MARKET LEVELS
Friday* Last week Dec. 31, 2008 One year ago
Dow Jones Industrial Avg 9,251 9,370 8,776 11,616
S&P 500 996 1,010 903 1,293
NASDAQ 1,972 2,000 1,577 2,454
Russell 2000 561 572 499 754
DJ STOXX Europe 600 (€) 229 231 198 286
Nikkei Index (¥) 10,597 10,412 8,860 12,957
Fed Funds Target 0%-0.25% 0%-0.25% 0%-0.25% 2.00%
2-Year Treasury Yield 1.04% 1.30% 0.77% 2.43%
10-Year Treasury Yield 3.52% 3.85% 2.21% 3.89%
U.S. $ / Euro 1.42 1.42 1.40 1.48
U.S. $ / British Pound 1.65 1.67 1.46 1.87
Yen / U.S. $ 94.65 97.57 90.64 109.74
Gold ($/oz) $946.95 $954.95 $882.05 $806.63
Oil $70.59 $70.93 $44.60 $115.01
*Levels reported as of 9:00 am Pacific Standard Time
MARKET RETURNS
Year-to-date (1/1/09-8/14/09)* Year-to-date (1/1/09-8/13/09)
Dow Jones Indus Avg. 5.41% 90 Day T-Bill 0.15%
S&P 500 10.32% 2-Year Treasury 0.54%
NASDAQ 25.03% 10-Year Treasury -8.88%
Russell 2000 12.27% ML High Yield Index 38.97%
MSCI World Index 16.39% JPM EMBI Global Diversified 20.77%
DJ STOXX Europe 600 15.28% JP Morgan Global Hedged -0.61%
*Returns reported as of 9:00 am Pacific Standard Time
RECAP OF THE WEEK'S ECONOMIC RELEASES
August 11 Wholesale Inventories – Wholesale inventories fell by 1.7% in June as distributors were able to move out
excess stockpiles. The July drop was almost twice as large as the predicted 0.9% decline and marks
the tenth consecutive month of decreases.
August 12 Trade Balance – The US trade deficit widened by 4.0% to $27.0 billion in June after unexpectedly
narrowing to $26.0 billion in May. Exports and imports increased by 2.0% and 2.3%, respectively,
signaling that the global economic slump may be coming to an end.
FOMC Rate Decision – The Federal Open Market Committee announced that it will maintain the
target range for the federal funds rate at 0.0 to 0.25% and that economic conditions are likely to
warrant exceptionally low levels of the federal funds rate for an extended period. In addition, the
Committee will gradually slow the pace of its purchases of Treasury securities and anticipates
that the full amount will be purchased by the end of October.
August 13 Retail Sales – Despite a boost from the government's cash-for-clunkers subsidy, US seasonally adjusted
retail sales fell 0.1% in July, the first decline in three months. The drop indicates that consumer demand
will likely remain weak even in the face of government stimulus measures.
Business Inventories – Business inventories fell by 1.1% in June, slightly less than the 1.2% drop in
May. This marks the eighth consecutive month of inventory declines larger than 1.0% and indicates that
higher demand may be clearing away unwanted supply.
Import and Export Prices – Import prices fell by 0.7% in July, largely due to price decreases for both
petroleum and nonpetroleum products. Export prices decreased by 0.3% in the same month as a result
of lowered agricultural export prices.
August 14 Consumer Price Index – Headline inflation was unchanged on a monthly basis in July but down 2.1%
on a year-over-year basis, the most rapid rate of decline since 1950. Core inflation, which excludes food
and energy, rose 0.1%, indicating that inflation will remain subdued for some time.
Euro Zone CPI – European consumer prices dropped more than the estimated 0.6%. Prices fell
0.7% from a year earlier after declining 0.1% in June. Core inflation rate, which excludes volatile
energy and food costs, eased to 1.3%.
Euro Zone GDP – The euro zone GDP contracted by 0.1% in the second quarteragainst
economists’ forecasts of a decline by 0.5%. Demand for European exports is improving as
government rescue packages and lower interest rates support spending.
Germany & France GDP – German and French economies grew unexpectedly in the second
quarter. GDP rose a seasonally adjusted 0.3% in both countries.
OVERVIEW ___________________________________________________
The Federal Reserve left its benchmark interest rate unchanged in a range between 0.0% and
0.25% at the conclusion of its August meeting on Wednesday. In its policy statement, the Fed
reiterated that economic conditions were likely to warrant a low federal funds rate for an
“extended period,” despite signs that the US economy is “leveling out.” The central bank also
discussed exiting parts of its credit easing program, suggesting that it may end its Treasury
purchase program in October when it has exhausted the $300 billion allocated for this purpose.
Going forward, the evolution of the economic data will play a key role in driving the Fed’s next
move. The 0.1% July drop in retail sales indicated that consumers are choosing to build savings
and pay down debt rather than increase spending, underscoring our expectation that real GDP
growth will remain at 1-2% for most of 2010. In this environment, we anticipate that the Fed will
leave short-term interest rates on hold until mid-2010 until it begins the process of gradually
raising its overnight rate to 1% by the end of next year.
