My outlook for 2010:
- Weak recovery: High unemployment and low expected growth rate of 2.5%-3% in 2010, not enough to push the unemployment rate under 9%, will force the FED to keep the target rate low.
- Steeply sloped yield curve due to low FED rate will maintain the short end of the curve down throughout 2010. Given a slow recovery, it will take some time before the FED raises the rate. The soonest will be at the June 2010 meeting. The FED Fund rate future (July 2010) priced in a 46% chance of a rate hike to 0.50%; we rather believe in an incremental increase to 0.25% to first gauge the market response before another 0.25% increase comes toward the end of 2010.
- Low inflation expectation in the next 12 months as all measures of inflation, CPI, PCE and PPI, show little price pressure. Consumer balance sheet de-leveraging will maintain CPI from expanding rapidly. Without a significant inflow in credit, it is difficult to envision a scenario in which prices rise rapidly out of control.
- Expected mortgage market to bottom mid of 2010 as predicted by the Case Shiller index.
Based on this market view we recommend:
- Investing in intermediate maturities fixed income securities with 5-7 years maturity and 4-6 in durations to benefit from the sloped yield curve in the intermediate range, that provide a relatively higher yield compare to short end and longer end of the curve.
- Investing in intermediate Collateralized Mortgage Obligations 5 years maturities, which also benefit from the attractiveness of the intermediate level of the yield curve. Planned Amortization Class (NYSE:PAC) Tranches are more attractive offering regular payments, relative safety, and notable yield advantages over other fixed-income securities of comparable credit quality. (Extension risk in the second half of next year)
- Investing in corporate sector, although the spread are tightening across the sector, there are still some opportunities in the Financial sectors which still offer good spread with substantial return.
- Investing in short term duration High Yield still attractive, but yields will rapidly decrease as the economy is improving.
- We think that there is some good value in the taxable-municipal-bond market, which relates to the running stimulus package. Lower defaults than corporate bonds with comparable yields.
