How do you expect the major asset classes to perform in 2005 and how are you positioned as a result?

Since we feel inflation is on the upswing, it follows that government bonds and very high-grade corporate bonds will probably not perform well on a relative basis. We will be underweight the pure interest-rate sensitive portion of the bond market as well as the interest-rate sensitive industry groups in the equity markets. On the other hand, a growing economy with slightly higher inflation should continue to be a reasonably favorable environment for credit-sensitive bonds in the mid- and low-grade categories. While some have expressed concerns for the high yield market due to narrow credit spreads and absolute yields that are not "high" on a historic basis, we believe that markets operate on a relative basis and the yields are competitive from that perspective. While default rates are below 2%, the market has priced this in, therefore high yield investors need to be ahead of the game regarding credit upgrades stemming from special situations. We always characterize the high yield market as investing in special situations, but in the next year it will be even more pronounced. Examples of such special situations include: merger activity that may improve credit ratings; private companies with public high-yield debt issuing IPOs and de-levering their balance sheets; and secondary stock offerings.

Both the equity and convertible market should benefit from an inflationary growth economy, improving prospects for IPO stock offerings, and a slightly less burdensome regulatory and governance environment. Corporate earnings should continue to grow, but at a slower rate as the rebound from the trough is well behind us. We believe that equity valuations are neither extremely cheap nor expensive so earnings may be the main driver of stock prices: with higher inflation looming, P/E expansion will be otherwise constrained, in our view. The weaker dollar favors large multinational companies while a slowing in earnings growth and an end to narrowing credit spreads favors large companies with stable growth. The emerging countries should also continue to do well as global growth continues apace. The most speculative stocks showed significant outperformance in the first phase of the rebound, but from here forward they will not be the stars of the show. Today, high-quality, low-volatility stocks are more attractively priced and should also benefit from the factors mentioned above. Additionally, the technology sector is full of risk and opportunity and we still feel this sector in a dynamic competitive market place offers some exciting growth opportunities. The convertible market should benefit from a reasonably strong equity backdrop, while securities with above average credit sensitivity will fare better than interest-rate sensitive securities. Continuing strength in the IPO market should also help feed new issuance in the convertible market. All in all, we expect the performance of convertible market to be competitive with equity markets.

« Previous | Overview | Next »