NEW YORK (
) -- Adriana Posada, manager of the
American Beacon Intermediate Bond Fund
, says a sluggish economic recovery will do little to help Treasuries in the months ahead.
The fund, which Posada manages with William Quinn and Wyatt Crumpler, has risen 6.5% this year. Over the past three years, the American Beacon Intermediate Bond Fund has returned an average of 7% annually, better than 89% of its
Welcome to TheStreet.com's Fund Manager Five Spot, where America's top mutual fund managers give their best stock picks in five fast and furious questions.
What is your view of the economy?
We have a cautious view of the economy. The equity and fixed-income markets have experienced extremely strong performance over the past several months, begging the question, "Why?" We acknowledge that the economy is in much better shape than it was in late '08 and early '09. The markets have thawed, and a sense of normalcy has returned. Economic data has come in less bad, but does that make it good? The economy shows signs of stabilizing from a tumbling fall rather than beginning a solid climb back out of the hole. When taking a closer look at the fundamentals of the overall economy, it is difficult to feel quite as optimistic. GDP fell 1% in the second quarter, while first-quarter GDP was revised from minus 5.7% to minus 6.4%. GDP has fallen 3.9% annualized since the second quarter of last year. This is the first time the economy has experienced four straight quarters of decline since records began in 1947.
Representing nearly 70% of GDP, consumers are certainly the backbone of the U.S. economy. But that backbone is under severe stress. Consumer confidence has improved somewhat on the strength of higher equity values in their 401(k) plans and firming prices in the housing market. However, consumers are saving more and credit is tightening. Along with the still-troubling job outlook, these combine to produce a far weaker consumer than we've seen for quite some time. Additionally, weighing on consumers are the impact of massive government programs debated in Washington and questions surrounding where the money will come from to support this level of spending. The freefall has ended, but now we are assessing the foundation of upcoming economic growth rather than the headline numbers themselves. We believe the economy will be slow to recover.
What is your view of U.S. Treasuries?
We are underweight Treasuries after having moved to overweight positions in corporates and agencies in early 2009. Spreads in nearly all other asset classes reached historical wides during the financial crisis, and we moved to overweight those sectors while underweighting Treasuries. However, the rollercoaster ride for the economy has yet to finish its course. The Federal Reserve is committed to keeping short-term rates low. They are attempting to influence the longer end of the Treasury yield curve through quantitative easing, or more simply put, through purchasing Treasuries. This, along with the ballooning deficits from Washington, have many concerned that yields on longer-term Treasuries will have to rise to entice investors to digest the massive amounts of supply coming ahead. We believe the Treasury yield curve is likely to remain steep for a long time.
What is your favorite sector of corporate bonds?
We believe the positive tone in the corporate bond market has produced a rally based more on technicals than on improving fundamentals. The flow of funds into investment-grade credit mutual funds has risen dramatically and institutions have invested large amounts of cash into the credit markets looking to take advantage of the historic yield spread levels. The yield spread on the Barclays U.S. Credit index has tightened from 493 basis points at the beginning the year to 224 bp at the end of July. There is still opportunity at this level, which is still above the 10-year historic mean of 159 bp, but going forward, the market will begin to fundamentally differentiate between stronger credits rather than a sector-wide tightening. With opportunity in the corporate sector rapidly dwindling, banking is one area where we still see attractive values. On average, it is one of the few remaining sectors with an attractive risk/return tradeoff. In early 2009, nearly every corporate bond sector was attractive as spreads were at historical wides and Treasury yields were at historical lows.
Today, however, many corporate sectors have substantially recovered, such as pharmaceuticals, capital-goods manufacturers and technology, but the banking sector still offers attractive yields. Other sectors within the broader finance category also have wide spreads, such as insurance, REITs and independent finance companies, but the risks offset the yields. Outside of banking, we are also focused on businesses with less exposure to high-end consumer markets, and our defensive positions favor electric utilities, pharmaceuticals and wireless telecom.
What is your view of residential-backed mortgage bonds?
The state of housing in the U.S. remains a mixed bag that is improving in the low- to mid-priced houses on the strength of lower conforming mortgage rates and first-time-buyer government incentives. Sales in higher-priced homes have lagged, while foreclosure inventories have grown. Cash flows remain relatively uncertain as the pipeline of borrowers looking for help with their mortgages grows. Single-family home starts increased for the fifth straight month in July, but total housing starts still suffer from a massive drop in multifamily units. Home prices as measured by the S&P/Case-Shiller index rose 2.9% in the second quarter, the first increase since 2006. While housing may be stabilizing, it still has quite a way to go in order to meet the levels of just a year ago, and much more to climb back to the peak as the S&P/Case-Shiller index is still down 31.3%. The flood of foreclosures weighs on an already stressed market and has kept home prices from much improvement despite strong demand. The foreclosure programs from Washington have had less than the desired effectiveness as only 9% of delinquent borrowers are in trial modifications.
Purchases of agency mortgage-backed securities from the Federal Reserve and Treasury programs and light volume from originators helped drive mortgage spreads tighter. The agency MBS index has generated positive performance for the eighth straight month. Recent improving prices for prime non-agency securities have been driven by technical forces as well. We are underweighted in the sector as we find better return potential in the corporate sector.
What is your view of commercial-backed mortgage bonds?
If we compare the performance of the ABS market when the TALF program was initiated and how it progressed month by month, we are able to project continued spread tightening for the CMBS market. The ABS TALF issuance began with projected IRR levels in the high teens, but as the program progressed, those returns narrowed substantially. This market reaction may serve as a reasonable proxy for CMBS, as we have seen dramatic spread tightening since the inception of TALF 2.0. The available supply of bonds is limited, providing an additional positive technical for further tightening. PPIP funds will also help decrease the outstanding pool of available securities. Without the aid of these government programs, the CMBS market would likely look much different as fundamentals are poor. Nearly $700 billion in commercial mortgages will need to refinance before the end of 2010. A large amount of commercial properties (5,315) were either in default, foreclosure or bankruptcy at the end of June, more than twice the number at the end of last year.
CMBS has been one of the best-performing sectors of the Barclay's Aggregate Index in the third quarter of this year. The substantial outperformance is largely attributable to the programs from Washington, TALF and the announced PPIP. These programs are most beneficial for those securities originally rated AAA which also meet Federal Reserve Bank of New York qualifications. A significant tiering between TALF eligible and non-eligible CMBS securities has begun. As with the banking sector, a proper-functioning commercial real estate market is an important element in this economic recovery, and policy makers appear to be in agreement. We are adding to this sector and carefully monitoring the loan fundamentals of holdings while looking for opportunities to add issues from our approved list to the portfolio.
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.