July 17, 2009
Friday* Last week Dec. 31, 2008 One year ago
Dow Jones Industrial Avg 8,738 8,147 8,776 11,447
S&P 500 940 879 903 1,260
NASDAQ 1,885 1,756 1,577 2,312
Russell 2000 520 481 499 697
DJ STOXX Europe 600 (€) 211 197 198 276
Nikkei Index (¥) 9,395 9,287 8,860 12,888
Fed Funds Target 0%-0.25% 0%-0.25% 0%-0.25% 2.00%
2-Year Treasury Yield 1.00% 0.90% 0.77% 2.49%
10-Year Treasury Yield 3.64% 3.30% 2.21% 3.99%
U.S. $ / Euro 1.41 1.39 1.40 1.59
U.S. $ / British Pound 1.63 1.62 1.46 2.00
Yen / U.S. $ 94.21 92.54 90.64 106.28
Gold ($/oz) $938.68 $913.05 $882.05 $957.43
Oil $63.89 $59.89 $44.60 $129.29
*Levels reported as of 11:00 am Pacific Standard Time
Year-to-date (1/1/09-7/17/09)* Year-to-date (1/1/09-7/16/09)
Dow Jones Indus Avg. -0.43% 90 Day T-Bill 0.13%
S&P 500 4.11% 2-Year Treasury 0.61%
NASDAQ 19.55% 10-Year Treasury -8.86%
Russell 2000 4.10% ML High Yield Index 29.66%
MSCI World Index 6.56% JPM EMBI Global Diversified 16.66%
DJ STOXX Europe 600 6.21% JP Morgan Global Hedged -0.89%
*Returns reported as of 11:00 am Pacific Standard Time
RECAP OF THE WEEK'S ECONOMIC RELEASES
July 14 Retail Sales – The Commerce Department announced a 0.6% rise in retail sales in June, up from the unrevised 0.5% increase in May. The rise was largely due to a jump in automobile sales and higher energy prices.
Producer Price Index - The Producer Price Index was up 1.8% in June, following an increase of 0.2% in May. The rise far exceeded the 1% forecast and marked the index’s biggest uptick since November 2007.
Euro Zone Industrial Production – The euro zone recorded the first increase in industrial
production in nine months (+0.5%). The numbers missed expectations of around +1.5%.
Industrial production was at -17.0% this time last year.
German ZEW Index – Expectations for economic activity declined from 44.8 to 39.5 over the last month in Germany. After eight consecutive increases, the current level lies still high above the average of 26.3.
July 15 Consumer Price Index – Headline inflation rose 0.7% in June versus 0.1% in May. Core inflation, which excludes food and energy, rose by 0.2% in June after increasing 0.1% in May. The acceleration in headline inflation was largely caused by a sharp increase in energy prices.
UK Housing Market – The RICS survey found that housing prices started to increase for the first time in 20 months in the UK. There are still small declines in prices but a shift is foreseeable.
July 16 Initial Claims - First time unemployment claims for the week ending July 11 fell by 47,000 to 522,000, the lowest level since January. The sharp drop is largely due to seasonal adjustments and the fact that General Motors and Chrysler shut down plants months before traditional July closings.
July 17 Housing Starts – Housing starts rose unexpectedly, climbing 3.6% to an annual rate of 582,000 in June from 562,000 in May. Though the month-over-month increase underscores the view that the housing market may be stabilizing and that the US economy is beginning to recover, housing starts were still down 46% on a year-over-year basis.
Inflation data released this week suggest that price pressures remain subdued. The headline consumer price index (CPI) was up 0.7% in June from the prior month, but the index is 1.5% lower than it was last year at this time. The volatility in the headline number has been driven by energy prices, which peaked at $145/barrel last July before tumbling to $63/barrel today. Core CPI inflation, which excludes food and energy prices and accounts for roughly 75% of the overall price level, has remained stickier at 1.7% yearover- year. However, core inflation could drift lower in the coming months due to declining shelter costs.
The rate of increase in the Owners' Equivalent Rent (OER), which measures what owners give up by occupying instead of renting their homes, has been falling. In June 2008, OER was up 2.6% from year ago levels compared to a 1.9% increase in June 2009. The OER accounts for about 24% of the headline inflation index and 30% of the core inflation index so it plays an important role in driving the overall price level. With the national rental vacancy rate at a near-record 10.1% and unemployment levels rising, rents, and the OER, will likely remain low for the rest of the year and keep inflation at bay.
• Treasury yields rose this week and the yield curve steepened as the longest-dated bonds sold off the most. A strong rebound in equities from last week’s drop coupled with reasonable earnings and economic data drove the move to higher yields. In addition, stronger-than-expected Consumer and Producer prices had a sociable impact on the long end. Agency spreads continue to stay near their tightest levels as investors become more comfortable with the idea that agency debt is government protected.
