(MENAFN- Khaleej Times) googletag.defineSlot('/1251894/Businessinarticle300x250', [300, 250],'div-gpt-ad-1479017441591-3').addService(googletag.pubads()); googletag.pubads().enableSyncRendering(); googletag.enableServices();googletag.display('div-gpt-ad-1479017441591-3'); The ancient Chinese curse "may you live in interesting times" is an apt epitaph for a global bond market that has lost $2 trillion since Election Day. Despite the upward shift and steeper slope of the US Treasury yield curve since Donald Trump won the White House on November 8, I still believe risks will rise, not fall, in the world debt markets in the next six months. One, Trump's economic policies mean a quantum rise in the US budget deficit at a time when the economy is at full employment. As the economy overheats on fiscal stimulus, the "bond vigilantes" demand a higher inflation risk premium and the Federal Reserve is forced to respond with a more aggressive stance on monetary tightening. This means it is probably time to book profits on bank equities, high yield debt, floating rate bank loans, agency mortgages, long duration investment grade corporate since the balance of risks, to borrow Dr. Greenspan's fabled phrase, no longer tilts in the arc of asymmetric, risk adjusted paydirt. Credit will be a tough place to hide for the complacent, the incompetent or the merely over leveraged.
Interest rate sensitive utilities and real estate trust (Retis) have been in bear markets since last summer, due to their role as "bond proxies" at a time when the ten-year US Treasury yield has risen almost 100 basis points from tis last cycle low. Despite the correction in US electrical utilities, the sector is not cheap at 17 times earnings while the average yield of 3.6 per cent is insufficient to compensate for both rising inflation and interest rate risk. While utilities have classic defensive characteristics, I cannot accept Morgan Stanley's case for a potential valuation rerating at a time when Wall Street faces at least six rate hikes in 2017 and 2018. I am also nervous about leveraged utilities funds that could be forced to liquidate shares if the Yellen Fed decides to get "ahead of the curve" in its monetary response to Trumpnomics.
Conventional wisdom dictates that a strengthening US economy is bullish for high yield debt. The problem is that the Street is long junk bonds up the wazoo. After all, the US high yield bond index fund (symbol JNK) was up 15 per cent in 2016, thanks to the spectacular recovery in energy and commodities issues. I would nibble at the high yield debt market if the index's credit spread to US Treasuries rises to at least 540 basis points. Leveraged high yield loans are unquestionably an attractive segment in the market, which benefit from post Trump economic momentum and bottom line windfall without excessive interest rate risk. Leveraged high yield loans benchmarked to LIBOR can offer a potential return of seven per cent in 2017. Bank loans are senior to bonds in the capital structure and have less duration risk. Energy loans to long life reserve shale oil producers in the Permian Basin are my preferred industry borrowers as they benefit most from Saudi Arabia's gift to the world oil market in Vienna.
The last six months were an exceptional opportunity to make money in the Alerian energy Master Limited Partnership index. Higher oil and gas prices have boosted the earnings prospects of energy midstream and pipeline MLP's and even after its recent rally the Alerian MLP index still trades at a seven per cent yield. Valuations are no longer cheap and if Brent falls below $50 (I expect zero compliance from Iraq a prospect not factored into the current black gold forward curve and it now makes sense to book profits here.
While Trump's election is nirvana for bank earnings, capital ratios and regulatory risk, the real juice since Election Day was investing in bank equities, not in their long maturity preferred shares hostage to interest rate risk. Despite the scale of the rally in US money center banks, I would accumulate trust banks (Bank of New York Mellon, State Street) as second derivative plays on rising interest rates.
Rising tensions between Washington and Beijing, Trump's protectionist big chill on world trade and 14 year highs on the US Dollar index is not exactly benign for investing in emerging markets debt. Political risks such as the Istanbul terror attacks, the impeachment of South Korean President Park, the mob rallies against the governor of Jakarta, India's rupee cash crunch, Malaysia's sovereign wealth scandal and Russian military interventions in Crimea/Ukraine/Syria are all scary. For now, I avoid EM dollar debt, other than inflation linked issues.
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