Peter Demirali, portfolio manager at New Jersey-based Cumberland Advisors, says that he will increase the firm's corporate exposure by 20%, or $40 million, once the equity market improves. He will swap out of $20 million in taxable municipal bonds and agencies. The move will be triggered when the Dow Jones Industrial Average returns to the 9000 level. He says, it should hit that level early in the fourth quarter, once the accounting environment reaches a healthier state and due to regulatory changes and cleaner earnings looking forward. He states that the economy continues to be strong and that the poor performance of the equity market is entirely attributable to accounting scandals. When the trigger is hit, Demirali expects corporate spreads to stabilize first, before beginning to tighten as the equity market further improves.
Demirali plans to buy the Citigroup 6.75% notes of '05 (Aa1/AA-), which were trading at 142 basis points over the curve last Monday. He says Citigroup bonds have widened out under both accounting and Latin America related woes, but he expects the spreads to come in. He feels confident with this name, as the bank is a solid double-A financial group pretty well diversified with its insurance, banking and securities businesses and good at risk management. Another likely purchase is the General Electric 4.25% notes of '05 (Aa2/A+), which were 91 basis points off the curve last Monday. Demirali says he likes this solid industrial group as he thinks its earnings will to hold up. He will also buy the Bank of America 6.62% notes of '04, which were yielding 50 basis points over Treasuries last Monday.
To finance those purchases, the firm will sell equal amounts of agencies and municipal bonds. Taxable munis have performed very well, he says, because they have not been exposed to accounting scandals. He will also sell Fannie Mae and Freddie Mac debentures. He reasons that with agency spreads tighter over the curve than corporate spreads, there is less room for further spread tightening in the agency sector.
Demirali manages a $200 million portfolio. He allocates 40% to TIPS, 35% to taxable munis, 15% to agencies, 5% to corporate investment-grade and 5% to Treasuries. The fund's duration, at 3.0-years, is significantly shorter than its benchmark, the Lehman Brothers government/credit index, which has a 5.46-year duration.
