Week ending July 10, 2
Friday* Last Week Dec. 31
2008 1 Yr Ago
Dow Jones Ind. Avg. 8,115 8,281 8,776 11,229
S&P 500 876 896 903 1,253
Nasdaq 100 1,748 1,797 1,577 2,258
The Russell 2000 477 497 499 670
DJ STOXX Europe 197 204 198 278
Nikkei Index 9,287 9,816 8,860 13,067
Fed Funds Target 0-0.25% 0-0.25% 0-0.25% 2.00%
2-Year U.S. Treasury Yield 0.89% 0.99% 0.77% 2.41%
10-Year U.S. Treasury Yield 3.29% 3.50% 2.21% 3.80%
U.S.$ / Euro 1.39 1.40 1.40 1.58
U.S.$ / British Pound 1.62 1.63 1.46 1.98
Yen / U.S.$ 952.36 96.04 90.64 107.07
Gold ($/oz) $911.84 $932.25 $882.05 $947.66
Oil $59.22 $66.73 $44.60 $141.65
*Levels as of 12:40 a.m. PST
Year to Date (1/1/09 - 7/10/09)
Dow Jones Industrial Avg -7.53%
S&P 500 -2.98%
Russell 2000 -4.47%
MSCI World Index 0.69%
DJ STOXX Europe 600 (euro) 2.90%
Year to Date (1/1/00 - 7/1/09)
90 Day T-Bill 0.13%
2-Year Treasury 0.66%
10-Year Treasury -7.80%
ML High Yield Index 29.06%
JP Morgan EMBI Global Diversified 15.91%
JP Morgan Global Hedged -0.65%
SM Non-Farm Manufacturing –The Institute for Supply Management’s index of non-farming businesses rose to 47 in June, up from 44 in May and beating forecasts of 46. Though readings less than 50 still signal a contraction, the index shrank at its slowest pace in nine months.
IMF World Economic Outlook – The International Monetary Fund raised its forecast for the 2010 global growth rate to 2.5%, compared with its April projection of a 1.9% rate. Despite this upward revision, IMF officials warned that the recovery would be weak and protracted.
German Industrial Production – German industrial output surged the most in almost 16 years in May, adding to signs that the recession in Europe’s largest economy is reaching its end. Production rose 3.7% from April, when it dropped 2.6%; this was the biggest gain since August 1993. Economists had predicted a gain of 0.5%.
Wholesale Inventories – Inventories at U.S. wholesalers fell for the ninth consecutive month, dropping 0.8% in May due to increased sales. The decrease in stockpiles was smaller than forecast and followed a revised 1.3% drop in April. July 10
University of Michigan Consumer Confidence - The University of Michigan index of consumer sentiment fell to its lowest level since March, dropping to 64.6 in July, down from 70.8 In June. The significant decrease reflects concerns about the rising unemployment level and signals a possible contraction in consumer spending even as the economy begins to recover.
Trade Balance – The U.S. trade balance unexpectedly narrowed in May, dropping 9.8% in the month to its lowest level in a decade. The deficit fell to $26 billion from $29.2 billion in April. Euro Zone OECD Leading Indicator – The Organization for Economic Co-operation and Development (OECD) said that its composite leading indicator (CLI) for the OECD-area rose to 94.0 in May from 93.2 in April. The euro zone showed the strongest increase with 1.0%.
This week, the International Monetary Fund (IMF) upgraded its global growth forecast to 2.5% in 2010, compared with its April projection of only 1.9%. Asia’s developing economies, predicted to grow at 7.0% in 2010, will likely rebound most rapidly, though a sustained recovery will depend on more advanced economies. Output in the United States and Japan is expected to stabilize in the second half of 2009 and gradually increase in 2010. A euro zone recovery will likely lag the rest of the world due to the region’s rising unemployment level and weak banking sector. The improvement in global financial conditions is largely due to aggressive government intervention: central banks have slashed interest rates to record lows and spent billions in an effort to prop up the faltering financial sector and raise demand. While many countries, especially Germany, are hoping to end their stimulus programs in the near future, the IMF warned that “policymakers must continue the strong monetary, fiscal and financial policies that they have put in place. If they do not, there is a great risk that the recovery falters." The IMF also predicted that unemployment levels will continue to rise through the end of 2010, further underscoring the view that the return to pre-recession conditions mandates sustained public intervention.
The recent rally in US Treasuries intensified this week on the back of the return of risk aversion and very strong auction results. Very weak unemployment data at the end of last week triggered a new wave of pessimism about the global economic outlook and led to further decline in equity markets across the globe, keeping the Treasury market well bid across all maturities. On Wednesday, the Treasury rally further strengthened after the 10 year Treasury auction stopped 5.5 basis points (bps) through market levels. As a result, short positions unwound, trade curves steepened, and the fear of convexity hedging increased the demand for Treasuries into Friday’s close.
