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By Michael Herbst | 02-16-2010 04:03 PM

When 'Risk-Free' Suddenly Isn't

Western Asset CIO and manager Steve Walsh says the sovereign risk of developed countries is going to confront investors over the intermediate term.

Michael Herbst: I'm glad you touched down on some of the uncertainties facing the bond markets these days for two reasons. One, you had mentioned how risks in some areas, such as what we're seeing in the situation with Greece right now, could actually lead to a reconsideration or a re-pricing of other kinds of risk that may or may not be connected to that situation at all. Could you expand on that a little bit?

Steve Walsh: Yeah. One of the observations over the course of the last 18 months has been risk has performed pretty much in tandem. When risk does poorly, all risk does poorly. Very highly correlated. Stocks are down, credit is down, all spreads widen out. In a normal period you get some variation. Asset classes perform at different levels. Greece obviously widening out from 100 over at the end of the summer to as much as 450 over a few weeks ago, is obviously responding to their particular budget situation.

But it has investors going, "Wait a minute, if Greece is going to trade at 450 over, where should high yield trade? Where should investment-grade corporate bonds trade?"

I mentioned that the U.K. government trades at 100 over. So all of the sudden the U.K. government trades at 100 over and so does Berkshire-Hathaway. How do I look at those two credits?

In our adult lifetimes we never had to think about developed countries' sovereign risk. I think that's going to be a big issue that is going to confront investors over the intermediate term as we move throughout this decade.

And today, it obviously has had a ripple effect. It's caused risk assets generally to widen out, since their tights in the middle part of January.

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