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By Christine Benz | 08-23-2011 04:17 AM

Calamos: Risk/Reward Trade-Off for Fixed Income 'Horrible'

Investors looking to build long-term wealth in this economic environment should focus on equities, says Calamos Investments' Nick Calamos.

Christine Benz: I think your firm is in a great position to assess multiple asset classes because you have a number of funds with a focus on international, domestic, fixed income, or convertibles, of course. I would like you to discuss amid this recent sell-off whether you think that there have been great pockets of opportunity created within any of those asset classes.

Nick Calamos: That's a great question. We think bonds are overdone. In fact, the 25-year bull market in bonds is probably over or very close to the end of. The risk/reward, nonetheless, is horrible.

Benz: So, do you mean for all fixed income, or Treasuries in particular?

Calamos: Well, definitely Treasuries but also high-grade fixed income does not offer quite the risk/reward that you would want. Bank loans are the same thing. So, the good news with some of the bank loans is that they're going to roll up to higher and higher yields if we get into that type of environment. But in general, fixed income is not that attractive. With high yield, the yields have widened out here a little bit so it's a little bit more attractive. But that's an area where a bubble will occur, too, because everybody has a huge appetite for yield, and they are been forced to push out on that risk spectrum to capture that yield.

So, to us with the reflation opportunity that we see, meaning the cyclical stocks have beaten up pretty good. A lot of more pricing recession right now into them. And the upside we think is fantastic because the Federal Reserve will probably start on a reflation play again. That will favor materials, precious metals, IT, industrials, to some extent energy, and hopefully someday financials. Those are the cyclicals that tend to get a bounce from the reflation move, and they are the most undervalued.

Benz: OK. Can you discuss any particular companies that you think have been way overdone in terms of a sell-off?

Calamos: Yeah. So, if we look at the energy sector, we think Chesapeake Energy still looks very, very attractive to us. The firm has a great portfolio of assets, and it is monetizing some of those as we speak. We think there is a lot of upside there. Oracle stock has been decimated in here. We think it's really overdone. It's a great business with a great global business model. It will figure out how to do the cloud portion quite a bit better, so I think that is a great opportunity.

As for stocks that have executed well that have just been thrown out with everything else, I think Salesforce.com is probably overdone in here. I also think that if you look through most of the industrials, they are pricing in a pretty weak environment, and companies like Eaton Corp. probably is a strong buy in here also. But I can almost go through three or four of these sectors and find tremendous opportunities. Your risk/reward is great; your upside potential is 2 or 3 times, which you would do in the bond markets today.

Benz: One area you haven't mentioned is financials, and that of course has been so controversial and also very beaten up. Are you not finding as much there as you are in some of the cyclical companies?

Calamos: Before this great recession occurred, we were out of the banks and out of the mortgage companies. We were primarily out of anything related to home building at all as well as financials. That kept us in relatively good position. We haven't stepped back in, and we haven't stepped back in because we don't have any clarity on whether or not the mortgage markets are clearing properly. You've got the government in buying assets there. The banks that are failing are being bought up by other banks but being forced to by the government, so the market is not clearing. We don't know how weak the loan portfolios are and how much additional pressures there is going to be in could be Europe. That situation will feed into our banks also.

So, I think the time we step into the banks is when we see banks betting their balance sheet, meaning they are making acquisitions with their balance sheet that are not being engineered by the government. That tells me that they have confidence in their loan portfolios and they have confidence in loan portfolios they are purchasing. They are going to do it with their own capital without a government subsidy to help them do it.

Benz: Last but not least Nick, I would like to hear your take on what are you saying to clients at this point who are feeling really nervous, wanting to flock to gold or cash or whatever else? What do you say to people to stay calm?

Calamos: Well, gold and cash are not bad alternatives for a potion of our portfolio. Gold is a hedge against a banking crisis, and obviously in this fixed-exchange-rate world that we're in between the Europeans and U.S. and China, there are some stresses there that may cause some additional problems. And cash is not a bad place if we're going to have inflation or deflation, so a portion of your assets can be there.

As an investor who wants to create wealth and actually build wealth, you're not going to do in those two vehicles most likely over the long term. Equities are the best place to be. As we reflate this economy, remember corporations earn their profits in nominal dollars. So, we do think reflation will work. We are going to inflate. We are going to see some more defaults. We are going to keep interest rates very low. That's the economy, and that's an environment that favors equity over fixed income to a large extent. It's going to be volatile. It's going to be scary, but the best place to make money in the market is typically where you're most uncomfortable. And it's very uncomfortable to be in equities today.

Benz: Right. Well, thank you for sharing your insights. We appreciate you taking your time to come over.

Calamos: My pleasure. Thank you.

Benz: Thanks for watching. I'm Christine Benz for Morningstar.

 

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