The stock market fell for the fourth consecutive week as commodity prices continued to trend lower and fears arose that economic recovery will be slower than expected. The S&P 500 index fell about 2% for the week with large-cap stocks outperforming small-cap stocks and large-cap growth stocks outperformed large-cap value stocks. The best performing sector was health care and the worst performing sector was telecommunication services. In the headlines this week, Amgen Inc. (AMGN) announced their drug Denosumab tested better than their rivals in treating breast cancer patients with bone disease. Shares of AMGN jumped almost 14% on the positive news. In other news, Google Inc. (GOOG) revealed plans to launch a new operating system next year to directly compete against Microsoft Corporation’s flagship product Windows. Shares of GOOG rallied almost 2% on the news.
Investment grade primary activity was dormant with only a handful of issuers tapping the market this week. This was expected ahead of earnings reports which will begin in earnest next week. With treasury yields falling sharply and a subdued equity market, it is a testament to the demand for credit exposure that spreads continue to tighten. There has been a limited amount of companies pre-announcing second quarter earnings, but most expect an aggregate improvement.
Investment grade corporate spreads tightened vaguely during a week where new issuance was almost non-existent and secondary trading kept investors jostling for yield. These two factors will most likely keep spreads grinding tighter throughout the month in spite of lower summertime activity. The Barclays Credit Index Option-Adjusted Spread (OAS) finished the week at +273, tighter by 1 bp. Financials tightened by 1 bp (banks flat, insurance +1), industrials remained unchanged (telecom +1, consumer non-cyclical flat, basic materials flat, capital goods -3, energy flat), and utilities remained unchanged.
Mortgages lagged the Treasury rally on higher volatility, a pickup in origination volume, and credit market apathy. The ‘green shoots’ of the spring rally are looking more like weeds. As yields moved aggressively lower, agency mortgage spreads widened by 5-7 bps. This was an unfortunate turn of events, as the market was earlier enjoying the release of a favorably slow prepayment report. Within the mortgage sectors, lower coupons underperformed higher coupons on a duration-adjusted basis and Ginnie Mae mortgages recovered versus their conventional cousins. The thirty-year current coupon versus the 10-year Treasury closed at 105 bps.
The municipal bond market started the second half of 2009 stronger, with tax-exempt bond yields moving sharply lower across the yield curve. In particular, from the 5-year maturity range out to 20-years, yields dropped 15 bps on the week. Five year AAA-rated GO bond yields reached 1.90%, 10-year yields hit 3.07% and 20-year bond yields fell to 4.12%. The tax-exempt yield curve is also modestly flatter from 2 to 20 years as investor demand has been piqued in the longer end of the market given that 2-year tax-exempt yields have dipped under 1%. In addition, longer taxable municipal bonds, such as the California Build America Bonds (BABs), saw a surge in demand from investors this week. A light calendar of new issuance, strong demand for bonds from flows into municipal bond funds and a rally in the Treasury market this week all helped give municipals a boost.
In terms of news, Fitch Ratings downgraded California GO debt from A- to BBB, citing the budget and cash flow situation. Speaking of which, the budget impasse continues in Sacramento—10 days after the start of the new fiscal year. Without a budget, the state cannot borrow in the capital markets. In fact, faced with bills to pay and not enough cash to meet all of the obligations, the State Controller this week began issuing IOUs—a form of deferred payment—to select payees. The state last issued IOUs when facing a cash crunch in 1992. Despite all this, California GO debt actually finished the week stronger.
Notable new deals this week include the $200 million California Infrastructure and Economic Development Bank - California Independent System Operator (CAISO) Corporation Project Revenue Bonds (rated A2/A) which offered a maximum yield of 5.88% in 2039. CAISO is a not-for-profit public-benefit corporation that charges fees for providing scheduling services for the market where buyers and sellers trade electricity—an essential service.
A level of uncertainty has crept back into the capital markets over the past three weeks, especially after the weaker-than-expected nonfarm payroll figures and the weak consumer confidence data. Major equity indices are off 7-8% from their mid-June 2009 highs and commodity prices (for example, crude oil) are significantly off their recent highs, as investors are beginning to fear that the expected economic stabilization may be further off than expected in April and May when the risk rally began. The high yield market is not immune to these market currents and has been softer over the past few weeks. Since mid-June, the Merrill Lynch High Yield Index is off 1.0%, which is small in the context of the asset class’s stellar second quarter performance. The high yield asset class continues to receive inflows, as reflected by the $329 million of inflows into high yield mutual funds this past week. In addition, the new issue market remains active, with close to $1 billion in new deals pricing this week including a $400 million deal for Regal Cinemas, one of the largest movie theater companies in the U.S.
