),mostofthemovementhappened
during the relatively sharp rise in benchmark rates
which spooked fixed income markets broadly during
thesecondquarter.TenyearUSTrates increased42
basispoints(bps)duringthequarter,andfinishedthe
month at 3.02%. The 10year rate at December
monthend is the highest such monthly close since
June2011.
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EmergingMarketsFixedIncome
In Emerging Markets Fixed Income (EMFI), all three
sectors of the markets; the external sovereign,
corporatedebt
and
local
currency
bonds,
represented
bytheJPMorganEmergingMarketBondIndexGlobal
Diversified (EMBI), the JP Morgan Corporate
Emerging Markets Bond Index Broad Diversified
(CEMBI)and the JPMorganGovernmentBond Index
Emerging Markets Broad Diversified (GBIEM)
respectively, posted mixed returns for the month of
Decemberandnegativereturnsfortheyear2013.
Developed markets saw uneven economic progress
over the course of 2013. The eurozone, which has
been mired in recession and stubbornly high
unemployment rates, in March 2013 saw the
European Union (EU) approve the bailout of yet
another member nation struggling with a banking
crisis,Cyprus.Thiswasthefirstinstanceofabailin
provision requiring uninsured depositors accounts
above 100,000 to partake in losses. The eurozone
continuedtostruggleduringthefirsthalfof2013:th
manufacturing sector contracted every mont
throughJune.
In
contrast,
the
latter
half
of
2013
sa
moderate expansion in the sector every mont
Servicerelatedindustrieswereclosebehind,withth
sector expanding every month from August onwar
TheEuropeanCentralBank(ECB)hasprovenkeent
combatdeflationarypressuresinthemonetaryunio
it made a surprise 25 bps cut to the benchma
refinancing rate in November and said it wou
support eurozonewide banks with as much liquidi
as necessary until mid2015. The ECBs hand ma
have been forced by October data showing inflatio
atjust 0.7% in October, well below the 2% level
targets.
Asia too, witnessed policymakers attempt to figh
deflationary pressures. China, where investors ha
feared weak growth could slow the global recover
posted
growth
that
was
the
slowest
since
the
Asiafinancial crisis of 19971998. This weak growth fe
throughtocommoditymarketsand ledmanyasset
such as precious metals, to post extremely wea
performance for 2013. Commoditylinked exporter
suchasAndeannationsinLatinAmerica(LatAm),sa
exceedingly weak exports on the back of China
cooling growth. Still, the new administration o
President Xi Jinping that took over in Marc
underlined
that
it
would
support
moderate
growtwhile also focusing on shrinking an excessive cred
bubble.Thegovernmentpublicallystateditwouldd
what was necessary to support 7.5% econom
growth in 2013, and this appears to be the like
target for 2014. The Chinese government has mad
clamping down on excessive lending, especially
propertymarkets,akeypolicyoutoffearofacred
QuarterlyCommentary
Tickers December
Return
4Q2013
Return
2013
Return
YTM Sp read
EMBI JPGCCOMP 0.51% 1.53% 5.25% 5.88% 308
CEMBI JBCDCOMP 0.17% 1.96% 0.60% 5.69% 311
GBIEM JGENBDUU 0.09% 0.73% 7.26% 6.79% N/A
Source:JPMorgan
(Pastperformanceisnoguaranteeoffutureresults.)
8.0%
6.0%
4.0%
2.0%
0.0%
2.0%
4.0%
6.0%
Dec12 Feb13 Apr13 Jun13 Aug13 Oct13 Dec13
JPMorganEmergingMarketsBondIndex
Performance12/31/2012through12/31/2013
EMBI
CEMBI
GBIEM
Source:JPMorgan
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bubble forming. Twice during the year, the central
bankallowedforovernightlendingratestoskyrocket
in order to illustrate to banks, especially smallto
medium
sized
ones,
that
it
was
serious
about
preempting a bubble. The new administration also
made battling widespread corruption one of its top
priorities. InJapan,PrimeMinisterShinzoAbebegan
to implement his socalled three arrow policies to
unlock growth: explicit 2% inflation targeting,use of
monetary QE (similar to the Fed), and widespread
publicandprivatesectoreconomicreforms.Investors
welcomed Abenomics, with the countrys equities
risingover
50%
and
the
yen
falling
approximately
17%
in2013.
In EMFI, the impact of tapering was felt across the
asset class, particularly amongst those countries
running twin deficits with weak growth prospects. A
number of countries, whose debt had otherwise
enjoyed strong performance in the lowrate
environment implemented by the Fed, now saw
waninginvestor
support
due
to
alack
of
meaningful
fiscalandeconomicreforms.CountriessuchasSouth
Africa, India, Indonesia, Ukraine, and Venezuela all
saw largespikes involatilitywithin foreignexchange
and debt markets, particularly over the summer as
investors braced for Septembers expected taper.
