The Stable Value Market Environment
Fourth Quarter 2009
David J. Molin, CFA
2009 will be remembered as a year of recovery
for the fixed income markets highlighted by an unprecedented
rally in risk assets as investor confidence returned in the
wake of massive government stimulus/liquidity programs and an
improving economic outlook. This renewed confidence emboldened
investors to move money out of low yielding cash and government
securities into higher yielding, riskier asset classes. As a
result, liquidity returned to non-Government related sectors
and credit spreads contracted significantly from historic wides
to end the year well below peak-crisis levels. After rallying
on strong demand earlier in the quarter, Treasury prices fell
in December as improving economic indicators and record levels
of supply pushed yields higher. By quarter's end, Treasury yields
were higher across all maturities, with the largest moves focused
in the mid to long end of the curve as yields on 2, 5, and 10
yr notes increased by 19, 37, and 53 bps, respectively. As a
result, the Treasury curve steepened with the spread between
two and 10-year Treasuries ending the quarter at a historically
wide 270 bps, compared to 236 bps last quarter. In contrast,
GIC yields, based on the average compound rate for a $5 million
contract, ended the quarter slightly lower for most maturities
as credit spreads over Treasuries continued to tighten. In the
end, GIC yields declined around 5 bps across short to intermediate
maturities, while yields on long maturities increased around
20 bps. As a result, the GIC yield curve steepened with the
difference between three and 10-year contracts ending the quarter
at a positive spread of 246 bps, up from 222 bps last quarter.
GICs continued to demonstrate solid relative value characteristics
when compared to high-investment grade alternatives with the
average five-year contract offering 90 bps over Treasuries at
the end of December. Moreover, the high contract offering based
on FCM's weekly GIC statistics yielded approximately 122 bps
over the corresponding Treasury, which is considered to be very
favorable when compared to spreads in the 80 bps range, before
wrap fees and commissions, on similar corporate bonds. During
the quarter, the broad equity markets continued to move higher
with the DJIA, S&P 500, and Nasdaq reporting strong total
returns of 8.1%, 6.0%, and 7.2%, respectively. The Barclays
Capital Aggregate Bond Index reported a modest total return
of 0.20% for the quarter as negative returns from the Treasury/Agency
sector offset solid performance from the Corporate sector, which
continued to benefit from tighter credit spreads.
Economic News: The economic picture has
transitioned from a historically deep recession to the beginning
of a recovery with most economists projecting solid near-term
economic growth driven by inventory builds and government stimulus.
However, the strength of the recovery will continue to be challenged
by high levels of unemployment, reduced household wealth, and
tepid consumer spending. Moreover, the sustainability of growth
remains the big question given that the economy will need to
find new growth engines once the effect of stimulus efforts
begin to fade. Current consensus is for GDP to improve to an
annual rate of 4.0% in the fourth quarter, up from the 2.2%
in the third quarter. During the quarter, the housing market
continued to show signs of improvement with some stabilization
in home prices and better than expected gains in existing home
sales as buyers continued to take advantage of low mortgage
rates, foreclosure sales, and government incentives. To meet
increased global demand for new orders, the manufacturing sector
continued to expand during the quarter, with factory activity,
as measured by the ISM Index, rising to its highest level since
2006. The consumer confidence index improved in December; however,
index readings remain historically weak as concerns over labor
market conditions continue to depress consumer optimism. That
said, retail sales continued to show signs of life with better
than expected gains reported for October and November. During
the quarter, the labor market continued to deteriorate, but
at a slower pace, as payrolls declined by 208,000 jobs, down
from the nearly 600,000 jobs lost in the third quarter. For
all of 2009, payrolls declined by 4.2 million jobs, compared
to 3.0 million jobs lost in 2008. The unemployment rate increased
from 9.8% in September to 10.0% in December, the highest level
since 1983. Inflation growth at the consumer level remained
well contained with the consumer price index (CPI) increasing
by 0.1% in December, after an increase of 0.4% in November.
At its December meeting, the FOMC maintained its Fed Funds target
at range of 0%-0.25%. The committee continues to anticipate
that economic conditions are likely to warrant exceptionally
low levels of the federal funds rate for an extended period.
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.
