2 things struck me recently.
1) Most stock markets, e.g. S&P500, MSCI World etc have entered into a decline. It is a stage where I would never enter the markets. However, I've discovered certain markets that are still in stage 2, in an upward trendline. Some are cheap, some are not. I'll be calling some of you to discuss how to take advantage of these leading markets.
2) The JP Morgan Investment Grade Index is at 250bps. I assume the blended IG rating is around A, because investment grade ranges from AAA to BBB. In 2007, the thinnest spread seen was around 100bps or slightly less. Now if the US raises interest rates by 1.5 percentage points in 2011 and the Fed Funds end up at 2%, the yield curve could steepen even more as the tenor rises. The 5 year risk free could rise by 1.7% and 10 year could rise to 4.5% or 2%. The max an IG bond can tighten is by 1.5% so a 5 year IG bond could see rates rise by 0.2% and a 10 year IG bond could rise by 0.5%. A 5 year IG bond's price could fall by 1% and a 10 year fall by 5%.
But the High Yield Index (BB to C, average B) is at 740bps. The lowest was in 2007 at 300bps. There is room to tighten by around 340bps. A 5yr risk free rising by 1.7% could still see rates for High Yields fall by 1.7%. This could mean a capital appreciation of around 7 - 8%. 10yr risk free rising by 2% could still see a fall in HY rates by 140bps. A 10-y HY bond could appreciate by around 12 - 14%. The biggest upside seems to be in HY bonds/perps/convertible bonds now.
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