Venezuela, which had performed strongly in 2012
despite a lack of marketfriendly policies under its
populistPresidentHugoChavez,sawitsdebtmarkets
sharplyreversecoursein2013.Followingthedeathof
thecharismaticChavezinMarch,hisnarrowlyelected
successor Nicolas Maduro has pursued a hardline
policy stance, with widespread asset seizure and
command pricesetting. India struggled over the
summerwithmisstepsby itscentralbankanda lack
of clear communication of its policy to combat FX
volatility,thoughtheselectionofanewcentralbank
governordidhelpcalmmarketssomewhatintoyea
end. South Africa struggled for much of 2013 am
fallingcommoditypricesandwidespreadstrikesini
critical
revenue
driving
mining
sector,
while
PresideJacob Zuma saw support ebb from breakawa
factionsofhisparty.
Sociopolitical unrest proved to be a theme acro
manyemergingmarketeconomies in2013 touchin
to varying degrees: Egypt, South Africa, Braz
Venezuela, Turkey, Ukraine, and Thailand, amon
others. Public anger at the perceived conservativ
Islamisttilt
of
leaders
in
both
Egypt
and
Turkey
sa
largescalepublicprotestsandclasheswithpolicefo
much of the spring. The protests and widesprea
clashes in Egypt eventually brought down th
relatively new government of Mohammed Morsi a
the military intervened on the side of antiIslami
protestors and imposed martial law as it wound u
outlawing Morsis Muslim Brotherhood part
Sporadic violence between the military and Islami
protestors/fighterscontinues.
Turkeys
protests
wer
sparked by the planned bulldozing of a public par
butswelledwithsecular,middleclassfigurescomin
outinangeratperceivedauthoritariantendencieso
PrimeMinisterRecepErdogans Islamistrulingpart
Though dying down somewhat toward late 201
following violent crackdowns, protests reignited
Decemberamidamajorcorruptioninvestigationth
continuestosweepthroughErdogansgovernment.
NotallEMmarketswitnessedturmoilin2013:Mexic
saw a series of major reforms tied to its revenu
criticalstateoilmonopolypassinto law,asPresiden
Enrique Pea Nieto seeks to boost flagging growt
whileColombia,wrackedbydecadesofcivilwar,sa
crucialprogressmadeinpeacetalksbetweenMarxi
rebelsandthegovernment inNovember,whichma
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pavethewayforthemainrebelgrouptolaydownits
armsandinsteadenterpolitics.
In
conjunction
with
the
selloff
in
EMFI
markets
following the first news of tapering in May was the
pace of outflows from both hard and local currency
funds totaling $39.8 billion from June to December.
For the calendar year, the emerging market debt
funds saw a net inflow of $10.3 billion, down
significantly from inflows of $97.5 billion in 2012.
Retail flows were particularly susceptible to taper
related headlines, such as strong economic data
releasesincluding
non
farm
payrolls.
Looking
forward
to2014,webelievethatmanyoftheseshorterterm
investors may have been flushed out of the asset
class, leaving stronger, longterm strategic buyers.
Strategic inflows from pension funds, insurance
companies, endowments, etc. totaled $26 billion in
2013, inline with prior years. Many crossover
investors, for whom emerging markets are not a
specialty,hadexposuretoonlythemostwellknown,
liquid
names:
when
outflows
spiked
from
May
through yearend, sovereign and local bond funds
sawcombinedoutflowsof$37billion,versusjust$1.7
billion leaving corporate debt since the end of May.
Furthermore, we feel that the selloff for much of
2013 left many fundamentally sound corporate
credits trading at attractive levels simply due to the
excessivefearoftaperingandratesrapidlyrising.
Weexpectdebtissuance,whichhadpickedupinthe
fourthquarter2013after trailingoff in thesummer,
tocontinueatleastthroughthefirstquarter2014,as
thereremainsasolidpipelineofnewissuancewaiting
tocometothemarket.
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GlobalDevelopedCredit
Although total returns for corporate credit in 2013
failed to match the spectacular results posted in
2012,
the
year
logged
respectable
performance
despite a meaningful rise in UST rates. The total
returnoftheBarclaysU.S.CreditIndexwas2.01%in
2013,farshortofthetotalreturnof9.39%postedin
2012. However, investment grade corporate bonds
posted an excess return over UST of 2.26% for the
year. Investment grade corporate bond spreads
tightened by 20 bps during 2013 led by financial
institutionswhichtightenedby46bps. TheBarclays
U.S. Corporate High Yield Index returned 7.44% in
2013,lessthanhalfofthe15.81%theIndexgainedin
2012. Excess returnspostedbyhighyieldcorporate
bonds came in at 9.23% for 2013. High yield bond
spreads tightenedby129bpsduring theyear ledby
industrialswhichtightenedby137bps. TheBarclays
U.S. High Yield Loan Index returned 5.39% in 2013
withtheassetclasscontinuingtoenjoystrong levels
of
demand
from
investors.
Gross
fixed
rate
investment grade supply in 2013 of $1.106 trillion
essentiallymatchedthe$1.086trillionissuedin2012.
The primary high yield market priced $325 billion in
2013, slightly lower than the $345 billion priced in
2012whichstillholdstherecordforannualhighyield
issuance.
