JP Turner & Company, LLC

    Caught between a rock and a hard place. That’s a pretty accurate way to describe the current dilemma facing conservative investors (income is secondary to principal preservation) in the bond market. On the one hand, aggressive easing by Federal Reserve policymakers continues to reduce the appeal of closely-indexed money market instruments such as T-bills, CDs and money markets. On the other hand, to capture higher returns, investors must either extend maturities on more volatile higher quality bonds (thereby increasing interest rate risk) and/or consider lower-tier investment grade bonds (increasing credit risk).
    With longer term Treasuries rates trading close to 45-year lows and much of the corporate bond and mortgage market in a state of flux due to the ongoing credit and subprime mortgage crisis, it’s easy to under-stand why many investors are confused about what to do with their savings and why money market balances re-main at record levels.
    Unfortunately, we don’t expect conditions in the Treasury sector to get “friendlier” anytime soon. Right now, we believe the futures and cash markets are priced for another 50 basis points in rate cuts which should push returns on money market instruments yet lower. It appears Fed policymakers aren’t going to stop reducing rates until they see money market balances begin to decline and reinvested elsewhere in the economy.
    Conversely, look for longer term rates, which are determined by investors, to start moving higher as it be-comes more apparent the Fed’s unprecedented liquidity infusion is rekindling growth but also potential inflation problems down the road. The bond market almost always anticipates changes in monetary policy and the economy ahead of the Fed and we could be close to such a turning point now.
    Bill Gross, a highly respected institutional bond investor, recently opined in an interview “Treasuries are the most overvalued asset in the world, bar none”. We’ve been bearish on Treasuries for some time and think longer term rates could be as much as 100 basis points higher by the end of this year. Because bond prices move inversely with yields, such a rate scenario would translate to paper losses on not just governments but also fixed-rate agencies, certain mortgages, and higher quality corporates and municipals with the longest maturities suffering the greatest price erosion.
    We recommend clients with undue exposure to more interest rate-sensitive securities begin reducing maturities (limiting average durations on portfolios to seven years and less) and reinvesting the proceeds in a combination of FDIC-insured CDs, floating rate coupons, shorter term mortgages and more economically-sensitive lower-tier investment grade bonds.

After Hitting Five-Year Highs In March, Investment Grade Corporate Bond Spreads Starting To Narrow

    All the news surrounding higher quality taxable bonds, however, isn’t bad. After briefly breeching five-year highs of 300 basis points in mid-March, spreads (yield advantage over benchmark Treasuries) on investment grade corporates – bonds rated Baa3 and above by Moody’s and BBB- and higher by Standard & Poor’s – have begun to narrow. We attribute the improved performance to a combination of factors including: expectations the bulk of the mega writedowns on bad loans is behind us, confidence aggressive, multi-faceted liquidity moves by the Fed staves off a protracted recession, stabilizing equity prices and pickup in primary issuance.
    It’s no coincidence prices on higher risk/higher return assets like corporate bonds and stocks are improving as prices on creditworthy Treasuries are falling, a reversal of the “flight to safety” that’s dominated the financial markets the previous two quarters. The big unknown, of course, is whether these investors are correct or early.
    Our sense is Mr. Market is on to something and the first quarter will mark a trough in the mega writedowns by major financial institutions – the bad news continues but gets gradually better and corporate bond spreads relative to Treasuries narrow further in the second half of 2008.
    One final observation. The credit crisis has resulted in two very different markets in terms of yields and risk within the investment grade corporate sector. For example, there’s little yield advantage (over Treasuries) on the debt of bluechip companies without direct exposure to the subprime meltdown due to strong demand. In fact, FDIC-insured certificates of deposit maturing in three years and less continue to pay very close to the same rates as AAA/AA rated corporates with comparable maturities. This is the reason we continue to believe government-guaranteed CDs (up to $100,000) offer the best alternative for shorter term safe monies.
    At the other end of the risk/yield spectrum in the investment grade corporate universe are the bonds of corpor-ations – especially brokers, banks and finance companies – hurt by the mortgage crisis and in potential need of additional capital. Many issues have been hammered, trading at steep discounts to par and offering junk bond-like yields. Once again the bond market is ahead of the ratings agencies and has begun pricing in credit downgrades. However, some of the selling has been forced, coming from institutional accounts that remain comfortable with a company’s prospects for recovery but nevertheless are unable to own below investment grade bonds.

Picks And Pans Among Investment Grade Corporates

    Listed below are examples of three widely-held types of investment grade corporates – a long-term fixed rate bond, a variable rate issue and a total return idea – issued by three well-known companies. Because of variances in credit quality and structure the three issues are likely going to perform differently over the next year and we provide our take on how we believe things play out.
    Individual corporate bonds, which trade in increments of $1,000 and pay semi-annually, should always be purchased in the context of a diversified portfolio. Please contact your JP Turner broker for additional product information, more complete list of available bonds and strategies that fit your specific needs and goals.

SELL
Issuer	Ratings	Ratings	Maturity	Call Feature	Call Feature	YTM	Yield to Worst
General Electric	Aaa/AAA	6.75%	3-15-32	noncallable	$105	6.34%	6.34%
SELL – Hey, GE is a great company but locking in to a 6+% yield for 25 years at this point in the rate cycle doesn’t excite us. Investors sensitive to volatility should consider taking profits on longer term issues like this and reinvest more defensively – like shorter term GE debt (5 years and less). We believe there’ll be an opportunity to buy issues such as this at much lower prices and higher yields in the next 18 months.

BUY
Issuer	Ratings	Ratings	Maturity	Call Feature	Call Feature	YTM	Yield to Worst
Household Finance	Aa3/AA-	6.58%	9/15/13	noncallable	$96.75	NA	NA
BUY – We like this issue for the same reason we don’t like the GE bond listed above. The coupon rate on the Household bond is variable. The rate is set at 255 basis points above the consumer price index (CPI) and the bond resets and pays monthly. By definition, owners of this bond will always keep pace with inflation. As much as many companies would love to continue to issue long term, fixed-rate debt at multi-decade low yields, demand for more floating rate debt is increasing.

BUY
Issuer	Ratings	Ratings	Maturity	Call Feature	Call Feature	YTM	Yield to Worst
Sallie Mae	Baa2/BBB-	5.00%	10/1/13	noncallable	$85.00	8.50%	8.50
BUY – SLM Corporation, better known as Sallie Mae, has been hurt by investors shunning bonds used to finance new stu-dent loans. With many lenders leaving the business, look for Congress to step in and provide some level of assistance for the nation’s largest student lender. Fears of downgrade to junk, which is likely, has exacerbated the selloff but also creat-ed an opportunity for more aggressive total returners. SLM offers a wide variety of structures and maturities.

Although the information included in this report has been obtained from sources we believe to be reliable, we do not guarantee its accuracy or completeness. This report is for informational purposes only and not intended as an offer or solicitation to purchase or sell any securities. Sources used to compile this report include: Bloomberg, bondmarkets.com, realmoney.com, oday, valubond.com, Wall Street Journal and wikipedia.com. More complete information is available upon request. Yields and price information as of 4-17-08. Peter Conroy - Bond Trading Desk - JP Turner & Company LLC.

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