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| David Horowitz |
Horowitz is a managing director and portfolio manager at Morgan Stanley Investment Management in New York. He is a member of MSIM's senior strategy team and leader of its high-grade credit research team. The high-grade credit portion comprises $17-20 billion across MSIM's core product funds.
Where do you see value?
In the corporate bond market, we don't see a lot. We did see in April a jump up in yield and spreads, but now we're approaching spread levels like those in March where spreads were not that attractive. The way we work things is we take prices from the market and take a view when the market takes an extreme position. Right now, corporate pricings are optimistic on the economy while the Treasury market is pessimistic on the economy. That represents some opportunity; we are not that constructive on credit.
Are there any industry sectors that are attractive?
There are a few sectors. We did have a significant overweight to the autos which we put on after their big move downward and that was a good trade for us. When the market has a clear overreaction to news flows, we'll take a view on a company. We think we're going to make money on a name where we see a specific opportunity, we're not currently seeing any good opportunities by being generally long the market.
I hate to say this phrase, but it is 'a bond picker's market.' Some of the trades that are going to be there are from news-driven cuts. The grocers are a sector where everybody has been talking about LBOs, which was again an opportunity for us which we capitalized on. We're looking for specific opportunities in an industry or in specific names and we're focusing on taking profits in our recent trades.
How are you going to generate returns during the latter half of the year?
We have been able to generate alpha in credit by being selective in securities. That's how we're going to do it going forward. We don't expect a broad market view to add alpha today. Current valuations are fairly full so we simply don't see the opportunities on a general sense that we look for. It's not the type of market where you'll outperform by 200 basis points in credit, but we will chip away and add incremental returns.
Do you feel the market has regained its stability?
That's our baseline view, but that's not how we're investing because that view is already fully priced into the market. I find it interesting how quickly sentiment has changed in the market. We hit the end of March and everybody's afraid: there are concerns about the auto market, correlation products and LBO rumors. And now we're almost back to early March sentiment. We're enjoying the volatility because it gives us opportunity. While the baseline view is for low volatility there is no opportunity there because it's fully priced in. If vol increases, that's how we'll make money. One measure of vol, the VIX, is near its 10-year low, so the market is pricing in an extremely low expectation for volatility. When the market takes an extreme forecast, that provides us with opportunity. The way to express it is not to be caught overweight in credit. We are either flat or underweight credit across our funds.
Are there any names or sectors you'd highlight as being attractive?
I'd rather not name specific names. We do think the Canadian newsprint sector is very much overlooked and is pricing in a pessimistic view of paper. Demand for paper is in a secular decline as online news picks up. But companies have done a good job of shuttering their capacity and we think the pessimistic view is extreme.
Are there any sectors you're avoiding?
We're avoiding the bank and broker sectors. We think those bonds are priced extremely expensively. They do have exposure to an inverted yield curve. As the curve flattens, their earnings could diminish. A very optimistic view is priced into their spreads. I don't know if I expect an inverted yield curve, but I do expect a flattening curve.
Do you expect the Federal Reserve to continue raising rates? To what level?
I think the Fed is a long way away from stopping. There's no number I'm looking at, but 3 1/4% is a long ways away. We think the market is being extremely pessimistic about the economy and optimistic about the Fed tightening.
Are you still concerned about shareholder-friendly and bondholder-unfriendly activities?
Absolutely. At the beginning of the year there was a pick up in LBOs and share buybacks. After 2002, corporations were doing a good job with their balance sheets. Now they think it's time to give back to their shareholders, which gives you some pause in the credit markets. In the spring, everyone was concerned about LBOs in retail, but that didn't happen to the extent it was priced in. We'll continue to avoid things like Kerr McGee. That was another opportunity to sell in front of the news happening, and buy after the news hit. I'd rather not name specific companies or industries we think are the most likely to be susceptible going forward. Our research is ongoing to uncover these sorts of opportunities.
How would you describe your investing strategy?
Many traditional managers use a purely fundamental approach, but we use a 50-50 blend of quant screens and fundamental analysis. We look at the bond market, the stock market and stock options. This allows us to screen out bonds that are very expensive or cheap. We think the correlation between the stock options market and the bond market is here to stay. Our job is to uncover value by extracting market forecasts from market prices and capitalizing on the opportunities where our fundamental view differs significantly from the market's.
What other trends are you focusing on?
We're trying to get more information on what we saw in April with the risk of leverage in the credit markets. While we did see some shaking out of some of that, we don't believe that's through. We don't know when, but it will shake out again it's a real shadow hanging over the bond market. If we see some defaults in high yield that could prompt the shake out.
Actually, my background was in mortgage-backed securities, and I remember when the collateralized mortgage obligation market came off the ground, which was shook out as well and came back to more simple structures. At some point, people start to lose understanding of what they're buying and are just reaching for extra yield. The credit derivatives markets seem to also be increasing in complexity and we would expect that eventually there would be some sort of an evolution similar to the CMO market which may prove to be painful for some players.