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| Greg Hosbein |
Greg Hosbein , portfolio manager, Segall Bryant & Hamill Investment Council What sectors do you think will outperform this year, and why?
Mortgages and high-grade corporates are two areas that could outperform this year based on the fact that the economy will continue growing and the treasury yield curve will begin to flatten. I would label it a bear flattener. Mortgages should do well because while rates may rise, interest rate volatility will decline along with pre-payments. In corporates, as the economy improves, it will continue to attract investor demand.
How will higher interest rates affect the technical outlook? Will issuers come to market as often and, if not, will this reduction in supply be positive for outstanding spreads?
Technicals in the corporate market remain solid. At the end of last year we saw a large amount of supply from one-off, smaller issuers trying to lock in lower rates. Corporate issuance could be lower this year, which will be positive for outstanding spreads. A lot of corporations spent the last two years terming out short-term borrowing needs or commercial paper and with the rebounding economy, companies will generate greater cash flow.
Will less supply put attention back on the secondary market and, if so, how do you expect liquidity to be?
Yes, attention will be back on the secondary market. Liquidity should remain solid at least until the Federal Reserve begins to raise rates. The low cost of funding and the steep yield curve are supporting liquidity. If you take away low-cost funding, liquidity could drive up pretty quickly. If short-term rates rise, liquidity will get worse. It really depends on how fast the Fed will react to the stronger economy and we think the Fed will be on hold for the first half of the year.
With the economy improving, a lot of investors are beginning to move down the credit ladder. Are there any red flags out there? What should bondholders be on the lookout for as they take on increasing levels of risk?
The thing to worry about when buying down is the fact that from a long-term perspective, you aren't getting rewarded on an absolute yield basis. We're seeing the average junk bond in the 6-7% range, selling at a premium, so you've got a lot more to lose than 12 months ago when high yields were around 10% and at a discount.
One industry to look out for is autos. They continue to be such a large part of the market and while sales have been good, you have to wonder how much is borrowed from future sales, discounts and finance specials. I think there is still opportunity in off-the-run names which are generally ignored by the market; mainly, smaller issuers in the industrial area. This year is going to be a game of protecting what you've earned over the last few years.