Fixed Income Q&A with Newfleet’s CIO
Q: What is the difference between today’s credit environment and the credit crisis of 2008 that triggered the “flight to quality?”
A: In 2008, there was dramatically more leverage in the system. In 2012, most Wall Street brokerages are affiliated with commercial banks, and their ability to use leverage has been reduced dramatically, from 15-times leverage multiples to the three-to-five-times range. Even though Wall Street was not taking on new inventory back then, massive maturities were coming due and there was absolutely no liquidity, so defaults catapulted to a much higher range. In terms of investment grade corporates, with rates at all time lows for the last 14 to 18 months, many companies have refinanced, and the debt maturity wall coming due is much smaller than it was – about an eighth of what it was in 2008, and about a quarter of what it was in 2002.
By comparison, today we don’t have big debt maturities, fundamentals have been very positive, and Corporate America has been very resilient. Companies haven’t spent additional dollars on capital expenditures or hired additional employees but have retained large cash balances. Corporations today versus 2008 have less leverage, better coverage ratios, and two to three times more cash on their balance sheets and are better able to weather the storm. From a corporate perspective, the market is much better positioned than it was in 2008.
Q: What are your thoughts on the Fed enacting a third round of quantitative easing (“QE3”)?
A: Clearly, the market is looking for more quantitative easing. If there is a QE3, it will likely take the form of mortgage-buybacks as the Fed wants to keep mortgage rates low and foreclosures down. We wouldn’t view any further Fed easing as constructive, just more kicking of the can down the road. There are a lot of bigger problems that need to be fixed in the economy than the housing market. Employment is the key to economic growth. Congress needs to address the fiscal cliff of austerity measures that will automatically kick in on January 1, 2013 so corporate America can get a handle on health care costs and taxation issues and start hiring again.
Q: When interest rates begin to rise, what fixed income sectors will likely benefit, and what sectors should investors avoid?
A: To this point, U.S. government assets have been beneficiaries of the Fed’s easy monetary policy and asset buybacks. When interest rates eventually rise, U.S. Treasuries, both intermediate and long, will get slammed. Municipal bonds with long durations will also be penalized. Investors may want to exercise caution and not go too far out on the yield curve. TIPS will benefit from rising rates but since government assets usually lag other sectors, floating rate bank loans may be preferable to TIPS. Short duration bank loans offer higher yields and would benefit from any growth in domestic GDP. Also worth considering are foreign bonds, particularly emerging market countries where global growth should pick up, with a focus on dollar-denominated and local currencies.