2010 FIXED INCOME
I have frequently mentioned the amazing similarities between the 2003 Capital Markets and the 2009 Capital Markets. Unfortunately, investors seem to only focus on the Equities performance. 2009 will be remembered as one the all time best years for the Corporate Bond market. Tremendous opportunity at the start of 2009 translated into phenomenal performance by years' end.
The question for 2010 - "Is there anymore upside opportunity left?"
Let's first look at the Treasury market, unfolding currently is a "Turtle Trend Change". A very slow, deliberate shift in the long term secular bull market toward a market with little to no opportunity. Yields really have nowhere to go but up. The question is "how fast?" I doubt a 2% Ten Year Treasury is the cards without a "major shock" to the financial system.
Currently Ten Year Yields appear posed to challenge this year's high around 4%. For 2010 does a Yield above 4% signal a "rapid" rise toward 5, 6 percent? Various factors suggest a "Turtle" move with slowly moving higher yields not a disorderly decline in Treasury valuations.
It moves slowly higher due to the following supportive Treasury indicators.
Historically low Fed Funds rate continues further.
The output gap is still too wide.
Tepid GDP growth and core inflation
However, it moves slowly higher due to the following bearish Treasury indicators.
Technical indicators point toward a breakout above 4%
A shift in US debt issuance from shorter maturities toward 6 and 7 year paper, thus an oversupply condition
A global recovery that looks more "Vish" than "Uish"
It all adds up to a yawner for the Treasury market, I can't even get excited about TIPS with core inflation under control.
SO THE OPPORTUNITY REMAINS IN CORPORATE BONDS
It's amazing to look back upon this time last year and think where credit spreads were trading. Truly "Armageddon" was priced in to the ridiculous wide spreads. The 2009 narrowing process has provided historic opportunity for investors. From junk to high quality "all boats did rise". For 2010 corporate boats will rise, just not all of them.
The Fed Reserve asset purchase program was extremely successful in supporting the MBS, CMBS, ABS and Agency markets. No doubt in 2010 the Fed will begin to wind down and eventual end those programs. That will present a modest risk to those sectors as the "training wheels" come off. So YES opportunity does still exist for MBS, CMBC, ABS and Agencies however understand the road may get bumpy as 2010 unfolds.
Supporting the corporate market will be a continued improvement in the default rate which has dramatically declined from the credit crisis Peyton Manning (18%) number with a possible target in The Yankees legend land - thinking the Mick (7%) and Joe D (5%) - insight for 2010.
One of the main themes from the 2003 / 2004 Capital Markets recovery was the transition in 2004 to much lower volatility. Historically, corporate bonds perform well in a falling Volatility environment.
To begin 2009 investors were clearly underestimating the resiliency in Corporate Health via the balance sheet. This recession was a "consumer" recession. Corporations were much healthier financially. Evidence of that appeared as the year progressed in the excellent earnings recovery. "Lean and Mean" also dramatically improved balance sheets. However, frozen ratings agencies were slow to initiate an upgrade cycle.
With plenty of cash on the sidelines investment grade and high yield bonds will continue to be attractive investments. I do not expect the performance of High Yields to come anywhere close to the historic returns of 2009, up over 50%, however opportunities still exist. In fact for the month of December High yields have returned above 2.5% while investment grade bonds are down highlighting the continued attractiveness in High Yields.
Spreads have dramatically declined during 2009. The momentum for 2010 for further improvement is in place. It will not be as broad based an opportunity as it was in 2009 but selective opportunities still exist.