Bond investors are bullish on Schwarzenegger

forbes ^ | 10/08/03 | Dean Patterson

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Bond investors are bullish on Schwarzenegger Reuters, 10.08.03, 12:42 PM ET

By Dean Patterson

NEW YORK (Reuters) - Bond investors Wednesday greeted Arnold Schwarzenegger's recall election victory with cautious optimism, saying his pro-business bias will help California's ailing economy in the long run.

"He understands California has to improve its business climate," said Scott Albrecht, tax-exempt bond fund manager at Federated Investors Inc. in Pittsburgh.

Actor and political novice Schwarzenegger, a Republican, easily won California's first-ever gubernatorial recall election on Tuesday, ousting Democratic Gov. Gray Davis less than 10 months into his second term.

"He will be a breath of fresh air. At least, he is talking to business about controlling taxes and spending," said Duane McAllister, a municipal bond fund manager at Strong Financial Corp. in Menomonee Falls, Wisconsin.

California municipal bonds held steady in the days leading up to the election, paying a yield premium in the 0.40 percent to 0.45 percent range over comparable top-rated municipal bonds, traders said. No trades were reported early Wednesday, which is not unusual in the relatively illiquid muni market.

California bonds have gained in recent months, but are unlikely to stray far from current levels because the recall election did not solve any of the state's many short-term fiscal problems, money managers said.

Schwarzenegger inherits an $8 billion structural budget deficit. He will be one of only two governors who need a super majority in the Legislature to pass either a budget or a tax increase.

More than half of California's budget is legally mandated for specific purposes, so he does not have a lot of room to maneuver, bond investors said.

"Over the long term, he is good for the state," McAllister said. "In the short term, he has the same mountain to climb."

Money managers predicted Schwarzenegger will assemble a better team of advisers than Davis had.

"Arnold is smart enough to surround himself with smart people," Albrecht said.

Investors also pointed out that California is poised to sell much more debt in the coming weeks, which tends to put some downward pressure on bond prices.

The state plans to sell $3 billion of short-term debt on Oct. 15 and $1.5 billion of general obligation bonds on Oct. 23, among other smaller offerings.

Given the upcoming supply and the low credit rating, California bonds are currently overpriced, said Mark McCray, municipal fund manager at PIMCO, based in Newport Beach, California, speaking on CNBC TV.

Albrecht said he has sold a sizable portion of his California bonds recently as the price came back from lows a few months ago.

California bonds were a great buy when they yielded more than 0.70 percent over top-rated bonds, he said, adding he plans to buy more once they cheapen up in the wake of new supply.