Within the investment grade universe during 201
the greatest excess returns were posted by Gamin
(+6.94%); Airlines (+6.28%); Supermarkets (+6.01%
Life Insurance (+5.76%); and Building Materia
(+5.55%). Theworstperformingsectorsonarelativ
basis were Media/Cable (+17 bps); Foreign Agencie
(+19 bps); Wireless Telecommunications (+40 bps
Supranationals (+43 bps); and Metals (+50 bps
Higher
quality
issues
(those
bonds
rated
single
A
obetter) materially underperformed their lower rate
counterparts given the continued predilection o
investors to trade down the risk curve to reach fo
yield. The topperforminghighyieldsectors in201
were Consumer Products (+10.35%); Technolog
(+10.22%); Building Materials (+8.74%); Pape
(+8.05%); and Gaming (+7.37%). The wor
performing sectors of 2013 were Pipelines (+2.12%
Media/Cable(+3.58%);
Wireless
Telecommunication
(+6.04%); Retailers (+7.55%); and NonCaptiv
Finance (+9.08%). As was the case with investme
grade corporate credit, lower quality bond
outperformed their higher rated counterparts wit
Caarated credits returning 13.82% in 2013 versus
returnof7.27%forBratedcreditsand5.05%forB
QuarterlyCommentary
4.0%
3.0%
2.0%
1.0%
0.0%
1.0%
2.0%
3.0%
Jan
13
Feb
13
M
ar13
Apr13
M
ay13
Jun
13
Jul13
A
ug
13
S
ep
13
Oct
13
N
ov
13
D
ec
13
PerformanceofSelectBarclaysIndices
12/31/2012through12/31/2013
U.S.HighYield
U.S.Credit
U.S.Aggregate
Source:Barclays Live
0
20
40
60
80
100
120
140
160
180
BillionsofU.S.
Dollar
s
TotalFixedRateInvestmentGradeSupply
Source:BarclaysLive
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ratedcredits.
Overall, default activity in 2013 was benign as both
default volume and the high yield default rate
reached
sixyear
lows.
According
to
JP
Morgan,
in
201329companiesdefaultedcomprising$18.9billion
in bonds and institutional loans. In comparison, 36
companies and $22.6 billion defaulted during 2012.
Notably, bond defaults were almost twice as
prevalentas loandefaults in2013with16bondonly
defaults versus only 9 loanonly defaults and 4
defaults in which the company had both bonds and
loansoutstanding.
Withrespecttofundflowsandinvestordemand,high
yield mutual funds experienced a net outflow of
assetsof$5.6billion in2013while loan fund inflows
totaled$62.9billionfortheyear.
Aswemovetoward2014,it islikelythemarketswill
experience continued interest rate volatility with
movements in the Treasury curve reflecting both
underlyingeconomicfundamentalsaswellasfurther
expectations
for
Fed
tapering
of
the
QE
program.
Corporate credit spreads should continue to tighten
in line with fundamental economic improvement.
However, spread movements for corporate credit
could be a bumpy ride in 2014 as well with more
spreadvolatilitythanthatwitnessedin2013ascredit
investors balance what have become the competing
forcesoffundamentalconditionsintheU.S.economy
with the challenges faced by the Fed in
communicatingfurther
tapering
actions.
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further
although
we
believe
the
majority
of
thextensionhasalreadyoccurred. Ifratesweretoris
significantly, we would project the MBS duration t
extendabove6,butnotmuchmorethanthat. Ifth
scenario were to play out over the next 12 month
the MBS sector could outperform the TS
sector. How it performs relative to the Corporat
sector willdepend in largepart on whathappens t
U.S.InvestmentGradeCorporatespreadsduringth
timeperiod.
One of the major reasons why MBS experienc
duration extension during rising rate periods is th
expectation of decreasing prepayment speeds on
going forward basis. Prepayment speeds went u
marginally for the month of December. This sligh
increaseinspeedsbrokethestringofsixconsecutiv
decliningmonthsofprepaymentspeeds. Prepaymen
AgencyMortgageBackedSecurities
AgencyMBShadareturnof0.47%forthemonthof
December 2013, according to the Barclays U.S. MBS
Index.For
December,
10
year
UST
rates
rose
by
23
bps, and the MBS sector outperformed the U.S.
Treasury (TSY) sector but underperformed the U.S.
Investment Grade Corporate sector according to the
BarclaysU.S.AggregateBondIndex. Forthecalendar
year2013,10yearUSTratesroseby125bpsandthe
Barclays U.S. MBS Index had a return of 1.41% for
sameperiod.This12monthperformancewasbetter
thantheperformancesofboththeU.S.TSYandU.S.
InvestmentGradeCorporatesectorsaccordingtothe
Barclays U.S. Aggregate Bond Index. This is an
example of mortgages outperforming the other
components of the Indexwhen rates risemore than
100bps.
