BondsOnline Advisor – January 2008

By Stephen Taub

The BondsOnline Advisor strives to present you with income investmentinsights from analysts throughout the United States.  Bonds, preferred stocks, real estate investment trusts, ormaster limited partnerships can be a part of a successful income portfolio –and BondsOnline and PreferredsOnline provide the “IncomeInvestor Tools” to keep you informed.

For a full list of this month’srecommendations subscribe to our Yield and Income Newsletter www.yieldandincome.com.  The newsletter is also available tomonthly and annual subscribers to PreferredsOnline – All Sectors, www.epreferreds.com

Equity Strategies

Citigroup: Once more, with volatility. This sort of sums upCiti’s outlook for the equity markets for 2008.

Like last year, it expects the first half to be strong and the secondhalf to be challenging due to margin deterioration, election uncertainty and whatit calls growing economic nationalism.

As a result, the investment bank—which published this view before themarkets opened the year sharply down—has set a year-end 2008 S&P 500 targetof 1,675 and 15,100 for the DJIA, which means it expects double-digit gains forthe year.

“We continue to think that a large-cap focus is important,” Citirecently told clients.

Citi also expects a shift away from commodity-based investment themesand their beneficiaries in 2008. It added that Industrials, Materials, andEnergy may not fare well in 2008 as overseas growth slows markedly and earningsestimates are trimmed back.

As for the investment bank’s second half worries, it explained that itis concerned about profit margins. “Survey work showing the difference betweenmanagement intentions to hike prices and lift labor costs raises the corporatemargin risk profile,” it said.

It also noted that last year, the peak in M&A activity occurred in May/June2007. Not a good omen. History has shown that the peak in the number of announceddeals leads equity markets by about 12 months. “Therefore, we could see theequity market top out around mid-year and begin to give back some of the gainsin the latter part of 2008,” Citi warned.

Citi also said there are a number of fundamentally importantintangibles that could weigh on the market in the second half of 2008,including uncertainty about the U.S. presidential elections, especially as itrelates to taxation and health care. Other concerns include the economicdirection of China following the Beijing Olympics in August since it may need todeal with various imbalances such as inflation, pollution, corruption, resourcemisallocation and product safety, as well as trade pressures growing fromAmerica and Europe.

“Our overall outlook for 2008 entails greater economic risk than hasbeen the case for the past few years, given the credit crunch and itsimplications for jobs and capital investment, as well as the psychologicalimpact of weaker home prices and elevated oil prices,” Citi added. “Inaddition, the probability of corporate margin weakness is increasing.  However, we believe these issues arewidely known and disseminated. As a result, we contend that much of the badnews is already priced into stocks.”

It added that should a recession be averted, as it expects, some of themost beaten-up groups like Diversified Financials and Retailers would likelyact as "coiled springs" and lead markets higher, with defensivesectors lagging.  “Hence, wecontinue to recommend a ‘barbell’ portfolio approach,” it explained.

This means emphasizing select areas within the Information Technology sectoralongside overweight stances in Financials and Consumer Discretionary; whileunderweighting Materials and Industrials. Within Energy, the bank said it worriesmost about the Energy Equipment & Services industry group.

Lehman recently warned clients to expect a tough year for the real economyand financial assets. “But with sentiment currently so decidedly negative, thenext 12 months may surprise on the high side,” it added.

It said investors should expect 13% returns for the world equitymarket, 4% for the world bond market, and about 6-8% returns for commodities.Alternative investments should fare even better, it added.

Lehman also asserted that moderate Fed easing should aid the front endof yield curves, while inflation apprehension and the rising probability ofeconomic firming in 2009 will lift intermediate-to-long end yields. “Theremarkable risk reset in 2007 provides an ample, but not invulnerable,performance cushion for all spread sectors,” it added.

Lehman said its best advice for what it called “outlook challenged”times is for investors to take the long view.

As for its equity strategy, the investment bank said a lot depends on whetheror not the U.S. economy suffers a recession.

Regarding its credit strategy, Lehman said 2008 will likely present thebest buying opportunity for high quality financials in the past decade.

It expects municipals to begin 2008 with a confluence of issuesweighing on liquidity, resulting in an opportunistic entry point for longhorizon buy-and-hold and asset swap investors.

Credit Suisse Securities forecasts a year-end target of 1,650 for the S&P500. It elaborates that it is focusing on big cap, high credit rating, highfree-cash-flow (FCF), quality growth stocks.

It also is benchmark bonds, expects a mild dollar rally and is bullishon precious metals.

Looking out globally, the Swiss-based firm’s London strategy group saidits big theme--as it has been for the last seven years--is to buy emergingmarkets, especially consumer-related-exposure via consumer staples, handsets,PCs, luxury goods and banks. It is also marginally overweight on metals andmining.

The bank is also focusing on what it calls Fed reflationtrades--domestic Hong Kong, Malaysia, Singapore, OPEC and gold.

“We are positive on domestic plays in countries where domestic leverageis low, where the country is a net commodity exporter and where the currency isundervalued,” it adds. They include Brazil, Russia and Malaysia.

