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Landmann: Government Intervention Working for Now

Miriam Sjoblom, CFA

Miriam Sjoblom: Hi. I'm Miriam Sjoblom, a mutual fund analyst with Morningstar. I'm here today with Laird Landmann, who is the Generalist Portfolio Manager of MetWest Total Return Bond and that's an Analyst Pick in our Morningstar intermediate-term bond category.

So, I appreciate you taking the time today.

Laird Landmann: Very much appreciate being here. Thank you.

Sjoblom: We hear a lot of reports about concerns about deflation. It's a new thing that has cropped up. We've got an economic data that's not looking so great. What are some of the challenges that you are facing as a bond manager in this environment?

Landmann: I think one of the biggest challenges we are facing is really there is a secular change going on in the marketplace, which is related to what we're seeing with the issuance of government debt, When all the crises began to hit in December of 2008, and a little bit before that, we looked at that at MetWest and what we decided was that really the government was going to have to step in and provide a huge Keynesian stimulus in order to get the economy back on track.

And we've really seen them follow through with that. And the one warning sign that we've been looking for where this might not work, where it might lead to a deflationary outcome was really a lack of acceptance on the part of the market of U.S. government debt or a crack in the dollar, and we've clearly seen neither of those. We've actually seen it go quite the other way. That's been very surprising I think for many market participants. But it clearly shows that the government has the tools it needs right now to keep the economy going. And we believe that they will use those tools to the fullest extent.

There are certainly lots of political winds out there right now that are insisting that we go the other way, that we move towards a regime of fiscal rectitude. We don't believe that the political will exists for that and that we'll continue to see stimulus from both the Federal Reserve and the fiscal government, and that they'll step into deal with the problems at hand.

And so we'll see this slow growth environment continue, where basically the private sector in a secular basis continues to pull back, savings rates move higher, the consumer becomes a less important part of the overall U.S. economy, and the government continues to step in and fill that gap. It's not necessarily a healthy long-term situation, but it certainly will keep growth going in the short term.

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Sjoblom: So, as a manager, how do you want to position your portfolios for that scenario?

Landmann: Well, I think for the next year or two it's going to be a very positive year for a lot of the spread sectors in the marketplace for corporate bonds, for some of the non-agency securities. This government support is going to provide a very, very nice environment of slow growth, a very stable environment, and at the same time, the issuance of Treasuries is going to begin to crowd out some of these sectors. We are seeing very strong technicals.

In the non-agency sector alone, we are probably going to see $200 billion to $300 billion of paydowns and defaults occur that is going to shrink that market dramatically and make it much harder to find attractive bonds. So, we think that sector of the market will continue to do well.

We think that the high-yield sector of the market will continue to do well and that a lot of the refinancings that needed to take place have taken place. That market is moving forward basically with much better debt levels for these companies. People are very worried about this bubble that needs to be refinanced in 2013 and 2014. If the economy stays stable, they will probably be quite manageable, and we are seeing quite a bit of refinancing going on right now. So, we are pretty optimistic, particularly compared to what equities will probably do in this slow growth environment as it relates to the high yield market. We think the high yield market we can earn an 8% yield is very, very attractive.

Sjoblom: So, what would some of the risks be to how you are positioning the fund now?

Landmann: Well, one of the biggest risks we see is really that this deflationary environment does take hold in full force. Clearly, the market and where interest rates have been going for the last month or two have really been signaling, as you pointed out, a strong bias towards this deflationary environment. If rates were to move down strongly 100, 200 basis points from here, I certainly think that would signal that the economy was potentially collapsing. And you might see a lot of fear re-enter the market and people fly into Treasuries to try to capture those returns and fly out of some of the spread sectors. That could certainly be a negative. But the long-term effects of those lower rates assuming that it didn't come also with all the deflationary consequences that those lower rates usually come with would be refinancing and further stimulus to the U.S economy. So, it would not necessarily be a long-term crisis.