LARGE-CAP EQUITIES ___________________________________________________________
• The stock market rallied for the first time in five weeks spurred by better-than-expected second quarter earnings from some of the largest S&P 500 companies. Goldman Sachs, JP Morgan, Intel, Google, IBM, and General Electric all surprised on the upside. The S&P 500 index jumped about 6% for the week with large-cap stocks underperforming small-cap stocks. In terms of style, large-cap growth stocks underperformed large-cap value stocks. The best performing sector was materials and the worst performing sector for the second straight week was telecommunication services. In the headlines this week, Goldman Sachs reported second quarter earnings of $4.93 per share, which trumped analyst estimates of $3.65 per share. The company attributed the strong quarter to record quarterly revenues in trading and stock underwriting.
CORPORATE BONDS _____________________________________________________________
• Investment grade primary activity was quiescent once again as second quarter earnings dominated investors’ attention. Notable deals this week included Carefusion, a spinoff of Cardinal Health, which came to the market with a $1.5 billion three-tranche deal that priced around +300 to Treasuries and Goldman Sachs who tapped the market with a $1 billion three-year deal priced at +212.5 over the 3-year Treasury after they reported better-than-expected second quarter earnings. We expect issuance to remain light throughout earnings.
• Investment grade corporate spreads tightened most of the week on the heels of several factors. Higher overall yields, decent earnings and lack of issuance all contributed to tighter spreads. CIT’s fiasco this week did not have a material negative effect on credit spreads. CIT bonds have been without a doubt the most traded name this week; however, broker and bank securities have tightened due to strong second quarter results from Goldman and JP Morgan. The Barclays Credit Index Option-Adjusted Spread (OAS) finished the week at +267, tighter by 6 basis points. Financials tightened by 5 basis points (banks -9, insurance flat); industrials tightened by 9 basis points (telecom -16, consumer non-cyclical -6, Basic Materials -20, Capital Goods -3, Energy -5); and utilities tightened by 9 basis points.
MORTGAGE-BACKED SECURITIES ________________________________________________
• Mortgages outperformed Treasuries as yields drifted higher back to the middle of the recent trading range. Agency 30-year mortgage spreads compressed 10 basis points to their narrowest levels of the summer. Mortgages also enjoyed a favorable environment for risk taking as equity and credit markets rebounded on better-than-expected economic data. Credit sensitive mortgage products shrugged off rating agency downgrades to rally ahead of this week’s subscription on the legacy Term Asset-Backed Loan Facility (TALF) assistance program. The 30-year current coupon versus the 30-year Treasury closed at 96 basis points.
MUNICIPAL BONDS _____________________________________________________________
• The tax-exempt yield curve steepened this week, with shorter-maturity bond yields falling 5-10 basis points and yields on longer maturity bonds rising slightly. Municipal bond yields, especially in the front end of the yield curve, have moved well below comparable Treasury yields. For example, two-year AAArated GO bonds now yield 75 basis points or 0.75%-just 79% of the two-year Treasury yield at 0.95%. A few key factors continue to favor municipal bonds though, including a relatively light summer issuance calendar, the overall slump in municipal issuance compared to a year ago and fresh investor money pouring into municipal bond funds. Also, for the second consecutive week taxable municipal bonds, such as the California Build America Bonds (BABs), saw a surge in demand from investors.
• Moody’s Investors Service lowered the state of California’s credit rating by two notches from A2 to Baa1 on Tuesday afternoon. On Wednesday and Thursday, the state’s Build America Bonds (BABs) traded tighter in spread to Treasuries by about 20-30 basis points. Tax-exempt California State General Obligations’ spreads to AAA-rated GOs tightened by 5 basis points on the week. It is interesting to note that 70%+ of tax-exempt buyers are households, while 97% of CA BABs buyers at new issuance in April were institutional investors. This may explain the difference in trading activity between the two markets. While a budget plan would not solve California’s near-term cash flow problems, it could alleviate the cash crunch by allowing the State to enter the market and issue revenue anticipation notes (RANs) or revenue anticipation warrants (RAWs) instead of issuing IOUs to vendors.
• The notable new issuance this week was dominated by Build America Bonds deals. Highlights included the Illinois Municipal Electric Agency Power Supply System Revenue Bonds (A1/A+/A+) that offered yields of 240 basis points over comparable Treasuries in the 2039 maturity. The North Carolina Turnpike Authority (Aa2/AA/AA-) also issued a slate of $353 million BABs, coming to market at +240 basis points to comparable Treasuries in the 2039 maturity.
