| BUSINESSWEEK ONLINE : DECEMBER 27, 1999 ISSUE | ||||||||
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| WHERE TO INVEST -- THE INVESTMENT SPECTRUM
Bondholders May Get Their Time in the Sun Many pros think it's bargain-hunting time A red-hot U.S. economy and three Federal Reserve interest rate hikes battered bond investors in 1999, the worst year for fixed income since 1994. But many pros think the worst is over, or at least close to it. There may not be a major rally in the near term, but the pros maintain that 30-year U.S. Treasury bond yields aren't likely to run up as quickly and sharply as they did in the past 12 months, when they shot from 4.95% to 6.38%. ''The bulk, if not all, of the damage is done,'' says Ian MacKinnon, head of fixed-income Vanguard Group. If that proves true, many pros say, now would be a terrific time to move into some of the bond market's greatest bargains: Treasury Inflation-Indexed Securities (TIPS), municipals, investment-grade and high-yield corporates, and emerging-market debt. Even long-term Treasuries look safe, for a change. Bond experts think that yields on 30-year Treasuries will trade between 6% and 6.7% over the next 12 months. Yields that high can provide investors with a comfortable cushion against any declines in the bonds' price. ''Even if the long bond [yield] goes to 6.7%, investors will still pocket a positive return,'' says Daniel J. Fuss, managing partner of Loomis Sayles & Co. Inflation, of course, is what really drives bond-market returns. Jitters persist over the acceleration in inflation in the consumer price index (CPI), which climbed to 2.6% from 1.6% in 1999 as oil prices doubled. Most economists now expect the inflation rate to reach at least 3%, on an annualized basis. ''Many of the factors that kept inflation under control are giving way,'' says Robert Brusca of Ecobest Consulting, an economic consulting firm in New York. As a result, market watchers think the Federal Reserve will hike rates at least once, and maybe even twice, in the first half. The chance of inflation rising is winning top bond managers over to TIPS. These inflation-indexed bonds make special annual payments equal to the change in the CPI. The cash accrues until you sell the bond or it matures. Assuming inflation averages 2.6% annually over the next decade, 10-year TIPS will have a minimum total return of 6.8%. But ''the odds of inflation averaging greater than 2.6% are probable,'' says Robert Rodriguez, manager of FPA New Income bond fund. If inflation spikes, these bonds will rally, unlike conventional debt. ''CHEAP MARKET.'' If you're thinking of buying TIPS, they're best put in tax-sheltered accounts, such as IRAs. If you hold TIPS in a taxable account, you'll have to pay taxes on the real yield and the cash that has accrued from the rise in the CPI. Buyers can find some equally tempting values in municipal bonds. ''The entire market is extremely cheap,'' says David Baldt, managing director of fixed income for Deutsche Asset Management. Demand has been anemic since mid-1998 as individual and institutional investors traded out of munis into higher-returning equities and Treasuries. But he points out that yields on tax-free AAA munis amount to 95% of Treasury yields; historically it has been around 82%. With long-term munis at 6%, vs. 6.25% for 30-year Treasuries, munis offer higher aftertax returns. So investors with a 40% state and federal tax burden are looking at tax-equivalent yields as high as 10%. Residents of high-tax states such as New York and California should find munis particularly attractive. Marilyn Cohen, president of Envision Capital Management, a Los Angeles fixed-income management firm, likes the New York City Water Finance Authority's 5.25% notes due in 2029, now yielding 6%, and California General Obligation 5.25% notes due in 2010, yielding 5%. Both are AAA. Investors may also consider municipal bond funds, such as Vanguard's offerings. CRITICAL BIZ. Corporate bonds, both investment grade and high yield, offer great value, but in exchange for more risk. Both sectors are trading at attractive spreads over Treasuries. ''Yields of 7.5% for a long corporate are great relative to the inflation rate,'' says MacKinnon, who recently bought Delta Air Lines' 7.9% notes due Dec. 15, 2009, yielding 8%. Stephen Peacher, chief investment officer of Putnam Investments' credit team, thinks the aerospace sector is extremely cheap. The industry has been beaten up because of a decline in defense spending. But ''it's a strong, sustainable business that is critical to the Defense Dept.,'' says Peacher. His pick: Lockheed Martin's 8.5% bonds, due in 2029, now yielding 8.3%. Two good funds are Managers Bond and Strong Corporate Bond, which returned 10.34% and 9.99%, respectively, for the five years ended Nov. 30. High-yield bond spreads over Treasuries, meanwhile, are even wider than average: You can earn an 11.5% yield--about 100 basis points over the historical norm. That's in part because of rising default rates. They have risen from a low of 0.99% at the end of 1997 to a recent 3.6%, and are expected to reach 4%. ''New issues were fast and furious in 1997 and 1998, and deals got done that shouldn't have,'' says Putnam's Peacher. But he thinks the market has already accounted for the rise in defaults. Andrew Cestone, manager of the Morgan Grenfell High Yield bond fund, has done well in telecommunications and cyclicals such as paper. He has avoided such troubled sectors as retailing and restaurants. His fund is up 15.4% through Dec. 10, vs. 4.46% for the Lipper High Yield Index. Cestone likes Germany-based Viatel, one of the first European telecom companies to have assets throughout the Continent. He owns Viatel's 12.5% notes due in 2008. These dollar-denominated bonds are yielding 13.8%. Even riskier, but potentially more rewarding, is emerging-market debt. Spreads over Treasuries have narrowed from 1,122 basis points last December, to a recent 876, which is still over the 800-point average. Peacher likes Mexican sovereign debt because he thinks the economy will continue to grow and borrowing levels will remain under control. The country's debt may also be raised to investment grade sometime next year. Consider investing in a no-load fund such as Scudder Emerging Markets Income, which returned 7.23% for the five years ended Nov. 30. After a disturbing 1999, the bond market appears poised to quiet down and give investors relief. Chances are good that for the first time in many months they won't be seeing their interest income wiped out by capital losses. By TODDI GUTNER _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP |
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