One of the major reasons for mortgage
outperformance in rising rate environments has
historically
been
due
to
the
shorter
duration
of
the
MBSsectorrelativetothoseoftheTSYandCorporate
sectors, according to the Barclays U.S. Aggregate
Bond Index.During therateriseof2013,durationof
Agency MBS extended from 3.18 years at the
beginningoftheyearto5.66yearsattheendofthe
year. This is the longest duration ever reported for
the sector. Should rates rise further, we would
expect the duration of the MBS sector to extend
QuarterlyCommentary
ConditionalPrepaymentRates(CPR)
2013 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
FannieMae(FNMA) 27.8 24.4 24.4 24.0 25.1 22.7 20.5 16.2 12.2 11.5 10.4 10.6
FreddieMac(FHLMC) 28.2 26.0 25.9 25.3 25.5 23.4 21.5 17.1 13.1 12.0 10.8 11.1
GinnieMae(GNMA) 23.3 21.9 21.8 23.0 22.2 19.4 18.2 14.9 12.2 12.1 11.2 11.2
BarclaysCapitalU.S.
MBSIndex 10/31/2013 11/29/2013 12/31/2013 Change
AverageDollarPrice 104.60 103.68 102.91 0.77
Duration 5.26 5.56 5.62 0.06
BarclaysCapitalU.S.
IndexReturns 10/31/2013 11/29/2013 12/31/2013
U.S.Aggregate 0.81% 0.37% 0.57%
U.S.MBS 0.68% 0.62% 0.47%
U.S.Corporate 1.44% 0.27% 0.25%
U.S.Treasury 0.48% 0.33% 0.91%
source:eMBS,BarclaysCapital
0.00
1,000.00
2,000.00
3,000.00
4,000.00
5,000.00
6,000.00
7,000.00
12/31/10
2/28/11
4/30/11
6/30/11
8/31/11
10/31/11
12/31/11
2/29/12
4/30/12
6/30/12
8/31/12
10/31/12
12/31/12
2/28/13
4/30/13
6/30/13
8/31/13
10/31/13
MortgageBankersAssociationRefinanceIndex
Source:MortgageBankersAssociationviaBloomberg
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would mean no more QE program 12months fro
now. Assumingthisscenarioplaysout,wewouldno
expect any widening of MBS. As in most market
MBS
performance
will
depend
on
both
the
supply
andemand for securities. Currently, the Fed is th
biggest player on the demand side and therefore i
actions are very important; however, there a
changes on the supply side of mortgages that hav
experienced even greater change than the Fe
tapering. Lastsummer,grossissuanceofAgencyMB
was approximately $150 billion per month. As rate
have risen, this number has come dow
significantly.
In
fact,
Decembers
number
was
$7billion,sothegross issuanceofAgencyMBS isdow
approximately $75 billion permonth from where
waslastsummer.
speedsdecreasedby60%over2013andAgencyMBS
experienced their slowest speeds since December
2008, which was in the middle of the subprime
housing
crisis.
We
are
already
in
an
environment
whereprepaymentspeedsareata5yearlow.
Future prepayment speeds will depend partly on
what happens to interest rates. A secondary factor
couldbeachangeinthegovernmentsinvolvementin
the mortgage process. Currently, the Home
Affordable Refinance Program (HARP) 2.0 is the
government program with one of the largest affects
on
prepayment
speeds.
HARP
2.0
is
experiencing
burnout,whichiswhathappensastimepassesand
the borrowers who qualify have already acted,
thereforeleavingfewereligibleborrowersthanthere
wereinthepast.Themortgagemarketisdealingwith
theconfirmationofMelWattas thenewdirectorof
Federal Housing Finance Agency (FHFA) as well,
replacing Ed DeMarco.The markets perception is
thatWattmaybemorefriendlytowardsborrowers
thanDeMarco,
which
could
lead
to
policy
decisions
thatcouldincreasetheprepaymentspeedsofcertain
mortgagesecurities.Thusfar,Watthasindicatedthat
he will postpone the previously announced increase
in fees across both Fannie Mae and Freddie Mac.
Watt officially takes the position on January 6,2014
and many investment professionals are closely
watching the decisions made by Watt and their
ramificationsonthefixedincomemarkets.
OnDecember18th,theFedannouncedthetaperingof
$10billionpermonthwithhalfofthetaperingbeing
inMBS.ThistakesthetotalamountofFedpurchases
to $75 billion per month, with $35 billion of that in
MBS (this doesnt include the reinvesting in MBS of
paydownsonoutstandingMBS,whichcanbeasmuch
as$1520billionpermonth). TheMBSmarketseems
tohavepricedina12monthtaperingprocesswhich
QuarterlyCommentary
3.00
3.50
4.00
4.50
5.00
5.50
12/31/10
1/31/11
2/28/11
3/31/11
4/30/11
5/31/11
6/30/11
7/31/11
8/31/11
9/30/11
10/31/11
11/30/11
12/31/11
1/31/12
2/29/12
3/31/12
4/30/12
5/31/12
6/30/12
7/31/12
8/31/12
9/30/12
10/31/12
11/30/12
12/31/12
1/31/13
2/28/13
3/31/13
4/30/13
5/31/13
6/30/13
7/31/13
8/31/13
9/30/13
10/31/13
1 1 / 3 0 / 1 3
FreddieMacCommitment Rate30 Year
Source:Bloomberg
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debated throughout 2013. News of the recor
settlementbyJPMorgandominatedthemarketplac
Ocwen, the largest nonbank servicer, is the late
entity making the headlines in regards to mortgag
litigation. Ocwen will provide $2.1 billion o
foreclosure compensation and principal modificatio
forhomeownerswhoarebehindon theirpayment
The settlement is based on regulator claims th
Ocwen abused its handling of borrowers loans. W
willcontinuetomonitortheseeventsclosely.
