NEW YORK (
) -- Peter Palfrey, co-manager of the
Loomis Sayles Core Plus Bond Fund
, says U.S. Treasury bonds' gains are limited while corporate and high-yield debt are attractive.
The bond mutual fund has risen 16% this year, better than about three-quarters of its
peers. Over the past year, the Loomis Sayles Core Plus Bond Fund is up more than 20%, beating 95% of its rivals.
Welcome to TheStreet.com's Fund Manager Five Spot, where America's top mutual fund managers give their views and picks in five questions.
How is the economy doing?
The U.S. and global economy has been undergoing a bottoming process over the past several quarters, thanks to an unprecedented level of monetary-policy accommodation, fiscal stimulus and governmental intervention aimed at re-opening credit markets, recapitalizing the financial system and helping to restore liquidity and investor confidence to the financial markets.
Corporations have taken advantage of the re-opening of financial markets by terming out debt, raising equity capital and otherwise shoring up balance-sheet liquidity. Government efforts to put a floor under residential home prices, keep delinquent consumers in their homes and to spur renewed activity in the new and existing residential home sales markets, however, have been more of a mixed success. Quantitative easing efforts have successfully driven consumer and corporate borrowing costs sharply lower from crisis levels, but have not yet addressed the massive negative equity problem in a significant portion of the U.S. residential home market. Record foreclosure rates, inventory overhang, tightened underwriting standards and limited financial flexibility of many borrowers has stymied a more meaningful recovery in the housing market. This, combined with unemployment approaching 10% and dim prospects for a quick recovery to stagnant wage growth, means that a major engine for the U.S. economy will remain idled for at least the next several years.
The liquidity-fueled rally in many of the risk markets reflects a correction from tremendously over-sold conditions, but does not necessarily reflect a lasting return to "business as usual" in the U.S. economy. Over the past several quarters, investors have celebrated results that were "not as bad as feared." With limited pricing power, intense competition and lower leverage, earnings growth may disappoint going forward. We anticipate a choppy, subpar economic recovery in upcoming years, highlighted by ongoing deleveraging of consumer balance sheets.
What is your view of U.S. Treasury bonds?
Treasury yields are the lowest in decades, even after adjusting for the rise in yields from record lows just last December. Deficit spending has never been higher in absolute terms, and the sheer magnitude of issuance needs has spooked U.S. and foreign investors alike. This has likely been a contributing factor in the decline in the U.S. dollar, as investors have grown more confident in playing the "reflation" trade, and more leery of the risk of the monetization of U.S. debt. However, even with all this investor concern over record deficits and debt supply, someone has been buying our debt. A closer look at the Treasury buyer base reveals record inflows from institutional and retail investors. Foreign central banks and other overseas investors, despite all the hand-wringing over a "foreign investor strike" have been size buyers in our auctions, often taking 40% to 60% of total supply. So there remains a demand for the safety and liquidity of U.S. Treasuries.
Treasuries appear fairly valued over the nearer term, with the potential for modest flattening from present levels should risk markets pull back for a period of time. Longer term, however, as the U.S. recovery finally starts to take hold, supply fears and an investor migration away from the security of Treasuries, and back into risky assets, combined with the Federal Reserve's desire to "normalize" current accommodative policy, will likely push interest rates higher from present levels.
Are U.S. corporate bonds attractive?
Investment-grade corporates have been a star performer this year, retracing much of the record spread-widening that occurred over the last several years, and last fall in particular. An improved economic backdrop, the re-opening of capital markets, record investor flows, and manageable net new issuance has all served to support the recovery in corporate spreads. However, while corporate bond spreads remain attractive on a historical basis, due to the extraordinarily low level in Treasury yields, higher-grade corporate bonds may offer limited upside from current levels. More cyclical, lower-rated high-grade corporate bonds do still offer attractive all-in yield, and remain well-supported by investors looking for yield, combined with reasonable risk characteristics in a recovering economy. Financials and more cyclical, longer-dated industrials remain relatively more attractive.
High-yield bonds have done well. Will that trend continue?
The high-yield bond market is still attractive in spread and absolute yield. We are seeing the default risk declining as capital-market access improves. However, we believe that much of the lower tier of the high-yield market has rallied too far given our expectations for a subpar economic recovery. In contrast to our view on the investment-grade corporate market, we favor high-yield companies in the upper tier of the rating category in more defensive industries.
Are TIPS worth buying?
TIPS, which went from trading at record-cheap levels late last year as deflation fears and a lack of liquidity dominated trading levels, currently look only "fairly valued" in terms of B/E spread after a sharp recovery in B/E spreads in 2009. The massive destruction of equity and home-value wealth, declining employment and consumer incomes and a lack of corporate pricing power have countered more recent run-ups in commodity-price pressures and a declining dollar. Nearer term, our benign outlook for inflation suggests a sideways trading pattern for a period of time, before year-over-year inflation starts to become more of an investor concern next year. Additionally, real yields have drifted back down to levels that look less compelling. We expect that there will be a more attractive entry point in this market later this year or early next year should risk markets falter and investors' deflation fears become more dominant.
Before joining TheStreet.com, Gregg Greenberg was a writer and segment producer for CNBC's Closing Bell. He previously worked at FleetBoston and Lehman Brothers in their Private Client Services divisions, covering high net-worth individuals and midsize hedge funds. Greenberg attended New York University's School of Business and Economic Reporting. He also has an M.B.A. from Cornell University's Johnson School of Business, and a B.A. in history from Amherst College.