HIGH-YIELD BONDS _____________________________________________________________
• The generally positive second quarter earnings from the larger US financial institutions (Citibank, Goldman Sachs and JP Morgan) have benefited the equity markets, with major equity indices up 4-5% this week, but have not had a materially positive impact on the high yield market. The financial uncertainty surrounding CIT (a major component of high yield indices since being downgraded to high yield status in May 2009) has negatively impacted high yield bond holders who own the CIT bonds. In addition to the issues surrounding CIT, the high yield market is cautiously viewing the developing second quarter earnings season. While the broad high yield market still appears to be flush with cash, inflows into high yield mutual funds have been exhibiting slowing trends over the past few weeks and were less than $100 million this week. The new issue market has also exhibited a moderating trend, with less than $1 billion in new issue high yield bonds pricing this week and the forward calendar of new deals relatively thin.
WESTERN EUROPEAN EQUITIES __________________________________________________
• European stocks went up this week. The sectors with the best performance were autos & parts (+18.4%) and basic resources (+14.1%). BMW (+13.7%) has decided to accelerate production after cutting the work week at its German plants. Porsche (+22.8%) seems to have solved the biggest hurdles in terms of their outstanding debts and a solution in the takeover action with VW (19.6%) is in sight. Xstrata, the world’s fourth-largest copper producer, climbed +18.6% due to merger activities. Stabilizing metal prices contributed to a good performance in the entire sector.
• The worst performing sectors were technology (+3.6%) and travel & leisure (+3.6%). Nokia’s
performance (-6.7%) was in line with expectations, but the company disappointed with a negative outlook due to price competition in the sector. Opap (-4.1%), a gambling company, missed its profit target after Greece imposed new taxes on gaming. Accor (-1.8%), Europe’s largest hotel operator, suffered from reduced business travel during this recession.
EASTERN EUROPEAN EQUITIES __________________________________________________
• The CECE index of equities traded in Central Europe (Czech Republic, Hungary, and Poland)
gained +9.2% this week, while the Russian stock index RTS went up +10.7%.
• Hungary sold its first debt to foreign investors since last year’s International Monetary Fund (IMF) bailout, taking advantage of the world’s strongest bond market rally to borrow €1 billion. Investors expressed interest to buy €2.9 billion of securities, nearly six times the €500 million the government initially planned to raise. The government lured buyers by offering a yield of 6.79% on a five-year debt, more than 5.9% over existing euro-bonds due in May 2014. Hungary became the first European Union nation to receive IMF aid last year as its bond market froze and a slide in the forint pushed up refinancing costs on foreign-currency loans.
GLOBAL BONDS AND CURRENCIES _______________________________________________
• Major non-US sovereign bond markets closed the week 5-10 basis points weaker following gains in global stock markets. The US Federal Reserve’s relatively upbeat assessment of the US economic outlook and news of a pick-up in the pace of economic growth in China in Q2 dampened global bond market sentiment, although the week’s European and UK inflation data provided some relative support for these markets and allowed them to outperform US Treasuries. The flash estimate of Euro-zone June inflation showed inflation turned negative last month, declining 0.1% on an annual basis, while the UK’s annual inflation rate dipped to 1.8%, below the Bank of England’s (BoE) 2% target, for the first time this cycle. Gilts were also assisted by speculation that the BoE may extend its quantitative easing program at its next policy meeting and by a further rise in UK unemployment to an all time record. In Japan, Prime Minister Aso announced a general election at the end of August, which is expected to end
the ruling Liberal Democratic Party’s domination of post-war Japanese politics. But this had little impact on Japanese government bonds (JGBs). Neither did the Bank of Japan’s decision to maintain its zero interest rate policy and extend its quantitative easing measures by three months to end December. Japanese government bonds finished the week a couple of basis points weaker across the curve.
• In currency markets the US dollar was marginally weaker against the Euro and Sterling, undermined by the improvement in risk appetite and news that China’s foreign exchange reserves reached a new high in the second quarter. The easing in risk aversion hurt the yen more and it closed the week about 0.5% lower against the greenback.
EMERGING-MARKET BONDS ____________________________________________________
• Emerging market dollar-pay debt spreads tightened this week on the back of strong economic data in China and better-than-expected US corporate earnings that led to a rally in equities. Increased investor risk appetite supported new bond supply from several state-owned companies in Colombia, Qatar, Korea and Kazakhstan.
• Monetary easing continues in emerging markets but central banks are signaling the end of the cycle is close. The Central Bank of Turkey reduced the key overnight borrowing rate by 50 basis points to 8.25% but the statement was less dovish than at the previous meeting. Mexico also cut the repo rate by 25 basis points to 4.50% and indicated it would pause going forward to monitor economic data.
• Moody’s raised South Africa’s foreign currency debt rating to A3 from Baa1, citing sound
macroeconomic policies and a build-up in foreign exchange reserves which stood at US$ 35.76 billion atthe end of June.
NEXT WEEK'S ECONOMIC RELEASES
July 19 German Producer Price Index
July 22 Mortgage Applications
July 23 Existing Home Sales, Poland June Net Inflation Figures
July 24 University of Michigan Consumer Confidence, German IFO Business Climate Index