NonAgencyMortgageBackedSecurities
Decembertradingvolumeexperiencedanuptickdue
to the liquidation of a large segment of INGs
portfolio
late
in
the
month.
The
ING
list
consisted
largely of payoption AdjustableRate Mortgage
(ARM)bondsandthus,thissectorofthemarketsaw
an almost threefold increase from November.
Despite thesize of the list and time in the year, the
list traded very well with bids coming from banks,
investment managers, hedge funds and insurance
companies.
Fundamentally, December remittance reports
showed mixed results. Prepay speeds on prime
collateral increased0.5ConditionalPrepaymentRate
(CPR) while AltA and subprime speeds decreased a
modest 0.5 CPR and 0.4 CPR, respectively. Rising
interest rates have been pressuring the fast prepay
speedsseenduringmuchofthesecondhalfof2013.
Liquidationsslowedforallsectorswiththeexception
of
subprime.
Average
Conditional
Default
Rates
(CDRs)decreasedby0.4forprimeand0.9CDRforAlt
A collateral while subprime, on average, saw
liquidations increase by 0.2 CDR. Loan modifications
slowed going into 2013 yearend with 1,947 loans
modified in December; 56% of all modified loans
were rate modifications, with the average mortgage
ratebeingreducedbyapproximately4%.Withsupply
still relatively low, technicals continued to put
pressure
on
yields
and
we
saw
a
slight
tightening
across all sectors. Prime finished the year trading
between 44.25%, AltA between 4.54.75%, and
subprimebetween55.5%.
On the political front, there was some concern on
whatchangeswouldbeimplementedwhenMelWatt
takesovertheDirectorshipoftheFHFA.Settlements
between mortgage issuers and investors were hotly
QuarterlyCommentary
30
35
40
45
50
55
60
65
70
75
80
6/30
/11
8/31
/11
10/31
/11
12/31
/11
2/29
/12
4/30
/12
6/30
/12
8/31
/12
10/31
/12
12/31
/12
2/28
/13
4/30
/13
6/30
/13
8/31
/13
10/31
/13
/
/
ABXPrices
ABX20062AAA
ABX20071AAA
Source:MarkItviaMorganStanley
86
89
92
95
98
101
104
107
110
113
6/30/11
8/31/11
10/31/11
12/31/11
2/29/12
4/30/12
6/30/12
8/31/12
10/31/12
12/31/12
2/28/13
4/30/13
6/30/13
8/31/13
10/31/13
PrimeXPrices
PrimeXFRM.1
PrimeXFRM.2
Source:MarkItviaMorgan Stanley
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QuarterlyCommentary
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Our investment focus for the sector continues t
emphasize security selection. We continue to focu
onshorter
duration
assets,
including
securities
with
more storied basis, as our ability to drill down t
the collateral and borrower allows us to adequate
assess risk. Looking forward, our outlook for th
sector continues to remain cautious give
uncertaintiesinthemacroenvironment.
CommercialMortgageBackedSecurities
Newissuanceactivitykeptinvestorsbusythroughout
themonth of December, finishing the year with $79
billionin
total
issuance,
the
highest
since
2008.
Of
the
total, $52 billion were from conduits, representing
less than half of the 20052007 conduit issuance
average. Overall, the market sentiment remains
cautiously optimistic as investors generally added to
positions lower down the capital stack now that the
Fed has brought some clarity to concerns with the
taper. Webelieve thatsomeof thebroader themes
for 2014 are the improvement in Commercial Real
Estate(CRE)fundamentals,increaseinCMBSissuance
in 2014 and concerns with the continued
deteriorationofnewissuecreditqualityduetolooser
lendingstandards. ForDecember,spreadsralliedinto
yearend with legacy AAA and junior AAA CMBS
spreads tightening versus November. In the new
issuemarket,AAAspreadsendedthemonth45bps
tighterwhileBBBspreadsimprovedby1012bps. For
the
month,
the
CMBS
portion
of
the
Barclays
U.S.
AggregateBond Indexreturned 0.29% inDecember,
+0.53%forthefourthquarterandfinished+0.23%for
theyear.
The delinquency rate continued its decline in
December ending the month at 7.43% (23 bps). By
property type, the 30+ day delinquency rate for
multifamilydeclinedto10.86%(28bps),industrialto
10.46%(+2bps),officeto8.13%(33bps),lodgingto
7.91%(+19
bps),
and
retail
to
6.06%
(26bp).
