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As the calendar moves towards 2012, The Oseme Investment Management Team has been monitoring the global investment management macro landscape. The global financial markets are heading into 2012 in a challenging macro investment environment, with very high instability across most asset classes. We see positive risk/reward opportunities for fixed income investors in U.S. high quality investment grade corporate bonds. Fundamentally, funding, liquidity and transparency issues for most credit related issues demand a premium yield, with high quality investment grade securities trading at particularly attractive level points.
At Oseme Finance, we have been closely monitoring four factors that may foretell stabilization in the fixed income market. First, the rate at which large financial institutions are lending to one another and the abatement of fears of counterparty failure. Second, bank deleveraging is progressing, with decline in bank asset-to-tangible equity ratios. Third, financial markets tend to work through the downturn in U.S. corporate earnings. Fourth, the U.S. housing market, one of the major causes of the global financial downturn, may be the last aspect to show signs of bottoming out.
Inflation-Indexed Securities
In spite of investors’ fears over the dramatic increases in the price of crude oil in the early part of 2011, feeding thoughts of inflation, it has been deflationary fears that are paramount as we approach the latter part of the year. The severe deflation relation related displacement in Treasury Inflation Protected Securities (TIPS) has made this market especially inexpensive. As a background information, TIPS are securities whose coupon rate is fixed but whose principal is indexed to the U.S. headline CPI index, as inflation rises and falls, the principal of the bond fluctuates. At final maturity, the bond id redeemed at the inflation adjusted principal, or original issue principal, whichever is greater.
Pre-Refunded Municipal Bonds
Many of the credit related income markets were under strong selling pressure in 2010 and a prolonged flight-to-quality situation developed in which investors avoided virtually all non-U.S. Treasury fixed income securities. Municipal bonds also faced intense selling pressure during 2010. Prices fell on Municipal Bonds, pushing yields above the yields of comparable U.S. Treasuries for almost all maturities, which was relatively unusual. The Municipal Bond market is in the process of a fundamental pricing shift to an environment driven by credit sensitivity as the primary influence, followed secondarily by interest rate sensitivity. This is due to two factors: (a) credit rating downgrades of the monoline bond insurers which backed many municipal bond issues and (b) financial stresses inflicted by the economic recession on state and local municipalities’ credit ratings.
We are recommending Pre-Refunded Municipal Bonds as part of the Municipal Bond market that appears attractive. Pre-Refunded Municipal Bonds are previously issued Municipal Bonds which generally carry coupon rates that are above prevailing interest rates; such bonds have been determined by the municipality to be secured by an escrow fund sufficient to pay off the entire bond issue on a specific call date in the future. Pre-Refunded Municipal Bonds yields have historically approximated an average 80 percent of the yield on U.S. Treasuries, due to the Federal Income tax exemption on coupon income.
Dividend Growers
The U.S. equity market has become deeply oversold and it is a sign of valuation support for the markets. Secondly, the equity market has suffered a permanent de-rating and equity investors has been demanding a premium of risk-free U.S. Treasury Note yields as compensation to assume the risk of owning equities.
However, not all dividend paying equities are created equal. For investors focused on dividends, it is imperative for them to look for companies that not only pay dividends but also consistently grow their dividends. Historically, during periods of financial market turbulence, companies that have increased their dividends customarily outperform those that have reduced their dividends.
M. Isi Eromosele is the President | Chief Executive Officer | Executive Creative Director of Oseme Group - Oseme Creative | Oseme Consulting | Oseme Finance
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