US MARKETS:
TREASURIES ________________________________________________________________________________
• US Treasuries had a strong performance this week, backed by better-than-expected
auctions in 3-year, 10-year, and 30-year bonds. Two-year on-the-run Treasury yields
finished the week 25 basis points (bps) lower, 10-year yields rallied 35 bps.
• At the end of the week the combination of unchanged consumer prices and lower-thanexpected
consumer confidence, expressed via the University of Michigan survey index,
accelerated this rally. This resulted in unwinding of short positions in longer dated maturities
and the re-emergence of curve flattening trades, with the yield spread between 2-yr notes
and 10-yr bonds tightening by 10 bps over the last five trading days.
LARGE-CAP EQUITIES___________________________________________________________
• The stock market fell for the first time in five weeks due to weaker-than-expected economic
data releases. The S&P 500 index fell about 1.3% for the week. Large-cap stocks
outperformed small-cap stocks. In terms of style, large-cap growth stocks outperformed
large-cap value stocks. The best performing sector was health care and the worst
performing sector was consumer discretionary. Earnings season continues to wind down
with retail companies dominating this week’s announcements. Wal-Mart Stores Inc reported
quarterly earnings of 88 cents per share, which beat analysts’ estimates of 86 cents per
share. The company attributed the positive quarter to cost reductions and better inventory
management. Shares of WMT rose almost 3% on the news.
CORPORATE BONDS _____________________________________________________________
• Investment grade primary activity continued its torrid pace during the first half of the week.
Money continues to pour into the high grade credit space despite Treasury yields falling
most of the week. For the first time in some time now, several new issues that priced this
week are actually trading wider to where they initially priced. Many investors think that the
widening is temporary as lower Treasury yields dampened interest from absolute yield
buyers. Thin summer trading also contributed to the move wider adding to the notion of
some that the widening was merely a function of the market running too far too fast.
• Investment grade corporate spreads tightened slightly on the week even though it felt like
most of the market was trading sideways on very thin volumes. Range-bound spread levels
should stay at least until post Labor Day weekend. It does feel like we have reached a point
where the buy-everything-you-can-get-your-hands-on mentality has given way to a more
rational approach. The Barclays Credit Index Option-Adjusted Spread (OAS) finished the
week at +213, tighter by 3 basis points. Financials tightened by 9 basis points (banks -7,
insurance -11); industrials widened by 1 basis point (telecom +3, consumer non-cyclical -1,
basic materials +9, capital goods -2, energy +6); and utilities widened by 1 basis point.
MORTGAGE-BACKED SECURITIES _______________________________________________
• Agency mortgages kept pace with Treasuries in the rally back to the middle of the range.
The mortgage market weathered a slew of economic reports and headline events that
offered mixed views on the direction of interest rates. This lack of direction is an ideal
environment for mortgages as rates have oscillated in a narrow 25 basis point range. Thirtyyear
current coupon pass-through spreads closed unchanged versus Treasuries at 94 basis
points. Although the production coupons experienced quiet spread movement, activity
picked up for the higher coupon agency mortgage market. The relatively benign
prepayment report has enticed investors to pay up for premium mortgages opting for an
attractive alternative to short government and corporate products.
MUNICIPAL BONDS _____________________________________________________________
• After closing in on its steepest levels on record, the municipal bond market yield curve
flattened this week. Yields on short maturity bonds edged higher and longer maturity yields
dipped lower. We are hearing – and seeing – investor interest sour for the front end of the
municipal market. An example will help explain why: a 2-year municipal bond yielding just
0.68% did not seem all that appealing as “risk-free” Treasury yields ratcheted up to 1.30% at
the end of last week. As a result, municipal investors held on to cash, shifted their focus
across markets (into taxables) or moved further out along the municipal curve. In addition,
the flood of Build America Bonds (BABs) serves as a substitute for long-term tax-exempt
issuance. Investors continue to anticipate this relative scarcity of longer term municipal
bonds in the markets, bidding up prices and sending yields lower. This helped push the yield
curve flatter. By Thursday, two-year AAA-rated bond yields rested at 0.71% and 30-year
bond yields fell to 4.62%.
• The pace of new supply kicked up a notch on the week as a flurry of deals hit the market.
One highlight was the $775 million Bay Area Toll Authority, San Francisco Bay Area Toll
Bridge Revenue Bonds. The Aa3/AA/AA- credit offered a maximum yield of 5.12% in the
2044 maturity and was met with heavy demand from investors.
HIGH-YIELD BONDS ____________________________________________________________
• The high yield bond market remained firm with bonds generally well-bid in August. The
relatively positive economic data (for example, declining unemployment rate) and the
continuing equity rally has resulted in continuing market momentum for high yield. The
broad Merrill Lynch high yield index is up 1.65% for August to-date and the Merrill Lynch
BB/B index is 1.3% for the month to-date. Similar to the past five months, it is the typically
CCC-rated segment of the market that is up the most as some investors continue to reach
for yield. High yield mutual funds continue to receive significant inflows, as investors
maintain their positive view of the asset class. The inflows this week totaled $713 million.