During
themonthofDecember,93loanstotaling$1.3billion
weredisposedof,resultinginanaveragelossseverity
of 50.4%. We anticipate the delinquency rate to
declinefurtherin2014withthependingresolutionof
CW Capital liquidation of $2.5 billion of defaulted
loans, fewer expected delinquencies and higher
resolutionrates.
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TheBarclaysCapitalU.S.GovernmentIndexreturne
2.60%fortheyear. Itwasthefirstfullcalendaryea
negativereturn
since
2009.
The
2013
return
include
areturnof 0.69%forthefourthquarterand 0.87
forDecember.Thefullyearyieldrisewassharpestfo
intermediatematurities,with the7yearand10yea
points on the yield curve posting matching 127 bp
rises,followedby102bpsrisesforthe5yearand3
year maturities. Returns were more negative fo
longer maturities. For the full year the 2year not
return was +0.30%, worsening to 2.47% for the
year note, 7.81% for the10yearnote,and 15.03
forthe30yearnote.
TheTreasurymarketselloffgarneredthelionssha
ofinvestorsattentionin2013,butsomeotherfixed
incomesectorsespeciallythosewithlessliquidityo
longer duration suffered even larger losse
Treasury InflationProtected Securities (TIP
substantially
underperformed
conventionTreasuries through 2013, burdened by both lon
durationandpoorliquidity,pluslowrealizedinflatio
and falling inflation expectations. The Barclays U.
TIPS Index returned 8.61% for the year. Ta
exempt bonds fared better, boosted by improvin
creditfundamentalsandastrongperformanceinth
fourth quarter. The Barclays Municipal Bond Inde
returned 2.55% for the year, including a +0.32
returnfor
the
fourth
quarter.
The powerful fixedincome liquidation cycle th
began in early May 2013 brought most investo
positions into line with postQE Fed policy an
sustained economic growth. We expect the bon
marketwillfindbuyinginterestfromsometradition
investorgroups,suchaspensionfundsandinsuranc
U.S.GovernmentSecurities
TheUSTmarketfinishedatumultuousyearonaweak
note, as the 10year Treasury note yield rose from
late
October
through
November
and
December
to
finishtheyearatitshighclosingyieldof3.03%.
Asforayearinreview,theyearbeganquietlyasthe
10year yield started 2013 at 1.76%, only modestly
abovethealltime lowyieldset inJuly2012. Aftera
smallselloffthemarketralliedto1.63%onMay1st.
May 3rd proved to be a turning point, with the UST
market selling off on a strongerthanexpected
employment report. Market sentiment shifted
dramaticallyas a broad rangeof investors sought to
liquidate longheld positions and shed duration. The
changed psychology was reinforced in late May by
Fed Chairman Bernanke, who discussed for the first
time a timetable for winding down and ending the
Feds asset purchase program. In early September
the 10year note yield had risen to 2.99%. By then,
investors seemed more comfortable with their fixed
incomeexposure.TheFedhelpedcalmbearishfears
bynoting
that
financial
conditions
had
tightened
due
totheselloffandbyemphasizingthatahikeinshort
termrateswouldnotinevitablyfollowontheheelsof
the end of the asset purchase program. Weak
economic data, resolution of the federal
governmentsfiscalcrisisandanunexpecteddelayin
the onset of the Feds taper all contributed to a
rally through September and October, but that rally
couldretraceonly50bpsoftheearlier140bps sell
offbefore
reversing.
QuarterlyCommentary
11/29/2013 12/31/2013 Change
3month 0.06 0.07 0.01
6month 0.10 0.09 0.01
1year 0.12 0.11 0.01
2year 0.28 0.38 0.10
3year 0.55 0.77 0.22
5year 1.37 1.74 0.37
10year 2.75 3.03 0.28
30year 3.81 3.97 0.16
Source:Bloomberg
YieldCurve
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QuarterlyCommentary
12/31/
companies, at 10year Treasury yields above 3.00%.
Higher yields could limit domestic economic growth.
While yields may rise modestly in 2014 we do not
expectarepeatof2013.
QuarterlyCommentary
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QuarterlyCommentary
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12.3%, respectively.The quarter was quite volati
for precious metals prices as the market initial
ralliedduring
the
U.S.
debt
ceiling
crisis,
followed
by
downward trend in the last two months of th
quarter. Chairman Bernanke announced the Fed
assetpurchaseprogramwouldbeginagradualdat
dependenttaper, leadingtoasharpselloff.Investo
continue to waiver between inflationary fears v
unintended consequences of the multitrillion dolla
balance sheets of central banks and potential re
yieldprospectsofinvestmentsinbonds. Ifrealyield
on other financial assets remain elevated and leve
of inflationremainnearalltime lows,goldandsilve
pricescouldhaveanotherbearishyearin2014.
