The economy may fail to hold its recent strength, and under this scenario the Fed likely extends another round of quantitative easing (QE). This leads to our preference for mortgages over high quality industrial corporate bonds and our preference for risk assets in general — i.e. bonds with credit risk in fixed income — and stocks.
This weak recovery faces continual risks that "confidence shocks" push it back into recession.The recent growth spurt (with Q4 GDP tracking 3%) likely fades into the first quarter of 2012, andunder such a scenario, the Fed likely extends yet another round of quantitative easing in response.This third round of QE may be more directed at mortgages in another attempt to use monetarypolicy to reduce mortgage rates in support of the housing market. That will benefit the outlook forthe investment performance of mortgages, but may offer only limited real world benefits. Thetrouble with housing is not the mortgage rate but the house price and this round, like those before it,offer little hope of fixing the housing market. The impact, however, will be to lower mortgage spreads,leading to our preference for mortgages over high quality industrial corporate bonds to start theyear. Additional benefits of QE3 from "portfolio rebalancing" may again lead to outperformanceof risk assets: bonds with credit risk in fixed income, and stocks more broadly.
Investment involves risk. The two main risks related to fixed income investing are interest rate risk and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds. Credit risk refers to the possibility that the issuer of the bond will not be able to make principal and interest payments. Investments in non-investment-grade debt securities ("high yield" or "junk" bonds) may be subject to greater market fluctuations and risk of default or loss of income and principal than securities in higher rating categories.
Index performance is shown for illustrative purposes only. You cannot invest directly in an index.
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Chris Leavy discusses why he believes equities offer the greatest potential for providing both total return and income growth in the current environment and makes a compelling case for investment in dividend-paying equities.