Ford Bonds Benefit at Expense of Toyota

NEW YORK ( TheStreet) -- Peter Palfrey, who helps manage the Loomis Sayles Core Plus Bond Fund ( NEFRX), says Ford's bonds remain attractive even as they've rallied, helped by Toyota's ( TM) car-quality problems.

The $324 million mutual fund has risen 25% in the past year, beating 77% of its competitors, and an annual average of 6.1% over five years, outperforming 92% of rivals. The Loomis Sayles Core Plus Bond Fund has 51% of its assets in corporate bonds and 22% each in government and mortgage debt. The rest is in cash, according to Bloomberg data.

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Welcome to's Fund Manager Five Spot, where America's top mutual fund managers give their best stock or bond picks and economic views in five questions.

What is your favorite corporate bond issue?

Palfrey: We like the bonds of the Ford Motor Credit Co., which continues to perform well and remains an integral part of the Ford Motor Co. FMCC has significantly improved its financial position and product offerings over the past nine months as exemplified by a year-end cash balance in excess of $25 billion, improved third-party vehicle quality and brand consideration scores, and a relatively robust product pipeline for the next 12 months.

Toyota's increasingly troubling and highly publicized quality problems also present an opportunity for Ford to boost market share. FMCC generated a $696 million operating profit in the fourth quarter and has improved its liquidity profile by accessing the asset-backed market. Although FMCC bonds have rallied during the past year, they still offer attractive yields in the 7.5% to 8% range for intermediate maturity (five to seven years) bonds.

What is your view of the economy?

Palfrey: The economy will continue on its slow growth, recovery path but with considerable cross-currents in coming quarters. Much of the recent growth has come off severely depressed levels, propelled by exceptionally accommodative monetary policy, budget-busting fiscal-stimulus programs, quantitative easing and herculean efforts by the U.S. and foreign governments to recapitalize the global financial system and restore the flow of credit and liquidity in markets. As fiscal and quantitative easing programs and policies wind down, we will lose one of the primary drivers of the 2009 recovery.

The U.S. consumer remains under-employed and over-levered. Payroll growth is becoming less negative but is unlikely to meaningfully reduce the level of unemployment sufficiently to underpin a more robust consumer-led recovery. Additionally, the growing sovereign-debt crisis in parts of Europe will remain a drag on European growth for at least the next several years and will also remain an investor concern in the U.K., Japan and perhaps even in the U.S. unless we see meaningful fiscal reform.

This uneven, slow growth outlook for most developed countries may not be a constructive backdrop for many of the riskier, more economically sensitive asset classes. It favors income and yield over capital appreciation.

Within the fixed-income market, corporations that have de-levered and improved balance-sheet quality and liquidity as well as structured products, including AAA-rated commercial mortgage-backed securities and short asset-backed securities paper, provide attractive yields in a slower-growth environment.

What are your expectations for the U.S. Treasury market?

Palfrey: Over the next three to six months, I expect Treasury yields to remain fairly range-bound, as supply and growth fears play tug-of-war against moderating economic activity. Later in the year, however, as the employment picture in the U.S. turns more positive, we could see short and intermediate-dated maturities start to price in the eventual removal of the current exceptionally accommodative monetary policy.

The very front end of the Treasury yield curve will likely remain well-anchored by a stable Fed monetary policy, perhaps through early 2011. However, intermediate and longer-dated maturities could trend higher as investors anticipate tighter monetary policy as economic slack in the economy starts to moderate. Ongoing Treasury supply pressures to fund a federal deficit in excess of $1.5 trillion, the potential for additional stimulus programs and aid to state government, and the lengthening of the average maturity of U.S. debt stock will all serve to push Treasury yields higher once investors become more confident in the U.S. and global recovery.

The reversal of some of the quantitative easing programs -- the potential sale of mortgage pass throughs, agency debentures or Treasuries -- will also remain a perceived threat to the longer end of the yield curve. However, inflationary pressures should remain quite benign over the next 12 to 18 months, due to excess slack in the U.S. economy, including decade-high unemployment and the destruction of wealth through the 2008 downturn.

What is your outlook for mortgage-backed bonds?

Palfrey: Through one of the most ambitious quantitative easing efforts of the U.S. government, the Federal Reserve has been the primary buyer of mortgage pass throughs over the past year and a half. The goal was lowering mortgage rates and providing liquidity to the residential mortgage market in an effort to stem the severe decline in residential home prices, the spike in foreclosures and to help banks improve balance sheet valuations. By the end of the easing program this month, the government will have accumulated a $1.25 trillion position in MBS.

During this period, mortgage prices have risen sharply, even as Treasury prices have fallen. This has compressed the yield premium available to mortgage investors to levels that are no longer as attractive by most valuation measures. Additionally, with the vast majority of the mortgage market now trading at a significant premium, prepayments through improved refi and housing activity, as well as premium erosion through rising defaults, will also cap the potential for incremental performance.

It is likely that the U.S. government will not choose to liquidate its mortgage pass through portfolio for fear of putting significant upward pressure on mortgage rates while the housing market is still recovering. The removal of the underlying bid to the market once the quantitative easing program winds down will likely stall any potential for meaningful improvement in MBS performance relative to Treasuries or alternative spread sectors.

Which foreign government bonds do you like best?

Palfrey: Local currency Canadian dollar and Mexican peso bonds appear to be well-positioned to leverage off the eventual recovery in the U.S. and global economies. Canada benefits from a solid fiscal position, as well as a strong energy sector, and boasts a sound financial system. Mexico, which came under severe pressure during the height of the global economic downturn, is highly levered toward a recovering U.S. manufacturing sector and should benefit from improved repatriation flows from Mexican workers in the U.S. as southwestern states show better economic activity in subsequent quarters. The peso is also likely to benefit from the recovery in global demand for oil.

Other emerging countries are benefitting from the sharp recovery in global economic activity. Economies more directly tied to the tremendous fiscally driven recovery in China, including Australia, are showing considerable strength and have already started to remove some of the monetary policy accommodation supplied during the crisis. However, countries more closely linked to China's strong growth, including Australia and Brazil, may be vulnerable to any kind of perceived slowdown.
Before joining, 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.