| BUSINESSWEEK ONLINE : JUNE 14, 1999 ISSUE | |||||||||||||||||||||||||||
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| COVER STORY
Make a Buck in Bonds Last year, Treasuries were the stars. Not anymore With the U.S. Treasury market locked in a battle between inflation hawks and New Economy thinkers who believe inflation is dead for now, yields on 30-year government bonds have been stuck between 5.25% and 6% for more than four months. This means investors can look forward to none of the capital gains they earned last year, when long bond yields plunged to a record 4.72% and prices soared. But this doesn't mean the bond market is bereft of value. Credit-market experts say you can still find good deals in corporate, municipal, and even emerging-market debt. ''I'm buying everything but Treasuries,'' says Daniel J. Fuss, managing partner for fixed income at Loomis, Sayles & Co(NEW). One big reason Fuss is in the market is that despite plenty of jitters over inflation and future Federal Reserve rate hikes, the economic environment remains relatively sanguine for bonds. To be sure, after the consumer price index took an unexpected 0.7% jump in April, the Fed warned that it was thinking about raising interest rates for the first time since March, 1997. Still, ''we are relatively optimistic about inflation'' remaining low, says Elliott Platt, director of economic research at Donaldson, Lufkin & Jenrette Inc., who expects economic growth to slow to 3% over the next six months, from 4.1% in the first quarter. What's more, ''there are still substantial problems remaining in the global economy,'' which would cause the Fed to pause before raising rates, adds William H. Gross, managing director of Pacific Investment Management Co. (PIMCO). HIKE HINTS. In fact, the Fed's very act of expressing its bias toward tighter money helped drive bond-market yields up. That may have accomplished the equivalent of tightening--but without an official rate hike. Most experts agree now that the Fed is likely to leave the federal funds rate--the rate on overnight loans among banks--at 4.75%. At most, they say, it might rise a modest 25 basis points over the next six months. Unlike 1998, when Treasuries were star performers, this year you'll need to take on some more risk to make a buck in bonds. That doesn't bother Wayne D. Lyski, chief investment officer at Alliance Fixed Income Investors. ''The market has unfairly discounted investment-grade and high-yield corporates and emerging-market debt because of inflation fears,'' he says. John Bender, co-manager of Strong Corporate Bond Fund, agrees. He likes telephone companies such as Sprint Corp.(FON) and MCI WorldCom Inc.(WCOM) because he thinks they have more stable earnings and cash flow than cyclical companies. He's also buying cable operators, including Time Warner Inc.(TWX) and Cablevision Systems Corp.(CVC), because he thinks they are well positioned to benefit from telecommunication deregulation. It's true that default rates on high-yield bonds have risen from a low of 1.5% in 1996 to 3.8% at the end of April. That's slightly above the long-term average default rate of 3.3%. Hard times in the oil patch account for some of the rise. As crude prices slumped a few months ago, some debt-laden energy companies suffered badly. Forcenergy Inc.(FEN), an oil and natural gas exploration company, filed for Chapter 11 bankruptcy this spring. Indeed, recent high-yield defaults ''reflect a problem with particular issues that should have never come to market in the first place, but not with the high-yield market overall,'' says Margaret Patel, portfolio manager for New York-based Third Avenue High-Yield fund. The high-yield sector still offers some good value, with yields of more than 9%. Patel is making a big bet on the fast-growing telecommunications industry. Level 3 Communications(LVLT) is one favorite. It's building a global, Internet-based network to transport data at low cost. Nextlink Communications(NXLK), a telecommunications provider to business customers, is another Patel favorite. Both are publicly traded. Investors who are willing to stomach volatility can find some bargains in emerging-market debt. After a gut-wrenching 1998, J.P. Morgan & Co.'s emerging-markets bond index has rebounded 5.8% through May 28. New York-based global economic consultant Maria Fiorini Ramirez likes Mexico because she thinks it will continue to benefit from strong U.S. economic growth. A robust stock market, up 50% this year in dollar terms, has helped bolster Mexican debt as well. Ramirez also expects Asia to have a decent rebound, with 4% economic growth outside of Japan, and recommends South Korean and Thai state debt. Both countries are further ahead in complying with International Monetary Fund guidelines than other Asian nations. Because it's very difficult for individuals to play many of these markets, the best way to dip into this sector is through such mutual funds as Fidelity Advisor Emerging Markets Income or Fidelity New Markets. Both returned nearly 12% through May 27. SAFETY FIRST? If you'd rather stick to safer havens and solid returns, you might want to look at mortgage-backed securities. These are packages of home mortgages bundled together and sold to investors. ''They are currently yielding about 130 basis points over Treasuries, the prepayment risk is low, and supply is dwindling, which all bode well for investors,'' says Dan Dektar, a portfolio manager of Smith Breeden Intermediate Duration U.S. Government fund. Dektar's fund is up 0.59% through May 28, vs. a 1.1% drop for three- to five-year Treasuries. Although bargains are rare in municipals, there are still some decent buys, says Marilyn Cohen, president of Envision Capital Management Inc., a Los Angeles fixed-income management firm. She recommends staying in the intermediate range of 7 to 15 years. Fifteen-year tax-free municipal bonds rated AA now yield an average of 5%. That's 89% of the yield on 15-year Treasuries. Historically, muni investors could expect only 82% of the Treasury yield, and the current aftertax return on Treasuries is lower than on munis, says Thomas C. Spalding, senior investment officer for John Nuveen & Co(JNC). Although corporates and munis are the bond mavens' picks for now, one class of Treasuries still stands out: TIPS. PIMCO's Bill Gross now has about 4%, or $6 billion of his $160 billion portfolio in Treasury Inflation-Indexed Securities, commonly known as TIPS. ''When the consumer price index goes up 0.7% in one month, that goes straight to the bottom line,'' says Gross. He bought TIPS because they were cheap relative to the rest of the market and figured that TIPS would do well if inflation was higher than 1.7%--which it was at the time of his purchase. Gross expects to participate in the next TIPS auction in early July. On the overall bond market, he remains ''cautious, with my eyes open and my fingers crossed.'' Even during this period of angst about future inflation, it's still possible to invest in bonds and get a decent return. BY TODDI GUTNER _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP |
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