On the other hand, CS said it would avoid what it deems to be low-endconsumer and poor-quality corporate plays and stocks with poor pricing powerwhere food/energy is a high proportion of costs.

As for sectors, it is overweight defensives such as utilities, consumerstaples excluding food producers, telecoms and US drugs.

On December 2, it raised banks to benchmark, recommendingunderleveraged banks in underleveraged economies. It is also overweightdiversified financials such as investment banks, asset managers and Europeanlife companies “for beta.”

Its favorite themes are global warming, water scarcity and higher foodprices.

REITs

After an amazing seven-year streak through 2006, REITs suffered a downyear in 2007. And Wall Street is not too optimistic about 2008.

Lehman, for example, has a neutral rating on the REIT sector in general. “Webelieve a slower economy, together with ongoing housing/credit concerns, willlikely weigh on the sector for the next several months and stock prices mightfall back from current levels,” it recently warned clients.

However, if there is no recession, Lehman said by mid-year the sectormight be seen as being more attractive. “This might be based on some confidenceabout an end to the downturn in housing and an overall economic improvement in2009,” it explained.

The investment bank’s year-end 2008 target for the RMS Index (totalreturn) is up 5-7%.

In general, it has a positive view of retail, a neutral/positive viewof offices, a neutral/negative view of industrial and a negative view ofapartments. “We generally favor companies with greater defensivecharacteristics,” it added recently.

Lehman recently upgraded one apartment company and downgraded two,listing 10 REITs as “top picks”.

Credit Suisse Securities recently initiated coverage of 13 office, mixedoffice, retail and multifamily REITs. It has “outperform” ratings on three issues, and has underperformratings on two. The rest of the 13 issues have a neutral rating.

For complete list of the REITs reviewed this month, including targetprices, please see the current issue of Yieldand Income Newsletter.  PreferredsOnline subscribers receivethis monthly newsletter as part of their subscription.

Energy Master LimitedPartnerships

Stifel Nicolaus, the regional brokerage currently has a “buy” ratingon four individual issues as well as two closed-end mutual funds thatspecialize in MLPs. Altogether, Stifel’s universe of around 100 issues has anaverage current yield of 6.6%. They range from 8% for the shipping-orientedissues to 5.5% for coal companies as well as partnerships that specialize ingas gathering and processing. For more, see PreferredsOnline and the current issueof Yield and Income Newsletter.

Closed End Funds

Stifel Nicolaus: Since the markets began falling from their highslast year, a wide range of closed-end funds have seen their discounts to netasset value widen substantially, Stifel points out. Many of them havedouble-digit discounts, in fact. In addition, they all offer high currentyields.

“We believe that by taking advantage of funds with large discounts,investors can reduce their exposure to risky asset classes, while benefitingfrom the excess yield and reduced share prices to achieve comparable gains,”the regional brokerage recently told clients.

Stifel recommends a diverse group of five equity closed-end funds. Itstresses that equity funds' asset value performance can vary widely based onsector concentration, use of leverage and other factors.

Each has seen its discount to NAV grow over the 2007 calendar year.Stifel maintains they offer the best long-term growth opportunity and provide taxadvantaged dividends. “Federal Reserve interest rate easing has reducedborrowing costs for leveraged funds and therefore has had a positive effect onearnings,” it adds.

UBS recently upgraded nine municipal bond closed-end funds to “buy” from“neutral.”

It pointed out that the muni markets in general have been underpressure recently due to the headlines associated with monoline insurers andactions by the rating agencies. However, so far the monoline insurers havemaintained their AAA ratings, even though some have been put on a negativewatch.

As a result of the flight-to-quality in general, muni market yields nowrange between 90% and 97% of the yields of treasury securities, UBS points out.“This, in our opinion, has created an opportunity,” it adds. And one way tobenefit from the cheapness of munis is with closed end funds.

In each of the funds, between 11% and 20% of the bonds are callable over thenext five years, depending upon the fund, which UBS deems to be reasonable.

Several funds are diversified over many states while a few aresingle-state funds.

Municipal Bonds

Citigroup recently asserted that the muni market faces somechallenges.

Even so, Citi maintains that munis remain quite cheap relative toTreasuries/LIBOR, but the absolute level of yields is curbing demand. “Asteeper yield curve would certainly help, and that seems a likely outcome, inour view, with the Fed having more work to do,” it told clients, adding thatthere could be as much as another 75 basis points in cuts, or more. “We expectmunis to outperform Treasuries from here,” it added. “We think some of the bestvalues are in medium quality munis insured by one of the potentially weaker AAAinsurers, which are already trading on the basis of their underlying ratings,in our opinion.”

Preferred Stocks

PreferredsOnline shows 20 floating rate preferreds currentlyyielding over 7.00%; all of them within the financial sector, which UBS states is undervalued.

For complete coverage, please purcha the current issue of Yield and Income Newsletter.  PreferredsOnlinesubscribers receive this monthly newsletter as part of their subscription.

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