Monday, January 11, 2010

Thought of the Day

Monness, Crespi, Hardt & Co., Inc.

767 Third Avenue
New York, NY 10017
212 838 7575
Sydney M. Williams
Thought of the Day
January 11, 2010

The yield on Treasuries rose in 2009 making U.S. Government Securities – the stand-out investment in 2008 – the goat last year. Money poured into corporate bond funds, to the tune of $239 billion, helping to bring down yields on Investment Grade Corporates by 128 basis points and on High Yield bonds by 786 basis points. Spreads between High Yield and Investment Grade and Investment Grade and Treasuries narrowed considerably, by 650 basis points and 298 basis points respectively. In other words, the further one went out on the risk curve in 2009, the better the performance.

Spreads are now below where they were at the end of 2007. It is hard to imagine that 2010 will be a repeat of 2009, at least as far as corporate bonds are concerned.

The growing federal deficit with the spending program in place, along with that proposed, will continue to put pressure on Treasuries. In fact, the Treasury just announced an increase in the TIPS (Treasury Inflation-Protected Securities) program, a recognition of the increasing creditor demand from China and Japan. The fiscal status of most States remains a mess. The incredible deal struck by Senator Ben Nelson of Nebraska and Harry Reid, in which the Federal government would pick up, in perpetuity, increased Medicaid costs associated with the ill-conceived health care Bill has raised the anger of governors in states such as California and New York with much larger Medicaid problems. (Senator Nelson now claims he never meant to have Nebraska receive special treatment. It is truly amazing how these guys can lie so brazenly! Term limits cannot arrive soon enough!) Given the sorry fiscal condition of State budgets, pressure will only intensify to add the estimated $25 to $30 billion Medicaid costs to the Federal deficit.

With mid-term elections around the corner and unemployment elevated, the Administration’s focus will finally move from health care, climate change and cap-and-trade to jobs. The economic recovery, even if slower than normal – restrained by a chastened consumer and rising taxes – will induce higher borrowing costs. Any whiff of inflation and bond funds will watch inflows morph into redemptions. In fixed income markets, ironically, municipals alone may have a good 2010. The problems within States have been widely publicized, so are well known and are likely discounted. Additionally, rising taxes increases the attractiveness of this tax-exempt sector.

It is widely anticipated that JP Morgan will be the first of the bailed-out banks to increase its dividend – a welcome relief to shareholders who were hit in the last two years, not only in their capital accounts, but, important to an aging population, in terms of income. Because of the greatly increased number of shares outstanding for many of these banks, it is unlikely that former dividend rates will be restored, but increases are better than decreases.

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