Some fixed-income money managers are sticking with low-inflation, moderate growth investment strategies that already have been hammered by surprise interest rate hikes.
The managers disagree with higher short-term inflation theorists. They also believe the excess leverage that contributed to this bond market bloodbath has been largely squeezed out of the market.
Of course, plenty of damage has been done.
"For a lot of people, this has been the biggest bear market in 10 years," said David Edington, a managing partner at Pacific Investment Management Co., Newport Beach, Calif.
Some managers report the Federal Reserve Board's pre-inflation fighting Feb. 4 and March 22 quarter-point short-term interest rate advances helped wipe out their first-quarter investment returns.
The best some money mangers will be able to say to clients in their first-quarter reports is that they outperformed their benchmarks by a few dozen basis points.
Salomon Brothers Inc., New York, announced the Salomon Broad Investment Grade Bond Index returned -2.81% for the first quarter - which Salomon said was the "worst return since May 1984."
Money managers could be surprised again by a Federal Reserve Board Chairman Alan Greenspan-led, sharper-than-expected interest rate hike or unanticipated robust economic growth figures in the coming weeks. More surprises would mean sorry investment returns for the first six months of the year for bond managers without a marked defensive posture.
PIMCO's bond portfolios went into the bloodbath with "a lot of cash on hand" and a slightly shorter duration than the market, said Mr. Edington.
Outperforming benchmarks in the first quarter, PIMCO has "fared pretty well," he said. Had PIMCO anticipated the speed of the interest rate climb, he said, its portfolios would have been positioned more defensively.
Taking advantage of some "decent values" after the price fall, PIMCO has put some money back into the market, he said. But Mr. Edington doesn't see a rebound to earlier price levels.
Jim Mulally, senior vice president at Capital Guardian Trust Co., Los Angeles, said he remains cautious, "but less so" than before the run-up in interest rates.
Mr. Mulally said the duration of portfolios has been moved back up to five years from a "relatively cautious" position of a "low four (-year)" duration. He said the portfolios' sensitivity to interest rates is approximately market neutral now.
(About 20% of bond managers do make significant duration bets and those managers who stay at the long end of the yield curve face a "serious concern," said Steve Nesbitt, a senior vice president at the pension consulting firm, Wilshire Associates, Santa Monica, Calif.)
Mr. Mulally still expects continued volatility in the bond market. February and March, he said, were "very tough months." But, he said, Capital Guardian's portfolios have outperformed the index by about 50 basis points.
As mortgage prices fell, said Mr. Mulally, Capital Guardian bought some because they were "so cheap." He believes the panic in the bond market is over.
Capital Guardian has about $5 billion in tax-exempt fixed-income assets.
At Hoisington Investment Management Co., Austin, Texas, Van R. Hoisington, chief investment officer, said he hasn't changed his portfolio strategy and continues to be invested in 30-year Treasury bonds. Hoisington has about $2.7 billion in tax-exempt fixed-income assets.
"It's been a sorry place to be for the last three months," said Mr. Hoisington. However, he doesn't think inflation will be a problem, he sees commodity prices headed down, and he thinks it is a low probability the Fed will tighten further.
"I certainly like (30-year Treasuries) at 7.26 if I liked them at 6.5," said Mr. Hoisington.
At 1838 Investment Advisors, Radnor, Pa., John Donaldson, a principal, says his firm had moved the duration of fixed-income portfolios to a "hair longer" from what was its market neutral position a month ago. 1838 manages about $1.2 billion in tax-exempt fixed-income assets.
Mr. Donaldson is looking for the market to sort itself out. "As recently as six months ago, we were in a psychological mode where the market would look for good news even in bad news. Now it has completely reversed. What we're uncertain about is how much time is required to wash out that bad psychology," said Mr. Donaldson.
In his view, "there is not reasonable evidence of across-the-board inflation that should make you nervous." He said his firm's portfolio has bettered the indexes by 20 basis points or so.
Kennedy Associates Inc., Seattle, which owns mortgage-backed securities, hasn't altered its position in the last few months. But strategists are thinking about it.
One question is whether spirited growth in the interest rate sensitive sector of the economy - like housing and autos - will slow now that interest rates are higher.
"We're still nervous. The wrong guy saying the wrong thing is still worth a point or two in the market," said Larry Backes, a senior vice president. However, he added, "inflation at the commodity level does not always mean inflation at the consumer level."
Kennedy has $1.6 billion in tax-exempt fixed-income assets.
At Criterion Investment Management, Houston, Terry Ellis, chief investment officer, declined comment. But in a mid-March letter to clients, Criterion executives expressed surprise at what they termed the Federal Reserve Board's "pre-emptive" action in raising interest rates.
"While this concept in neither revolutionary nor cerebral, it is the first time in recent memory in which the Fed has acted so early," the letter said.
Although expressing concern about the trade situation with Japan, the letter said: "The probable outcome is for any rise in interest rates to be of relatively short duration (and) for interest rates on long maturities to do significantly better than interest rates on short maturities." Criterion has about $10.8 billion in tax-exempt fixed-income assets.
In a similar letter in mid-March, Brown Brothers Harriman & Co., New York, told its clients: "In view of the exaggerated concern over inflation, apparent in the bond market, we wonder whether we might indeed be approaching the thresholds of accelerating inflation in terms of employment and capacity utilization. We conclude that we are getting closer, but not close enough to view it as a problem."
As for predictions, PIMCO's Mr. Edington believes long-bond interest rates will range between 7% and 7.5% for this quarter. Capital Guardian's Mr. Mulally agrees, although he anticipates further tightening of interest rates by the Federal Reserve Board.
Mr. Edington thinks short-term interest rates will go up 25 basis points a quarter. He said short-term rates going up 50 basis a quarter would be the "outside" limit in his view.
He also believes a lot of the bond market's excess leverage has been squeezed out. Some undisciplined investors, he said, bought derivative and structured investments they didn't understand and that had hidden "bad convexity" that only showed the speed of their price movement after a 50-basis point or so run-up in interest rates.
Mr. Edington cautioned that if the business cycle catches momentum, the bond market will move much differently from his current scenario. On the other hand, he said, some of the strong economic signals in the fourth quarter of 1993 could have been driven by low interest rates and be a "flash in the pan" now that interest rates are much higher.