Trinity's fixed-income strategy

With Walmart's (WMT) earnings this morning, it is clear that the consumer is slowing. (We owe readers an apology: I thought WMT would report earnings last Thursday, August 8th, but instead WMT reported this morning.)

With WMT lowering guidance thanks to a weakened consumer, and WMT accounting for 10% of all retail sales, and consumption 2/3rd's of GDP, it doesn't take a genius to figure out that GDP could suffer in coming months.

With a Fed that could start cutting rates before we see the end of August or September, here is how we are positioning our fixed-income accounts regarding interest rate risk, and credit risk:

If and when the Fed cuts rates, I think the yield curve will in fact steepen, and I would expect the 10-year to trade above 5% and begin returning to more normal slope. Ex fed funds, the 2 - 10 year spread is now back to a positive +35 bp's thus the steepening is beginning already.

We are positioning muni portfolios in the 5 - 7 year maturity range (non-callable), in high quality insured or AA notes, with no credit risk being taken. I think the 5-7 year maturities will outperform in an environment where the Fed is friendlier and where we are moving from an inverted to a normally-sloped curve. The 2-year Treasury is currently yielding 4.44%, thus it has discounted three Fed easings already, which is why we are positioning within 5 - 7 year maturity. We would buy 10-year paper if we get over 5.25%.

In terms of credit risk, I think it is is still too early as credit spreads could continue to widen through September - October, '07. Corporate high yield is getting more interesting, but we have not put any money back into high yield (after selling all of our exposure in early 2005).

All of our taxable bond accounts have been 100% money market the last two years, which didn't look so hot when high yield was trading at +150 Treasuries, but it looks much better now.

Given the currency risk, we have never been international fixed-income investors, preferring to take interest rate and credit risk, and leaving currency risk for others.

I think over the next year we will see some great opportunities to put money to work in high yield, corporate high grade,mortgage-backed (MBS) and asset-backed (ABS), but now is not yet the time.

position in WMT