War Room 28 March 2012 Fixed Income in 2012: Are Bonds Still En Vogue?

War Room Monthly macro discussion Using tools in context Update on HiddenLevers Features Your feedback welcome

Fixed Income in 2012 – Are Bonds Still En Vogue? Market Snapshot Fixed Income Fundamentals Outlook + Scenarios Fixed Income Functionality

FIXED INCOME IN 2012: MARKET SNAPSHOT HiddenLevers

Market Snapshot: US Benchmark Rate US Interest Rates at all time low, and pledge from Fed extended – rates will remain here until mid The New Normal

Market Snapshot – Fixed Income good stories Treasuries + Emerging Markets Debt Funds have trounced the S&P 500, without the volatility

Market Snapshot – Fixed Income good stories Less volatility since the crisis helps folks sleep better Many still haunted by Meredith Whitney comments in October 2010 for no reason

FIXED INCOME FUNDAMENTALS HiddenLevers

Fixed Income: Credit Risk Profiles Even through financial crisis, credit risk not an issue for investment grade – but CCC and below has 57% lifetime default rate.

Credit Risk: HY Credit Spreads Credit spreads much narrower than crisis levels Still above 30 yr average Further narrowing = upside for HY, Munis, EM debt Widening = flight back to treasuries Sources: Citigroup + BofA Merrill Lynch

Interest Rate Risk - Duration How to control duration? Shorten maturities Increase yield Hold to maturity Floating rate issues Higher yield considerations Increased credit risk Higher correlation to stocks Sources: National Associations of Realtors, Home Builders, and Wells Fargo

Interest Rate Risk: Yield Curve The current yield curve is significantly lower than historical averages, with seemingly little precedent to drop further – High Inflation 2003 – Last Recovery Last Cycle Peak What's Next? Avg Yield Curve Source: Fidelity

FIXED INCOME IN 2012: OUTLOOK + SCENARIOS HiddenLevers

Interest Rates Stay Low – Deflation Worry US Interest rates going nowhere Bernanke’s worst fear, and the reason for QE

Consequences - Inflation: 1.Fed forced to tighten to contain inflation pledge goes bye bye – Fed eats crow 3.Commodities keep rising – push cost of everything 4.Negative impact for equities and bond markets Interest Rates Rise – What is the Driver? Consequences - Growth: 1.Fed tightens as we get back to normalcy 2. Borrowing costs rise for financial firms, REITs 3.Bullish for equities as bonds lose luster 4.Precious metals not as shiny either

FIXED INCOME – NEW FEATURES HiddenLevers

HiddenLevers - New Features Fixed Income Support Cusips + Options now uploadable Macro Profile for Portfolio – need feedback Coming soon: Scenario Hedging Wizard Excel-type pasting for Add Portfolio

Fixed Income Functionality CUSIPs now supported in edit portfolio or via portfolio upload You can also manually enter custom fixed-income or cash- flow investments (including real estate) How it works: – Interest Rate Risk Modeling: Calculates duration and convexity to model interest rate risk – Credit Risk Modeling: Uses industry/sector or proxy symbol to determine correlations, and uses ratings to determine volatility