Outlook for bonds
Evergreen Investment Management---Pietronico, Michael---Portfolio Manager
>> the credit rating of new york city’s $1.2 worth of tobacco bonds, state and local governments have sold more than $19 billion of such debt. that was back in 1998. our next guest says investors should avoid tobacco bonds, though, because they’re too risky. michael pietronico joins us now with his outlook for bonds. let’s start moody’s downgrade today an the tobacco bonds. warning, these bonds should be hazardous to your health, the same way they do with cigarettes?
>> no, but they’re not for everybody. and the litigation risk that’s out there in the future is really unquantity fieable. and we feel as if in this stage in the economic cycle it would be best for investors to move up the credit cycle, get a little bit more defensive, buy general obligation bonds and central purpose revenue bonds. the tobacco bonds have had a tremendous run in the last three and six months. we think the price appreciation potential is behind it and the litigation risks could come out of left field and we feel the best returns have already been had.
>> do you expect more downgrades in other states?
>> i don’t think the downgrades are going to be the issue moving forward. this downgrade today was more anticipated in the market , more of a catching up to reality-type downgrade. what concerns us more is again, the lit ration risk, the judgments that can come out of jury trials that are very hard to quantify. and municipal investors are conservative by nature. so we think that they should be moving towards general obligation bonds and better revenues.
>> on the other coast, we’ve got california getting ready to sell $15 billion worth of bonds. calling them around bonds, i guess. what do you think of those prospect there is?
>> certainly for an investor who dabbles in california municipal bonds, you have to pay close attention to how that goes. we’re on the negative side in terms of the state. we’re not of the opinion that they’ve clarified anything structurally by issuing these bonds. and ultimately, nothing has really changed. they’re going to be borrowing a lot of money. they have assumptions that the company is going to do well for quite a long time. and we’re concerned they have to raise revenues, raise tacks an cut spending. they still haven’t got ton a point where they agree on that.
>> where do you think spreads aregoing going to come for this then? pretty high?
>> it depends on whether the bonds are going to be insured. if insurance companies want to insure the deal, yields will be slower. if they’re uninsured you’re probably looking at 60 to 80 points higher than your traditional triple-a bonds.
>> let’s talk about municipal bonds. we’ve kind of gotten into a trading raid on governments. people say they really can’t go a whole lot lower. so the outlook for the overall bond market doesn’t seem to be great. what about the muny area?
>> we’re not bearish. we don’t think rates are going to go dramatically higher. it wouldn’t surprise us if rates go up another 25 basis levels. but to the extent rates move higher, there’s a lot of money looking to move into higher-rate interest bonds. and by the stock’s performance in the last few weeks, there’s still a predisposition towards fixed income in an environment that we have right now.
>> what about maturity? any particular length of time that you want to be into a muny right now?
>> our preference is for the 10 to 15-year area of the municipal curve. absolute years are in the 3.40 to almost 4% range which we think is ok, given the low underlying rate of inflation. we’re generally against being inside of fife years because the yields are generally in the 1.2%, 1.3% range and the relative valuations just scream of valuation. so we like 10 to 15 years.
>> let me ask you about your outlook for inflation. we had an interview with the fed president who says deflation is an issue. are you concerned about that? or maybe the feds overstimulating the economy and we’ll see a lot of inflation in a year or so?
>> that was a great interview. i’m concerned that he’s concerned. at this stage of game, for him to seen show that kine of concern really speaks of the lack of confidence i think the fed has in this rebound in the economy. interest rates have fallen over the last quarter and a lot of that has to do so with the fund rates being 1%. the economy may slow in the second half of the year and i think his concerns are warranted.
>> at this point, that would be good for your business?
>> to the degree that it keeps people interested in fantasticed income, that’s good. we certainly don’t like to see an environment where yields are this low but i think fundamentals require it.
>> at the end of the year, where do you see spreads?
>> municipal spreads?
>> municipal spreads are active relative to treasury. supply has gone out of play up dramatically. i like the idea of moving into municipals here at current ratios. they’re anywhere from 87% to 95% of treasuries. and considering where absolute interest rates are, we think that’s good value.
>> thank you very much. michael pietronico. if financing of general mo tors was an independent company, it would be the eighth largest u.s. bank. we’ll find how much the automo taker relies on gmac.
