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Kiesel: Housing Sector Looks Sturdy

Thanks to strong growth in the sector, housing debt looks to be among the more attractive enclaves in today's bond market, says PIMCO's Mark Kiesel.

Sumit Desai: You mentioned you're still bullish on housing. What is the best way to play that growth, and how is that translating into your portfolio holdings?

Mark Kiesel: So, this is one of the most exciting things still available in the market today. You and I have talked about this for three years and, every time we talk, you keep seeing me more and more excited. And the reason is that it's growing two times faster than the overall economy. The overall economy is growing 4% to 5%. Housing is growing at 10%. Housing, I think, will still grow faster than the overall economy, and that's because you're growing off of such a depressed base. You are underbuilding versus long-term demand. Household formations are now at 1.5 million units. You've added almost three million private-sector jobs. You've got five million job openings right now, and you've grown job openings by one million in the last year. So, demand is coming off the sidelines. Thirty-one percent of people between the ages of 25 and 34 are living at home.

If you look at the first-time buyer--you look at that 25-34 cohort--you've added 718,000 jobs in the last year, which is the strongest in 15 years. So, the whole point is, all these people are going to come off the sidelines. And guess what? Whereas banks won't be lending to that higher-risk [exploration and production] company or maybe not extending credit to that metals and mining company, I'm pretty confident, over time, credit has become more available for consumers. Seventy percent of the economy is the consumer, and the consumer is doing very well. Specifically, what do you want to own? Nonagency mortgages, building-materials companies. We're here in Chicago. One of the largest gypsum manufacturers in the world is here in Chicago. Warren Buffett is the largest equityholder. This company has raised prices 40% from the trough in the last three or four years. Volumes are picking up. That's a great business.

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This is a company that was five times leveraged--that's three and a half times leveraged. We think they're going to two times leveraged. There are numerous examples of building-materials companies out there where the fundamentals are improving because you're growing off of not a 4.5% to 5% growth model, but a 10% growth model. You can organically deleverage your balance sheet a half to a full turn per year when you're doing that. This is fantastic. These companies are getting upgraded at the same time that a lot of energy, metals, and mining companies are getting downgraded. This stuff is getting upgraded.

So, we've been adding to that. We've been adding to home improvement. We've been adding to homebuilders. Another sector we've recently added to that we haven't talked a lot about is REITs. REITs actually have covenant protection. This is amazing. Think about this: With banks, the regulator is there to cause capital to be retained in the capital structure. So, you know why we've liked banks because basically the regulators are trying to make the banks safer.

Desai: They're cleaning up the balance sheets.

Kiesel: Yes. When you look at REITs, you've got rising occupancy, rising rates, you own a hard asset, and--guess what--you've got four covenants. Minimum interest coverage: 1.5 times. Maximum secured debt: 40% of total assets. Maximum unsecured debt: 60% of total assets. Maximum unencumbered assets: 150% to total debt. So, those four covenants actually protect you as a bondholder. Where else can you invest as a bondholder where the company actually has to act in your interest? The REITs sector and the banking sector. In the technology sector, they're issuing billions and billions of dollars of debt, and what are they doing? They're buying their stock back.

So, many companies are releveraging. They're either doing that because they can--they tap into the bond market and releverage, using the bond market to buy their stock back--or they're releveraging because of poor fundamentals. PIMCO is picking the companies and the sectors that are actually deleveraging and acting in the bondholder's interest. So, there's enormous value right now in active management and steering clients toward where the real fundamental value is and staying away from a lot of this risk.

Desai: So, given everything that we've talked about today--with the potential for rates to rise over the long term, lots of risk around the commodities sector, but a fairly strong economic environment here in the U.S. otherwise--how should a fixed-income investor position his or her portfolio to not only protect against some of these risks but also to be able to take advantage of those growth opportunities?

Kiesel: We like owning more credit today. Credit looks cheap versus a lot of assets. It looks cheap within fixed income; it also looks cheap relative to equities. The yields now on the longer-maturity, high-quality investment-grade corporate bonds are more than the free cash flow on the S&P 500--about 5-6%. That hasn't happened in five years. So, credit, specifically long-maturity corporate bonds, look as cheap as they've looked in six years. Importantly, to your point, with stable-to-improving fundamentals in the U.S. economy, we see low defaults. That should support the credit cycle. Most importantly, when rates rise, typically credit spreads tend to tighten, because what happens is while Treasury rates have more duration or interest-rate risk, credit is more a reflection of the broad trends in the economy. So, those spreads should tighten.

We're in a unique period in history where the market has had to digest over $1 trillion of new supply at a time when rates were low. Obviously, people took a step back. Going forward, should rates rise, you will likely see more demand for credit--particularly from insurance companies as well as pension funds. At the same time, as that demand comes in, higher rates will lead to less issuance. Companies won't issue at higher spreads and higher interest rates, so you're set up today for credit to outperform. That's why we think investors should buy the corporate-bond market today.

Desai: Thanks, Mark. It's always great to hear your views. Thank you for your time.

Kiesel: Thank you.