For2013,theenergycomplexwasupover5%,drive
by increased demand and global tension. Quarter
energy prices were mixed with the SPGSCI Energ
Index returning 1.3%, refined products, natural ga
and
Brent
crude
posting
positive
returns,
and
Wcrude returning 4.4%.Increasing nonOPEC crud
production may continue to degrade the cartel
ability to control global oil supply. Over the last fe
years, new U.S. extraction technologies have led t
historically high production growth with mo
potential for 2014; this may lead to an increase
divergence in the price of WTI crude versus Bren
crude. The U.S. currently imports roughly 500,00
barrelsper
day
while
domestic
supply
is
forecast
t
increase over 1 million barrels per day in 201
Coupledwiththecurrentexportban,theU.S.mark
could see falling prices in 2014. Natural gas return
were positive on the quarter returning 12.5% o
strongerseasonaldemandforthewinterthusfar,th
strongperformanceallowednaturalgastogenerate
positive9.1%returnin2013.
Commodities
The Standard and Poors (S&P) Goldman Sachs
Commodity Excess Return Index (SPGSCI ER) ended
the
fourth
quarter
down
0.34%.
For
the
year,
the
Index suffered a small loss of 1.3%, though these
numbers do not tell the entire story. Of the five
sectors represented by the SPGSCI, only the energy
sector had positive returns for both the fourth
quarterand2013. Inflationaryfearswanedasyear
overyear(YoY)U.S.CPIhoverednear1%,alevelnot
seen since mid2010. This was exacerbated in the
fourthquarterby the Feds decision to implement a
gradual tapering of its large scale asset purchase
program, known as quantitative easing (QE). In the
developed world, preliminary forecasts showed that
Europewasfinallyekingfromthedepthsofrecession,
and the U.S. economy appeared to be gaining
momentum albeit at a slow rate. Unfortunately,
major commodity consumers such as China, Brazil
and Indiacontinue togrowatpacesslowerthan the
previous
decade,
which
could
put
a
damper
on
demandgrowthin2014.
Preciousmetalssufferedin2013returning29.8%for
the year. It was the first calendar year that gold
sufferedanegativereturnsince2000.Theweakness
continued throughout yearend with both gold and
silver giving back all of the positive returns they
reapedfrom
the
third
quarter
losing
9.5%
and
QuarterlyCommentary
0.34%
1.26%
9.67%
0.37%1.31%
6.71%
12.00%
10.00%
8.00%
6.00%
4.00%
2.00%
0.00%
2.00%
S&PGSCIE R E ner gy Pr ec ious
Metals
Industrials Livestock Agriculture
QuarterlyExcessReturnsofGSCSICommoditySectors
September30,2013 December31,2013
Source:Bloomberg, DoubleLine
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stronger U.S. housing market and ameliorate
concernsregardingEMgrowth.
The
Livestock
sector
saw
a
modest
loss
of
1.3%
in
thfourthquarter.Withinthesector,hogsweretheon
loserforthequartergivingback5.8%duetothelo
impactofthethirdquartersporcinevirusoutbreak
the U.S. Fears of a supply shock due to pigle
mortality and quarantine conditions failed t
materialize leaving supply relatively unaffected. Th
spread between the performance of Live Cattle an
Feeder Cattle narrowed to 65 bps on the quarte
with
both
gaining
in
priceby
73
bps
and
138
bp
respectively. Ontheyearlivestocklost3.7%in201
goingforwardwatchforincreasedmeatconsumptio
from emerging markets that could drive deman
higherin2014.
The agricultural sector ended 2013 with a 6.7
return inthefourthquarter,cappingoffaweakyea
where18.1%was lost.Corncontinued itsslidedow
morethan
6.9%
in
the
fourth
quarter
on
increasin
inventory levels, stemming from larger acreage an
higher potential crop yields. Further weakne
stemmed from the Environmental Protectio
Agencys (EPAs) decision to reduce the ethan
mandate landing a particularly hard blow to cor
based suppliers contributing to a 2013 loss o
30.3%. Soybeanspostedapositive2.0%returninth
Chinese, Brazilian and Indian economic growth was
moderated this year putting a demand side damper
on
commodity
prices
in
2013,
for
the
year
they
returned12.9%. Onaquarterlybasis,industrialslost
0.4% on uncertainty concerning the next political
economic epoch in China. Going forward excess
inventories may lead to a demand driven market
where marginal cost of production will set prices,
potentially leading to downward price pressureover
the longer term. Copper inventory iscoming off all
time highs with the Chinese physical premium
increasingto
levels
not
seen
since
2009;
this
should
leadtowardsautilizationofexcesssupply. Withnew
multiyear project mines coming online the supply
surplus will likely continue for at least the next
several years providing limited upside to prices
without a large demand side catalyst. Potential
positiveshockstodemandin2014couldcomefroma
QuarterlyCommentary
1.28%
5.08%
29.79%
12.92%
3.66%
18.05%
35.00%
30.00%
25.00%
20.00%
15.00%
10.00%
5.00%
0.00%
5.00%
10.00%
S&PGSCIE R Ener gy Pr eci ous
Metals
Industrials Livestock Agriculture
YearlyExcessReturnsofGSCSICommoditySectors
December31,2012December31,2013
Source:Bloomberg, DoubleLine
15.00%
12.50%
10.00%
7.50%
5.00%
2.50%
0.00%
2.50%
5.00%
7.50%
10.00%
12.50%15.00%
S&PGSCIER
NaturalGas
UnleadedGas
Zinc
BrentCrude
Lead
GasOil
HeatingOil
Soybeans
Cocoa
FeederCattle
Copper
LiveCattle
Nickel
WTICrude
Cotton
Aluminum
Coffee
LeanHogs
Corn
Gold
Sugar
Silver
Wheat
KansasWheat
QuarterlyExcessReturnsofGSCSICommoditySectors
September 30,2013December31,2013
Source: Bloomberg, DoubleLine
40.00%
35.00%
30.00%
25.00%
20.00%
15.00%
10.00%
5.00%
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
S&PGSCIER
Cocoa
Soybeans
NaturalGas
Cotton
BrentCrude
WTICrude
GasOil
UnleadedGas
HeatingOil
LeanHogs
FeederCattle
LiveCattle
Zinc
Copper
Lead
Sugar
Nickel
Aluminum
KansasWheat
Wheat
Gold
Corn
Coffee
l
YearlyExcessReturnsofGSCSICommodity Sectors
December31,2012December31,2013
Source:Bloomberg, DoubleLine
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fourth quarter finishing out a strong 2013 campaign
in which they returned 10.5% on supply concerns in
Brazil and crop yield concerns in the United States.
