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| Graham Allen |
Allen is a senior portfolio manager at Bradford & Marzec and manages up to $500 million in sovereign debt from Los Angeles. He joined the company in 1988 and was there for 10 years before going to Wells Capital Management in 1998. He returned to Bradford & Marzec last year.
What is your outlook for the sovereign market?
We're invested in the intermediate to short end of the yield curve of the dollar bloc countries like Australia, New Zealand and the U.K. The Bank of Australia, the Bank of New Zealand and the Bank of England have been increasing interest rates at a faster pace than the Federal Reserve. As a result, the short end of the yield curve has some fairly decent spread there.
If we do in fact go into a global slowdown next year, we could get a rally at the short end of the curve because the central banks have overdone the rate hikes. Here's why: the U.K. has had an extremely strong real estate market, which could be building inexorably higher. One reason they've been raising rates so aggressively is that they're trying to slow down property prices. If we go into a slowdown next year and prices start declining, they could very quickly change their tack and bring rates down a bit. In the meantime we're picking up decent yield over U.S. rates. The two-to-five-year gilt is 80 basis points over Treasuries.
How has recent weakness in the dollar affected your strategy?
We tend to invest in non-dollar sovereign bonds instead of Treasuries, so we're underweight in Treasuries, although not significantly, as part of our sector rotation.
Our non-dollar assets are invested in the sovereign bonds of developed countries such as Australia, Germany and New Zealand. We're generally very conservative on being exposed to foreign exchange because currencies are notoriously volatile. We've seen tremendous moves on the dollar. It's not unusual to see these kinds of volatile corrections. That level of volatility means that if you're going to be exposed to foreign exchange, you've got to monitor the situation and sell forward at a certain time and in a certain strike range.
Are you investing more heavily in TIPS?
We have held TIPS, but lately we have lightened up in TIPS because they have richened recently. We generally hold 10-year TIPS and in. We did participate in the five-, 10- and 20-year auctions.
What we've seen is that TIPS have performed quite well. Short-term rates have moved higher while long-term rates have stayed unchanged. Despite that, core inflation has been creeping up, as have gold and commodity prices. The inference is that the long end of the yield curve hasn't reflected the upward creep of inflation. One reason is the strong foreign demand for U.S. Treasuries. Our TIPS policy tends to be relatively short-term and that kind of scenario would advocate increased weighting to TIPS. If rates do move higher, we might consider that in the future.
What are your concerns for the corporate sector going into the end of the year?
We've been overweight spread product by 20% despite the fact that spreads have tightened in and spread improvement has run its course. We still think that value lies there. As we go into the end of the year, it's going to be quite crucial how the Christmas season pans out if you're looking for a continuation in growth in the U.S. economy and how spiking oil prices affect the economy's growth. You've got to be confident that oil will stay down in the lower $40s to stay invested in corporates because rising oil prices would eat into global disposable income. If we see oil at $50 and above, credit quality could deteriorate because of slowing growth, which could cause credit spreads to widen out.
We'll be looking at retail to see how the consumer is going to power the economy. Assuming we get relatively decent retail sales, we could be overweight in corporates going into the next year. Wal-Mart Stores is clearly important, but of course, Wal-Mart is at the low end of the retail scale. If you look at other retailers, the high end tends to do better in indications than the discount end. I'm not convinced Wal-Mart's warning that future sales will not be as high as expected shoots the plane down, but it calls into question how it will affect the rest of the retail outlets. Wal-Mart's warning was the first indication Christmas isn't going to be as strong as we thought it would be, although I expect a lot of purchases made online haven't been reported yet. Signs have been mixed, but even if we get an average Christmas season, we would look to be overweight.