I Can't Believe It's Not Butter

Short-term investors are finding out that you can't always get what you want. In recent days, the auction rate securities auction has seen many failed auctions. Though it is not our market, we have received enough questions regarding auction-rate preferreds that we will touch on the subject. Besides, this is a problem which could portend another credit crunch which would affect our markets as well.

During the past few days, there have been many failed autcions. There were 100 failed auctions just yesterday, according to the Wall Street Journal. Many of the failed auctions were for funds exposed to student loans. Investors do not wish to be exposed to securities backed by risky assets. This does not mean that these auction rates securities will default, but getting out of them could be challenging. This goes back to point that a money market aletrnative is not a money market. Is margerine, butter? Is aspartame, sugar? Of course not. Though the can often be viable subsitutes, they are still substitutes. We are not saying that investirs should stay away from auction securities. Only that, as with all investments (including funds and managed vehicles) both FAs and clients should know what they are getting themselves into.

What does renewed credit crunch mean for short-term rates and Fed policy? Another round of liquidity difficulties increase the likelihood of further Fed easing. There could also be another disconnect between short-term borrowing rates (Fed Funds effective rate and U.S. dollare LIBOR) and the actual Fd Funds rate and T-Bills. Further Fed easing also increase the possibility of inflation, or at least decrease the possibility of deflation. Therefore, long-term treasury yields could trend higher this year, even as short-term rates are forced lower by Fed policy.

What about credit spreads? Renewed liquidty concernds could spark another round spread widening, especially among the financials. However, if the Fed is successful, the financial sector could experience the greates amount of spread tigtening during a recovery. With credit spreads in the financial sector at or near record wides, we believe they offer value for investors who can tolerate headline risk. We do not see much value in buying long-term treasuries at this time. Actually, we do not see much value in buying very short-term treasuries either. Agencies, corporates, preferreds and certian bank products offer the best values in taxable fixed income.

Investors may also consider insured munis which have strong underlying credit ratings. There have been occassions in which insured munis were trading with higher yields than their uninsured brethren as some investors pre-emptively sold their insured positions.