December 20, 2012
Reflecting on the past year brings about a few recurring themes: the fiscal cliff, the European debt crisis, housing, employment, and actions of the Federal Reserve. The outcomes of many of these situations are well beyond our control, but the allocation of our capital is well within our control. Lacking a crystal ball, long term investors may want to continue to focus on a diverse array of asset classes, with a low correlation among one another, focused on achieving the greatest return per unit of risk. Depending on risk tolerances, Alamo Capital continues to see favorable values in global equity indexes, as well as municipal and mortgage bond markets, and we are allocating less capital toward the corporate bond market.
The corporate bond market had a great run in 2012. Issuers took advantage of near record low yields and refinanced debt at an unprecedented pace. As a result, many investors saw their bonds get called away, with the opportunity to reinvest at lower rates. High-grade debt saw 10-year yields of some companies lag both their respective equity dividends, and long-term inflationary expectations. Both of those figures defy long-term fixed income investing principles, and spurs thoughts of a bubble effect. In the event interest rates rise, bonds with smaller coupons, such as many of this year’s new issues, will experience more severe price changes. While that matters less if a position is held to maturity, it matters far more if an investor holds a bond fund, as they will be subject to both the current net asset value, and redemptions. Some analysts are predicting a high-grade corporate bond fund bubble may be close to popping. However, the federal reserve has modified their language from keeping interest rates near all-time lows through 2015, to maintaining current rates until unemployment dips below 6.5%, so long as inflation stays below 2.5%. While interest rates should seemingly bounce off of near historic lows at some point, there are a number of barriers that could make it challenging for unemployment to dip below 6.5%.
Municipal bonds continue to represent an enticing value to investors. With the ratio of tax-free municipal bonds to comparably rated treasuries staying in excess of 1, in relation to a historical mean of 0.8, we expect municipal bonds to perform favorably in comparison to corporate debt and treasuries. Talks of limiting tax deductions has struck fear in some investors, though due to the fact that other common deductions such as child, education, home interest, would be included in such a deal, we believe investors are more likely to face higher personal income tax rates. The aforementioned deductions benefit lower-income individuals and families the most, the exact people the government is striving to lower the effective tax rate for. Alamo Capital feels income, dividend, and capital gains taxes are likely to rise, which makes tax-free income from municipal bond investments all the more desirable. Quite a few bonds have been getting called away, however, redevelopment agencies have thus far been prevented from being called due to ABX126, barring a few exceptions, including unspent bond proceeds, and evolving interpretations of the legislation. If investors have learned one thing over the past few years, when uncertainty begins to stir, they ought to be searching for opportunities.
We are excited for the prospects that lay ahead in 2013. While the macroeconomic picture may be fluid, we continue to adapt to seek what we view as the best opportunities for our clients. Our Investment Information department is filled with investment philosophies designed to help your money work for you, based on your personal risk tolerances. By creating balanced portfolios, catered to each individual client, featuring diversified equity and fixed income strategies, many clients have been rather pleased with the long term results. Whether you watch your investments on a daily basis, or haven’t looked at your portfolio since your last statement, we encourage you to speak with your Alamo Capital Investment Advisor to find the best solutions for your investment portfolio. From all of us at Alamo Capital, we wish you a Happy New Year!