Western European Equities
European stocks went down this week. The sectors with the worst performance were insurance (-6.6%) and basic resources (-5.9%). Bad news about declining real insurance premiums put pressure on the entire sector. Big companies are being forced to reduce costs and outsource certain functions. Over seven companies lost more than 10%, led by Aviva (-18.0%). Basic resources was the second worst performer this week with Norsk Hydro ASA (-13.4%) leading the share plunge.
The best performing sectors were retail (-0.28%) and healthcare (-0.99%). The best performers in retail were Home Retail Group (+4.6%) and Next Plc (+4.2%). The healthcare sector remains a safe haven in a bearish week. Glaxosmithkline (+2.9%) gained after a takeover of Bristol Myers Squibb divisions in the Middle East and North Africa. News about the introduction of a new diabetes drug supported Astrazeneca’s shares (+1.1%).
Eastern European Equities
The CECE index of equities traded in Central Europe (Czech Republic, Hungary, and Poland) lost 3.2% this week, while the Russian stock index RTS went down 13.0%.
Russia’s currency, the ruble, weakened the most since February as oil prices dropped, Russia cut interest rates, and the budget deficit widened in the country’s worst economic slump in a decade. The ruble depreciated as much as 3.1% to 32.76 per dollar and the Micex Index sank to a three-month low.
Oil (Russia’s main export) fell 1.5% to $59.48 a barrel, bringing this week’s drop to 11% as concerns deepened that a prolonged global economic slowdown will dampen demand for fuel. Lower oil revenue means that less foreign currency will flow into Russia, which leads to a bigger budget deficit and reduces the central bank’s ability to defend the ruble.
Global Bonds and Currencies
Over the past week major sovereign bond markets extended the previous week’s gains as financial markets’ confidence in the global economic outlook waivered and equity markets and commodity prices dipped accordingly. The weaker than expected US payroll data released late in the previous week was one trigger for these jitters. Another was the cautious note struck by the IMF in its latest round of forecasts, published in the past week. Investors are looking anxiously towards the forthcoming US second quarter earnings season and market sentiment is likely to remain fragile until this hurdle is cleared. The past week’s data provided scant reassurance meantime. Industrial production rose in Germany, but dipped in the UK, while the third successive monthly decline in Japanese machinery orders raised doubts about the demand for exports from the entire Asian region. All these factors combined to drive government bond yields several basis points lower across the curve in Europe and Japan, in sympathy with moves in the US Treasury market. Short-dated UK Gilt yields also declined. But longer-dated Gilts bucked the trend, rising about 10 bps on the week, after a surprise move by the Bank of England at its monthly policy meeting. Instead of extending its quantitative easing program by a further £25 billion, up to its limit of £150 billion, as was widely tipped in the media, it instead suspended it from next month, without providing any insight into its future plans. The Bank said only that it will review the program at its August meeting, in light of its latest inflation projections, which will be available then.
In currency markets, yen strength was the week’s main theme. It rose to a 5-month high against the US dollar as risk aversion returned. Japan’s current account surplus recorded its fifth successive improvement and technical factors turned supportive. Risk aversion also assisted the US dollar, especially against commodity currencies, as oil and other commodity prices declined. However the dollar closed the week only marginally firmer against the euro and sterling.
Emerging market dollar-pay debt spreads were wider this week, as investors turned more cautious on the back of some weaker-than-expected economic data. In turn, US Treasury yields rallied, which also contributed to the widening in credit spreads.
Oil exporting countries, including Russia, felt the negative impact of sharply declining oil prices this week as crude oil prices fell 11%. As a consequence, Russian assets sold off late in the week, including its currency the ruble, which depreciated the most in five months.
The Central Bank of Chile cut interest rates by 25 bps from 0.75% to 0.50%, in line with markets expectations. The Central Bank explicitly stated that interest rates will stay at a low level for a prolonged period of time. On the back of this announcement and also the decline in commodity prices this week, local rates were unchanged and the Chilean peso depreciated.
NEXT WEEKS ECONOMIC RELEASES
July 14 Retail Sales, Producer Price Index, Euro Zone Industrial Production, German ZEW Indicator of Economic Sentiment
July 15 Consumer Price Index, Euro Zone Inflation
July 16 Turkey Consumer Confidence
July 17 Housing Starts
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