Surprisingly, given the time of the year, the high yield new issuance remains strong, with
over $5 billion of deals pricing this week. New deals included a $1 billion financing for
Case New Holland, the agricultural and construction equipment company, and a $1.3 billion
bond deal for Sprint Nextel, one of the largest wireless telecommunication companies.
INTERNATIONAL MARKETS:
WESTERN EUROPEAN EQUITIES __________________________________________________
• European stocks went down this week. The sectors with the worst performance were
auto & parts (-3.9%) and food & beverage (-1.1%). Volkswagen (-21.0%) pulled
down the performance of the entire sector as the takeover of Porsche is now
finalized. On the other hand, Porsche gained 11.2% as a result. Chrysler creditors
were granted permission to sue Daimler (-2.2%) over $9 billion in transfers. The food
& beverage sector suffered from high unemployment rates and cost conscious
consumers. The entire sector is suffering under hard price competition, especially
breweries. Heineken (-3.8%), Coca Cola (-3.3%) and Nestle (-3.1%) performed the
worst.
• The best performing sectors were real estate (+5.3%) and utility (+2.8%). A group of
Indian and Gulf investors is considering a take-over of Derwent London leading to an
increase of its stock by +10.2%. British real estate continues to show good growth,
specifically Land Securities (+6.6%) and Brit Land Co (+6.4%). In the utility sector,
Endesa (7.7%) profited from rising energy prices. In Germany, E.ON (+5.6%) and
RWE (+2.6%) benefited from a recovery of the sector overall.
EASTERN EUROPEAN EQUITIES __________________________________________________
• The CECE index of equities traded in Central Europe (Czech Republic, Hungary,
and Poland) gained +0.6% this week, while the Russian stock index RTS went down
-1.9%.
• The euro zone’s two largest economies, Germany and France, unexpectedly returned to
growth in the second quarter, hauling Europe out of its worst recession since World War II.
This reduced the drop in the 16-nation bloc’s GDP to just 0.1%, helping it outperform the
US and the UK. Global stimulus measures to battle the deepest slump since the Great
Depression have boosted demand for European exports and government packages are
supporting spending at home. Government and household spending were among the main
drivers of second quarter growth in Germany and France. This is also good news for the
economies of Emerging Europe, as trade with Western Europe is an important component
of their growth story.
GLOBAL BONDS AND CURRENCIES _____________________________________________
• The past week was a particularly good one for shorter-dated sovereign bonds in most
markets, supported by equity market jitters early in the week, weaker than expected US
retail sales and jobless data and by indications from the US Fed that rates will remain low
for an ‘extended period’. Two-year Bunds finished the week more than 20 basis points
lower, in line with developments in the US Treasury market, despite unexpected news that
both the French and German economies expanded modestly in Q2 after four successive
quarters of contraction. Short-dated UK Gilts received an extra fillip from the release of the
Bank of England’s (BoE) quarterly Inflation Report. Two-year Gilt yields fell more than 30
basis points on the week after the BoE said that the UK’s recovery will be ‘slow and
protracted’, suggesting that its accommodative policy stance will remain in place for some
time. The buoyant mood filtered up the European and UK yield curves but gains were most
modest in the 10-year zone. The Japanese government bond (JGB) market had a quieter
time than the other sovereign markets, with the short end of the JGB curve closing virtually
unchanged and longer-dated JGBs only a few basis points firmer on scepticism about the
sustainability of the Japanese recovery.
• In currency markets the US dollar was generally weaker against its major crosses
following the Fed’s hint that rates would remain at current low levels. At the same time, the
Euro received a boost from the better-than-expected French and German Q2 GDP data.
The Australian and New Zealand dollars also rose against the greenback due to firmer
commodity prices and mounting speculation that these countries will lead the rise in rates.
Sterling lagged, closing the week lower against the dollar, on disappointment at the BoE’s
cautious comments on the UK’s economic outlook.
EMERGING-MARKET BONDS ____________________________________________________
• Emerging market dollar-pay debt spreads widened this week as risk appetite receded. The
Federal Reserve meeting, however, delivered a statement that was in line with
expectations and reinforced investors' expectations that the global economic recovery is
under way.
• In South Africa, the Central Bank cut its benchmark interest rate by 50 basis points from
7.50% to 7%, a surprise to the market as no change had been expected. The cut was
based on the continued weakness in the South African economy and signs that inflationary
pressures are easing. Local bonds rallied on the news.
NEXT WEEK'S ECONOMIC RELEASES
August 17 Turkey May Jobless Figures
August 18 Producer Price Index, Housing Starts, German ZEW Economic Sentiment
August 19 Crude Inventories
August 20 Leading Indicators, Poland July Inflation
August 21 Existing Home Sales
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