The Stable Value Market Environment
Third Quarter 2011
David J. Molin, CFA
The summer of 2011 will be remembered as a period
of considerable volatility for the financial markets as events
around the globe conspired to weigh negatively on market sentiment.
Within the fixed markets, the "risk off" trade dominated
as investors sought out the safety of U.S. government securities
in reaction to a series of unnerving events beginning with the
possibility of a US default as congress battled over raising
the debt ceiling and the subsequent downgrade of the US credit
rating by Standard and Poor's. As the quarter moved on, investors
were faced with the prospect of a European debt crisis spinning
out of control and slower than expected economic growth in the
US. As a result, Treasuries rallied, sending yields to generational
lows, and spreads gapped wider for all fixed income credit sectors.
In the end, Treasury yields were lower across all maturities
with the largest moves focused in the long end of the curve
as yields on 2, 5, and 10 yr notes declined by 21, 81, and 124
bps to 0.24%, 0.95%, and 1.92%, respectively. As a result, the
Treasury curve flattened with the spread between two and 10-year
Treasuries ending the quarter at 168 bps, compared to 270 bps
last quarter. Following suit, GIC yields, based on the average
compound rate for a $5 million contract, ended the quarter lower,
but to lesser degree as credit spreads widened, with yields
decreasing by around 15 to 45 bps across short to intermediate
maturities. The GIC yield curve also flattened with the difference
between three and 10-year contracts ending the quarter at a
positive spread of 191 bps. GICs continued to demonstrate solid
relative value characteristics when compared to high-investment
grade alternatives with the average three-year contract offering
around 60 bps over Treasuries at the end of September. Moreover,
the high contract offering based on FCM's weekly GIC statistics
yielded 100 bps over the corresponding Treasury, which is considered
to be favorable when compared to similar corporate bonds, after
wrap fees and commissions. The broad equity markets fell sharply
during the quarter with the DJIA, S&P 500, and Nasdaq reporting
total returns of -11.5%,-13.9%, and -12.7%, respectively. In
contrast, the Barclays Capital Aggregate Bond Index reported
a relatively strong total return of 3.82% as index performance
continued to benefit from declining yields.
Economic News: Economic reports released
during the quarter generally depicted slowing economic growth,
leading many economists to lower near term forecasts. Although
most still expect growth to pick up for the remainder of the
year and into 2012, the economy still faces a number of headwinds
including high unemployment, a depressed housing market, state
and local government budget cuts, and less accommodative fiscal
policy. After disappointing growth of 0.4% and 1.3% in the first
and second quarters, current consensus is for GDP growth of
around 2.5% in the third quarter driven by improvements in consumer
and business spending. Consumer sentiment, as measured by the
consumer confidence index, fell to its lowest levels since 2009
during the quarter as the difficult job market continued to
weigh on consumer optimism. Despite depressed sentiment, consumer
spending remained resilient with retail sales, excluding autos
and gas, increasing by a better than expected 0.5% in September,
after a gain of 0.5% in August. After slowing in July and August,
the manufacturing sector, as measured by the ISM Index, expanded
at a better than expected pace in September driven by a pick
up in auto production. However, the pace of expansion remained
well below the levels reported earlier in the year. Despite
better than expected housing starts in September, the housing
market continued to stagnate during the quarter with sales of
existing homes remaining near historic lows and home prices
continuing to drift lower. The labor market continued to be
very challenging with the unemployment rate holding at 9.1%
in September. The economy added only 287,000 jobs during the
quarter, which is down slightly from the 290,000 jobs gained
in the second quarter and well below the 600,000 level many
believe is necessary to create meaningful reductions in the
unemployment rate. Inflation growth at the consumer level continued
to creep higher with the consumer price index (CPI) increasing
by 0.3% in September, after a 0.4% and 0.5% increase in August
and July, respectively. At its August and September meetings,
the FOMC maintained its Fed Funds target at a range of 0%-0.25%
and initiated two new accommodative policy measures. At the
August meeting, the committee removed its "extended period"
language from its outlook statement and added a timeframe for
"exceptionally low" levels of the Fed Funds rate until
at least mid-2013. In addition, at the September meeting, the
FOMC initiated "operation twist" in which it will
extend the average maturity of its Treasury holdings.
The following chart illustrates
GIC yields for $5.0 million, five-year investment only, compound
interest contracts. The rates are net of expenses with no
commission payable.
