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6.A. - Page 16 of 49
<br />QUARTERLY MARKET SUMMARY
<br />SUMMARY
<br />• In Q4, U.S. economic conditions were impacted by: (1) a resurgence in global coronavirus
<br />cases causing the reintroduction of some lockdown measures;
<br />(2) expedited vaccine approval initiatives but challenging logistics surrounding mass
<br />inoculation; (3) a contentious U.S. presidential election resulting in the election of Joe Biden;
<br />(4) months of filibustering over a second stimulus package that eventually passed in
<br />December; and (5) moderating labor market and consumer spending data.
<br />• The economic outlook remains uncertain, between the pace and efficacy of the global
<br />vaccine rollout and a major resurgence of virus cases.
<br />• Political turmoil in the U.S. adds to the unpredictability, but, remarkably, the markets have
<br />largely discounted the downside. Underlying the recent low market volatility is confidence in
<br />the Federal Reserve (Fed) and global central banks that have supported economic stability
<br />and expansion.
<br />• The Fed reaffirmed its commitment to utilize the full scope of its monetary authority until a
<br />full economic recovery is achieved. It kept short-term rates in their current range of 0.00% to
<br />0.25% and committed to continue its plans to buy $80 billion in Treasury securities and $40
<br />billion in agency mortgage-backed securities (MBS) monthly. Due to the economic progress
<br />to date, the Fed also released more optimistic expectations for 2021, lowering its
<br />unemployment rate projection to 5.0% by year end and raising its forecast for real gross
<br />domestic product (GDP) to 4.2% for the upcoming year. After Joe Biden's election as the
<br />next U.S. president, Janet Yellen was nominated to be the next Treasury Secretary, which
<br />should provide a more welcoming approach to further COVID-related fiscal support.
<br />• Amidst a tumultuous year, domestic equity markets continued to surge ahead with the Dow
<br />Jones, S&P 500, and Nasdaq posting new record highs during the quarter. U.S. small -cap
<br />stocks had a remarkably strong fourth quarter. International and emerging market returns
<br />were also robust despite the economic impact of the resurging virus.
<br />ECONOMIC SNAPSHOT
<br />After an unprecedented 31.4% contraction in Q2, U.S. GDP rebounded at a record pace in
<br />Q3, rising 33.4%. Despite this, economic output remains about 3.5% below its level at the
<br />close of 2019. The labor market recovery slowed in Q4, with non-farm payrolls falling
<br />140,000 in December as surging COVID-19 cases stymied the recovery. The unemployment
<br />rate ended the year at 6.7%, down from 7.8% at the beginning of the quarter, but overall
<br />employment remains nine million less than pre -pandemic. Weekly unemployment filings
<br />remained elevated—above 700,000 for 40 straight weeks—while the number of long-term
<br />unemployed (for 27 weeks or more) increased to four million during the quarter, representing
<br />37% of the total unemployed population.
<br />After a strong V-shaped bounce -back earlier in the year, both consumer confidence and retail
<br />sales fell in Q4. U.S. manufacturing and services activity, however, continued to rebound.
<br />The Markit Manufacturing PMI climbed for an eighth straight month to 57.1 to close out the
<br />year—well above the reading of 50 that signals expansion. The housing market also
<br />remained strong, although both new and existing homes sales cooled slightly by quarter end.
<br />Historically low mortgage rates continue to underpin housing demand and drive home prices
<br />higher.
<br />For the Quarter Ended December 31, 2020
<br />Fixed Income Management
<br />INTEREST RATES
<br />• Shorter -term Treasury yields remained low in Q4, anchored by the Fed's near -zero interest
<br />rate policy. Longer-term Treasury yields rose sharply, steepening the curve and increasing the
<br />spread between the yield on 10- and 2 -year Treasuries to 0.79% at year-end—a three-year
<br />high. The bond market appears to be looking beyond the current economic challenges and
<br />focusing more on the outlook for stronger growth later in the year and a potential rise in
<br />inflation. The vaccine rollout has pulled forward some of that optimism, while the prospects for
<br />additional fiscal stimulus and deficit spending from the new administration has increased.
<br />• At quarter -end, the yield on a 3 -month Treasury Bill stood at 0.07%, the 2 -year note
<br />was 0.12%, the 5 -year was 0.36%, while the 10- and 30 -year were 0.92% and 1.65%,
<br />respectively. The 10 -year Treasury was up 23 bps (0.23%) during the quarter.
<br />• As a result of low rates and a steeper yield curve, Treasury index returns were mixed. Short-
<br />term Treasury benchmarks (5 years and under) ended the quarter with slightly positive
<br />returns, while longer -duration indices were notably negative, but were strongly positive for the
<br />year. For example, the 3 -month constant -maturity U.S. Treasury Index returned 0.03%, while
<br />the and 2 -year returned 0.06%, the 5 -year benchmark returned -0.22%, while the 10- and 30 -
<br />year benchmark notes returned -1.91 % and -4.21 %, respectively.
<br />SECTOR PERFORMANCE
<br />• Yield spreads continued to narrow in Q4, albeit at a more modest pace, having retraced to
<br />pre-COVID levels in most sectors. Broad portfolio diversification was additive to portfolio
<br />performance in Q4 as most investment-grade (IG) fixed income sectors generated
<br />incremental returns relative to Treasuries.
<br />• Federal agency yield spreads snapped back to pre -pandemic levels across the curve and
<br />generated attractive excess returns relative to similar -duration U.S. Treasuries. Callable
<br />agency yield spreads were historically narrow in Q4 and offered little value.
<br />The IG corporate sector continued to be a top performer as yield spreads returned to the
<br />tight spreads of the recovery phase following the brief bout of volatility at the end of Q3.
<br />Credit spreads continued to compress, leading to a third consecutive quarter of relative
<br />outperformance versus comparable maturity U.S. Treasuries, with the rally largely led by
<br />BBB -rated issues. The corporate sector continues to benefit from insatiable demand for
<br />yield, strong Fed monetary support, and optimism about the economy.
<br />• The asset-backed securities sector performed well in Q4 as spreads tightened and
<br />approached the record lows of early 2020. Strong collateral performance and better-than-
<br />expected macroeconomic data contributed to the sector's outperformance compared to
<br />similar duration Treasuries. Light issuance in Q4 had strong investor demand, while credit
<br />card structures modestly outperformed auto -loan backed deals.
<br />• After struggling for much of the year due to heightened prepayments, the broad agency
<br />MBS sector generated positive excess returns. MBS continue to experience elevated
<br />prepayments and refinancing activity, the result of persistently low mortgage rates. Within
<br />the agency MBS sector, commercial MBS was a top performer, with strong positive excess
<br />returns due to heightened investor demand and significantly less prepayment impact
<br />compared to pass-through MBS.
<br />• In short-term money markets, rates are expected to remain low for the foreseeable future.
<br />Commercial paper and negotiable bank CD yield spreads widened a bit in Q4, providing a
<br />chance for short-term investors to capture incremental yield, but supply continues to decline.
<br />PFM Asset Management LLC
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