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| Kris Kowal |
Kowal is chief investment officer of fixed income at DuPont in Wilmington, Del. It runs $5 billion in fixed income for the company's pension program and for outside accounts. The portfolio is comprised mostly of investment-grade paper with a 10-15% bucket for emerging markets and high yield.
Do you see any opportunities in high yield?
We have a tough time finding opportunities in high yield right now. We still have some selective opportunities and we're kind of riding our positions. We haven't put on any new positions this year; we have positions which are quite old where we really understand the credits. Overall there are more risks and the spread markets are pretty pricy as a result of the excess liquidity the Federal Reserve is talking about.
Do you think spreads are going to widen substantially? What does it hinge on?
I anticipate spread widening. Everything hangs on inflation and guessing how the Fed is going to react to inflation. In March, the [Federal Open Market Committee] was hawkish in the tightening cycle and turned toward inflation risk and oil hitting its second peak. The Fed believes the U.S. economy and the global economy are okay and in the U.S. the biggest risk is inflation. If you believe it's okay then there will be no big negative surprises and the Fed will continue to tighten by 25 basis points. They didn't drop the measured statement, but adjusted it because they want the market to know they could. They're moving away from being transparent and will start fighting inflation going forward. There's still a risk with inflation; if it comes in on May 3 that they raise another 25bps and then we see a really high inflation we could see 50bps, which would be bad, especially for the spread markets.
Are you avoiding spread product as a result?
We're still overweight high yield. We're overweight transportation and see limited opportunities in airline bonds, some utilities and some industrials. This year, though, we've had a tough time adding anything new and we've assumed a defensive position. We're underweight mortgage-backed securities versus Treasuries and staying underweight in investment-grade corporates.
In emerging markets, we're not concerned about fundamentals now. The Fed is orchestrating a soft landing here in the U.S. and oil can come down and emerging markets will do okay. I don't know if it will outperform. The problem is in every tightening cycle somebody lands into trouble. Previously the yield curve was too steep and short term rates were too low. Right now they're trying to take out excess liquidity maybe nobody will run into trouble, but I think somebody will run into it.
What sectors will be hit hardest?
Historically the sector that runs into trouble as rates go up is the banking sector, because that's how companies in the sector make money, by borrowing short and making it on the long end. There will be no banking crisis, but they'll have a tougher time making money. And some of the more leveraged players, like hedge funds, might run into trouble. We have an underweight in financial paper and like industrial companies and utilities better.
What's your view on rising interest rates?
I cannot predict the Fed, but we're modeling the 10-year in the range of 5%, 4-5% and for interest rates to move in time in the 5-5 1/2% range. We don't see rates going to 8% or anything unless there's really bad inflation; in our view inflation is edging higher but I don't think a huge rise in inflation is somewhere soon.
What credit trends are you focusing on?
There are definitely more shareholder-positive actions. Last year everybody was cleaning their books and balance sheets. At some point, they decided [to focus on] dividends which we're seeing right now. There was about a 2% rise in dividends over the last half a year and more M&A. We'll see that trend continue, but balance sheets and corporates are in pretty good shape. When the Fed overhikes that can put the economy into a recession. It can happen that the economy is going to slow down and the next half a year to a year, later on then some corporates will have trouble. Corporates did a pretty good job of clearing their balance sheets, refinancing debt with these low spreads, everybody is buying whatever comes to market.
Our central view on the economy is while we're not economists, if you play in fixed-income you have to have a view on the economy is that the economy is slowing down but we don't see a recession. All of these continued renewals of Fed policies... Congress is talking about fiscal balances, coupled with higher prices and higher rates reviving liquidity. In the second quarter we'll see the economy slow down but it could be good for the market if it stops worrying about inflation. We'll see 2-2 1/2 % growth and business conditions will be okay.