Fixed-income investors are exercising patience these days, with slow-moving rates that are expected to edge up slightly in 2011.
Although bond strategists at Neuberger Berman foresee a slow recovery in mortgage-related investments, stronger high-yield fundamentals could reward investors for their loyalty to the assets.
For one thing, high-yield default rates could drop to near zero in 2011. During the Great Recession, about 25% of high-yield debt had defaulted. That occurrence had the effect of sloughing off bad credits, leaving the industry with companies that had better credit profiles than they had before the recession, Thomas P. O’Reilly, a managing director, said during a Wednesday outlook event in New York City. O’Reilly, who also is co-portfolio manager for high yield and blended credit portfolios cited a couple of other reasons for the better prospects.
As the high yield markets revived in 2010, issuance had reached about $250 billion, two-thirds of which was refinance business. “That has taken care of a lot of near-term needs,” O’Reilly said. Together with an improving economy, all signs for a more positive 2011 are in place.
O’Reilly said he is looking for returns to fall in a range between high single-digit and low double digits for the next year.
Housing values have a shorter distance to fall before bottoming out, but that point is within striking distance, according to Thomas Sontag, a managing director at Neuberger Berman. While the Case-Shiller Index estimates that housing prices have fallen 28% from their peak, Neuberger Berman estimates that prices are down about 30%, and the industry is about 5% off of the bottom, Sontag said.
“The real issue out there is we don’t foresee any recovery in housing prices in the next four to five years,” Sontag said. A number of government programs designed to relieve homeowners in duress have prolonged foreclosure processes.
Also, there are apparently four million homes for sale in the country, representing an inventory span of 10 months. Worse still, is a so-called shadow inventory of seven million homes, which will take about 40 months to work through, Sontag said. That will drag out the price recovery, he said.
Government rescue programs for homeowners have also allowed some to live in their homes for 25 months without making any mortgage payments. “The market has given the signal that they can stay in their homes without paying for two years,” Sontag said.
While fixed-income investors are certainly affected by the dynamics of the high-yield and mortgage sub-sectors, many want to know how patient they have to be with low rates. Andrew Johnson, a managing director and chief investment officer for investment grade strategies, said a 10-year Treasury bill at 3.5% makes eminent sense. “Absent a rise in inflation, we have no expectation for rates to be materially higher,” Johnson said. “Rates are fair today and will evolve as the economy evolves.”
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