Taxable Bond Commentary
Prudent Security Selection is Critical

Now more than ever, prudent security selection is es-sential to preserving capital and reaching investment goals. As described in our last Oakwood Outlook, we began a program of purchasing corporate bonds on a selective basis. Our choices remain profitable and retain strong balance sheets. Nonetheless we have suspended this program until the future of the economy and the credit markets becomes more clear. In the meantime many corporations are seeking to raise capital reserves through issuing long-term debt. In many cases this is a reaction to the freezing up of the shorter term commercial paper market. As this onslaught of newly issued bonds hits the marketplace, yield differentials are widening to historic levels versus the benchmark Treasuries. When we recommence our corporate bond buying program, these enticing yield levels will prove rewarding to our clients.

Lessons learned from the bond market
The bond market has historically been an excellent forecaster of economic conditions and inflation trends. And, unfortunately, wider yield-spreads tend to indicate stress for future earnings and stock prices. As shown in the first of two graphs, the 10-year Treasury yield continues to move lower from its earlier peak as economic fundamentals deteriorate and investors flee to the safety of government obligations. Simultaneously, as shown in the second graph, commodity prices are also retreating from recent peaks. With the exception of gold, most food and energy-based commodities are now moving lower. While gold on an historical basis correlates to inflation expectations, the extension of the financial crisis to overseas markets may be a catalyst in its recent rise.

Can the housing market stabilize?
We focus attention on the 10-year Treasury because of its general correlation to 30-year mortgage rates. A sustained 10-year yield of 3.50% is a prerequisite for a stable housing market. While this starting goal has been achieved, we have not yet managed to maintain this yield level due to large price gyrations in the bond market. Nonetheless, we are encouraged by its downward trend from a 4.25% peak yield in June. This should begin to entice prospective home buyers and stabilize existing home values.

Portfolio structure is critical to future success. This is not a market that rewards investors betting on higher interest rates, or those who search for a bottom in banking, financial, and mortgage-backed sectors. In this environment, definitive forecasting is a fool’s errand. Instead, we continue to look for unusual stock price behavior and scrutinize news developments to both validate our corporate bond choices and as a signal to sell.

Bernanke is a heavyweight
The Fed Chairman may be the only person who is truly unbiased to the outcome of the financial crisis. His assessment that the situation is serious enough to warrant a strong Government rescue plan carries heavy weight in our estimation. At the same time, we believe it is essential for the Government to evaluate each situation on its own merits and avoid reckless capital allocation. We hope the assumption is that most of the monies spent will not return to the Treasury, since the impact from any rescue plan can have a lasting effect for years to come. In this way, a positive outcome will be a delayed reward we can look forward to.