Wheatand
Kansas
Wheat
ended
the
year
on
adown
ticklosing12.3%and13.6%,respectivelyinthefourth
quarteranddown27.2%and26.2%,correspondingly,
ontheyear.
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U.S.Equities
InMayandJune,theprospectoftheFedtaperingits
QEpolicieshelped todrive the market down5%, its
greatestdeclineoftheyearalbeitamoderateone.By
midDecember,however,anticipationoftaperingwas
welldigested by the market and macroeconomic
fundamentals were looking stronger. By the time of
theFedsDecembermeeting,theyieldonthe10year
Treasury had already risen 1.27%, a 78% increase
from summer lows in 2013. Judging from the rise in
stock prices, the decline in unemployment, and the
overall more positive tone in macroeconomic data,
this increase in rates was easily absorbed by the
economy. Therefore, when the longanticipated
announcement of the taper occurred on December
18th, thestockmarketreactednotwith thealarmof
June,butbyrallyingthroughyearend. TheS&P500
Indexclosedtheyearatanalltimehigh,up32%for
theyear. Forthefourthmonthinarow,theS&P500
Index closed the monthhigher than it began,as the
S&P500Indexwasdowninonlytwomonthsin2013.
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pressure inthefourthquarteras investorsremaine
mixed on whether or not the broadbased reform
announcedby theChinesegovernment inNovembe
will set the stage for positive longterm growt
trajectoryorwill itcomeatathecostof lowersho
to medium term growth, which could unravel som
overzealous sectors of the economy. The Shangh
Composite Index was down 2.70% during the fourt
quarter.
Going
forward,
global
equity
markets
should
focus
oU.S.growth and the pace of Fed tapering. Europea
and Japanesemarketswillbemonitoring theaction
oftheECBandBOJ,asbothbanksarelikelytorema
highlyaccommodativein2014.EmergingMarketsw
be highly contingent on U.S. rates and a smoot
transitioninChina.
GlobalEquities
Global equity markets, as measured by the Morgan
StanleyCapital InternationalAllWorldCountry Index
(MSCI ACWI), performed well in fourth quarter, as
equitiesshruggedofftheannouncementofFedtaper
inDecemberandembracedthebetterthanexpected
economicdatathatwasreleasedovertheperiod.The
MSCIACWIreturned6.93%fortheperiod.
Europeanequitieswerepositiveinthefourthquarter
with Germany, Italy, and Spain the top performing
countries
with
the
Deutsche
Borse
AG
German
Stock
Index (DAX), Financial Times Stock Exchange Milano
Italia Borsa (FTSE MIB), and ndice Bursatil Espaol
(IBEX)up11.14%,8.79%,and7.95%,respectively.The
Cotation Assiste en Continu (CAC 40) and Financial
TimesStockExchange(FTSE100)werealsopositivein
the fourth quarter returning +3.68% and 4.44%,
respectively. European equities were supported in
part by an ECB that cut its key interest rate and
pledgedto
maintain
its
accommodative
stance
for
an
extendedperiod.Theeconomicdataoutoftheregion
also showed signs that the region was climbing its
wayoutofrecession.
Japanese equities performed extremely well in the
fourth quarter with the Nikkei +12.70%. Japanese
equities were supported by the weakness in the
Japanese Yen and the belief that the Bank of Japan
(BOJ)will
step
up
its
quantitative
easing
program
to
offset drag from fiscal reform. Emerging markets, as
measured by the MSCI Emerging Market Index,
underperformedDevelopedMarketsover theperiod
withtheindexonlyup1.54%.RisingratesintheU.S.
were a headwind to Emerging Market equities as
foreign investorspulledcapitaloutofcountrieswith
high external financing needs; e.g., Brazil, Indonesia,
and Turkey. Chinese equities were also under
QuarterlyCommentary
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