As portfolio managers set their investment compasses for 1994, many say the needles are pointing toward equities and away from fixed-income instruments.
Realizing that they will be hard pressed to match the stellar performances in the U.S. bond market this year, many money managers say they are shying away from fixed-income investments and putting their money into equities. They argue that stocks will offer a better rate of return than securities backed by the U.S. Treasury and corporations.
"The rest of the 1990s belongs clearly to equities," said Heiko H. Thieme, chief executive officer of the American Heritage Management Corp. and portfolio manager of the American Heritage Fund. "This trend will become more evident in the next few months."
U.S. fixed-income investments will probably underperform stocks because the latest interest rate cycle has run its full course and money managers believe rates around the globe are likely to change little in the next several months. Against that backdrop, liquidity in the bond market has hit a peak and will evaporate as the U.S. economy continues to build momentum.
"The trough in interest rates has been seen for this cycle, but the threat of a sharp rise is still distant," said Stanley A. Nabi, chief investment strategist at the Bessemer Trust Co. "I see less volatility in the U.S. bond market and less opportunity for profit."
Nabi said that with intermediate and long-term rates at levels not seen for more that a generation, "returns in the fixed-income sector are not likely to exceed the coupon over the next 12 months."
In betting that short-term rates will hold steady in the United States, Nabi asserts that with global real interest rates mostly higher than those in the U.S., the Federal Reserve may await the potentially favorable impact of declining rates among other export partners before taking action.
While admitting he is worried about increased volatility in the global financial markets, Nabi said he believes there will be excellent "value" investment opportunities in equities in such sectors as diversified manufacturing, energy, specialty chemicals, and transportation.
The risk for the U.S. bond market is the loss of an important source of sponsorship - the retail investors who played a key role in the great bond market rally of 1993. Treasury market participants say that the lack of buy-side demand for paper could pose serious problems for the market and the overall direction of long-term interest rates.
"If portfolio managers steer clear of governments, it will have negative implications both in terms of rates and overall morale in the market," said James Somers, president of Somers Asset Management Inc. in Radnor, Pa. "It would not be a good development."
But in. keeping with the idea of a well-diversified portfolio, U.S. based money managers have not written off fixed-income investments all together.
For those looking to stock up on bonds, Nabi's strategy is to gradually shorten portfolio duration and to apply a balanced mix of very short and very long maturities, in the shape of a barbell, to gamer the largest return with the lowest risk.
Provided that the inflation trend in America remains constructive to the markets, Thieme's game plan is to buy long-dated Treasury paper at higher yield levels. "I would be a big buyer of bonds if yields rose significantly over 6.25%," he said.
The bite of upcoming tax increases has brought municipal bonds into vogue. Most believe tax-exempt bonds remain quite attractive on a tax-adjusted basis and will benefit from increased sponsorship at the expense of government and corporate securities.
"Higher taxes in the U.S. are making municipal bonds more attractive," said G. David MacEwen, senior municipal portfolio manager at The Benham Group in Mountain View, Calif.
Most money managers suggest putting at least some portion of one's portfolio into tax-free bonds, particularly those in the intermediate maturity sector of the market. Money managers generally are buying municipal bonds in maturities ranging from five to seven years to shield themselves from the potential for a sudden spike in interest rates.
For example, Bessemer Trust is recommending that its clients invest about 26% of their portfolios in munis.