Financial News & TipsAlan S. Moore / L’Observateur / September 9, 1998With U.S. equity markets experiencing heightened volatility in recentweeks, the U.S. economy showing signs of slowing and emerging marketsin turmoil, it makes sense for total rate of return investors to revisit their asset allocation strategy and re-position a portion of their holdings into bonds-less volatile fixed-income securities.
Published 12:00 am Wednesday, September 9, 1998
Bonds are obligations from issuers to repay debt plus interest over a predetermined time period and offer a predictable income stream despite fluctuations in the stock market. As such, these fixed-income securitiesare generally less risky than stocks and have historically represented a safe haven for investors in times of market uncertainty.
Year-to-date, the bond market has recorded a gain of roughly 10% compared to the DJIA which has declined approximately 2-3%. Investorswho may want to realize losses to offset gains, may consider gradually reducing their exposure to higher risk equity holdings. Proceeds may bereinvested into corporate bonds- presently, ‘BBB’ corporate bond spreads in the 10 year maturity range have widened roughly 25-30 basis points on a net basis since early July, making this sector very attractive relative to the credit risks which have remained unchanged-that possess non-cyclical defensive characteristics and are trading at attractive valuations relative to the overall market. The following are some general guidelines:1. Strong Market Players. At this time, investors should consider buyingselectively into well-known investment-grade companies that benefit from strong market positions, have proven and credible management, generate significant and reliable free cash flow and offer good earnings prospects. There is a preference for industrial sectors that will be lessaffected by the impact of a cyclical downturn. These industries includeconsumer products, energy/utilities, healthcare/pharmaceuticals, pipelines, railroads, supermarkets/drugstores, waste services and diversified corporates.
2. Long-Duration, Low-Coupon Bonds. Treasury yields have declined 100-120 basis points over the past year. Importantly, current economic andmarket trends indicate that interest rates will continue to decline over the next six to 12 months. This implies that investors should focus onbuying longer duration, low coupon corporate bonds since these instruments tend to be more price sensitive with better performance in a contracting interest rate environment.
3. Liquidity. In a volatile market, investors should gravitate towards themore liquid issues that are actively traded. This allows investors toeasily unwind positions and re-allocate their asset mix if market direction or market sentiment changes.
4. Risk-Reward. Some investors may consider repositioning some of theirequity holdings into high yield corporates in order to preserve the potential for equity-like capital appreciation while dampening their portfolio’s volatility. To the extent high yield corporates make sense,investors should look to purchase the debt of large creditworthy businesses with significant equity value beneath their debt position, a business profile that will likely weather any economic downturn, positive cash flow and good call protection.
5. Finally, given that inflation is expected to remain relatively low in thenear term, the risk of erosion in bond returns is minimal.
Investors interested in making a change to their portfolios should contact their tax and financial advisors for help determining the right asset mix based upon their personal investment objectives and time horizon.
(Alan S. Moore is Financial Advisor in the New Orleans office of LeggMason Wood Walker, Inc., a diversified securities brokerage and financialservices firm that is a member of the New York Stock Exchange, Inc. andSIPC.)
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