Meet the Street: What's Next for Bonds?

Good news around the corner for the stock market means good news for the bond market, as Prescott B. Crocker, managing director of Evergreen Investment Management, sees it. Crocker, lead manager on the Evergreen High-Yield Bond Fund, which is up 6.29% so far this year, admits that the luster of fixed-income investments, which have done well over the past two years and particularly post-Sept. 11, may be fading.

Prescott B. Crocker, Managing Director, Evergreen Investment Management

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But he still sees pockets of strong investment opportunities in the fixed-income markets, both in the near- and the midterm. Pointing to the tremendous fiscal and monetary stimuli of the past three months, Crocker also likes 10-year Treasuries, now yielding 4.74%. In fact, Crocker predicts the Fed will lower the fed funds rate another 25 basis points, to 1.75%.

And -- fairly confident that the stock market and the economy will finally pick up by early spring (which means that the usual risks associated with junk bonds should decline in tandem) -- Crocker is also putting his money on corporate and high-yield instruments.

TSC: One of your most interesting comments is that the equities markets will finally stage its long-awaited rally roughly around March or April. Why do you believe this, and how will this impact the bond markets?

Crocker: We believe the stock market will rally over the next three months, given the fiscal and monetary stimuli from the government, particularly over the past three months and post-Sept. 11. In fact, I see the fed funds rate going down another 25 basis points to 1.75%. This will boost the equities markets, which, in turn, will impact the bond market because of lower risk.

In fact, we are going to be taking on higher risk in the Evergreen High-Yield Bond Fund, and I would even predict returns of 5% to 7% in the stock market over the next two years, vs. 9.5% returns in high yield over the next two years. For a risk-accepting investor, we believe that high yield provides an opportunity at this time.

For the risk-averse, we would recommend TIPS [Treasury Inflation Protected Securities], which are now returning 3.4% real, guaranteed returns. I think it's generous, especially because it's guaranteed by the U.S. government.

TSC: Your bullish outlook for bonds through 2004 may turn out to be true, but for now, at least, the bond market has lost some of its sizzle over the past two weeks. Can you explain what's happened?

Crocker: The initial jobless claims, which had already been terrible and deteriorating, came out worse on Nov. 21. The expectation was for 427,000, and it turned out to be 460,000. It just knocked the pins out of the bond market over the next three to four trading days.

But if you take a look since then, you will clearly see that a rally in the bond market started on Nov. 27, particularly in the 10-year bond. I would say that while the bond market has been steadily increasing over the past two years, it is still technically sound. And if you look at the difference between the current 4.74% yield on the 10-year Treasury and the 1%-1.5% inflation expected over the next year, you will see a solid, real return there. The prices are justified.

TSC: But what about the risk of inflation?

Crocker: Well, many economists are now talking about the D word: deflation. That's the big risk here. And while some see it as a risk, I am pretty sure that neither inflation nor deflation will become an issue.