Payden & Rygel
July 24, 2009
MARKET LEVELS
Friday* Last week Dec. 31, 2008 One year ago
Dow Jones Industrial Avg 9,041 8,744 8,776 11,349
S&P 500 972 940 903 1,253
NASDAQ 1,952 1,887 1,577 2,280
Russell 2000 544 519 499 702
DJ STOXX Europe 600 (€) 220 211 198 282
Nikkei Index (¥) 9,945 9,395 8,860 13,603
Fed Funds Target 0%-0.25% 0%-0.25% 0%-0.25% 2.00%
2-Year Treasury Yield 1.01% 0.99% 0.77% 2.61%
10-Year Treasury Yield 3.67% 3.65% 2.21% 4.00%
U.S. $ / Euro 1.42 1.41 1.40 1.57
U.S. $ / British Pound 1.64 1.63 1.46 1.99
Yen / U.S. $ 94.82 94.19 90.64 107.33
Gold ($/oz) $952.73 $937.50 $882.05 $928.05
Oil $65.99 $63.56 $44.60 $124.74
*Levels reported as of 10:00 am Pacific Standard Time
MARKET RETURNS
Year-to-date (1/1/09-7/24/09)* Year-to-date (1/1/09-7/23/09)
Dow Jones Indus Avg. 3.02% 90 Day T-Bill 0.13%
S&P 500 7.64% 2-Year Treasury 0.49%
NASDAQ 23.81% 10-Year Treasury -9.91%
Russell 2000 9.01% ML High Yield Index 32.74%
MSCI World Index 11.35% JPM EMBI Global Diversified 18.07%
DJ STOXX Europe 600 10.74% JP Morgan Global Hedged -1.29%
*Returns reported as of 10:00 am Pacific Standard Time
RECAP OF THE WEEK'S ECONOMIC RELEASES
July 20 Leading Indicators – The index of US leading indicators rose in June for the third consecutive month by 0.7%, following a revised 1.3% gain in May. This marks the first three-consecutive-month increase since 2004.
July 21 Bernanke Testimony before Senate – As part of the central bank's semiannual report on
monetary policy and the economy, Federal Reserve Chairman Ben Bernanke outlined possible
exit strategies from quantitative easing and emphasized that massive inflation could be avoided.
July 23 Existing Home Sales – Sales of existing homes rose for the third straight month, indicating a possible end to the four-year housing slump that precipitated the recession. Purchases increased 3.6% to an annual rate of 4.89 million in June, the highest level since October 2008.
July 24 University of Michigan Consumer Confidence - The Reuters/University of Michigan final index of consumer sentiment fell in July to 66, down from 70.8 in June. The decrease, the index’s first in five months, is likely due to continued weakness in the labor market and falling home values.
PMI Manufacturing & Services – The euro zone recorded the slowest rate of contraction since last summer, with the composite index rising to 46.8 (from 44.6 last month).
OVERVIEW ___________________________________________________
Chairman of the Federal Reserve Ben Bernanke’s July 21 testimony before Congress was meant to assure those concerned about the long-term inflationary impact of Fed policy that the central bank was prepared to mop up liquidity when the time comes. However, Bernanke emphasized that "accommodative policies will likely be warranted for an extended period." In other words, the Fed is on hold and will remain so until an economic recovery is firmly in place.
Bernanke also outlined three possibilities for the Fed's exit strategy from quantitative easing: the natural unwinding of Fed credit facilities as improving financial conditions lead private sector participants to provide credit to market participants, selling Treasury bills and depositing the proceeds with the Federal Reserve, or offering term deposits to banks—analogous to the certificates of deposit that banks offer their customers. These measures provide the Fed with latitude to tighten monetary policy before an inflation problem emerges. Those who believe the build up of reserves on bank balance sheets is inflationary are only correct if those reserves are lent out. Inflation is a by-product of too much money chasing too few goods. Currently, plenty of money exists on bank balance sheets, but no one is using it to buy or invest. If the money is not being lent out, there is no inflation problem. Put another way, the Fed is pushing on a string. Banks are probably reluctant to lend because they are reserving excess capital against assets of questionable value that they already have on the r balance sheets. Hopefully, this will change as the economy begins to post positive economic growth rates in the third and fourth quarters and confidence begins to return.
US MARKETS:
TREASURIES ________________________________________________________________________________
• Although daily volatility in Treasury yields remained high, the week-over-week change was minimal as investors balanced the modest improvement in economic data and appreciation in risk assets against the outlook for sluggish growth and company specific credit concerns. Agency spreads continue to maintain their narrow levels relative to Treasuries as market participants gain increasing confidence in viewing the agency credit risk as supported by the US government. Yield directionality takes its cue next week from a full slate of economic data, including home sales, durable goods, GDP and claims data.
LARGE-CAP EQUITIES___________________________________________________________
• The stock market rallied for the second consecutive week and reached new highs for the year due to strong corporate earnings. Both the S&P 500 index and Dow Jones Industrial Average were up over 3.5% for the week. Small-cap stocks outperformed large-cap stocks for the week. In terms of style, large-cap value stocks outperformed large-cap growth stocks. The best performing sector was materials and the worst performing sector was consumer staples. So far this earnings season, approximately 35% of the companies in the S&P 500 have reported earnings. Among these companies, 74% of them have beaten expectations. If this pace continues, it will be the highest proportion of consensus beats since 1993. Some notable companies that reported positive earnings this week were Caterpillar, Starbucks, Apple, eBay, Ford, and AT&T.
CORPORATE BONDS _____________________________________________________________
• Investment grade primary activity picked up noticeably albeit midway through earnings season. Corporate earnings have surprised to the upside across most sectors, adding fuel to an already technically supportive market. CIT’s state of affairs has yet to be determined which has caused a wide range of trade prints. One notable deal this week included a multi-tranche $1.95 billion deal from Boeing who came to the market after reporting second quarter earnings were well above the consensus expectations.
• Investment grade corporate spreads continued to tighten on improving corporate performance and recovering economic conditions. The current imbalance between incredibly strong demand and insufficient supply is rising, fueling the current state of affairs in the corporate bond market. The Barclays Credit Index Option-Adjusted Spread (OAS) finished the week at +247, tighter by 20 basis points. Financials tightened by 28 basis points (banks -34, insurance -22); industrials tightened by 20 basis points (telecom -27, consumer non-cyclical -17, basic materials -31, capital goods -16, energy -17); and utilities tightened by 18 basis points.
MORTGAGE-BACKED SECURITIES _______________________________________________
• Agency mortgages outperformed Treasuries as yields hovered in a narrow trading range. The
current environment is ideal for mortgages as conflicting signals on the economy and monetary
policy leave the bond market directionless. Mortgage spreads narrowed and demand from the US Government and money managers absorbed the steady stream of supply from originators. For the week, the 30-year current coupon versus the 10-year Treasury closed at 95 basis points.
MUNICIPAL BONDS _____________________________________________________________
• The municipal bond market was roughly unchanged over the last week. Two-year AAA-rated general obligation (GO) bond yields finished a 0.74% -- a difference over last week of just 1 basis point. Tenyear AAA-rated bond yields hit 3.00% compared to 2.99% last week. A slowdown in new issuance volume coupled with continued demand from retail buyers kept the forces of supply/demand balanced. However, relative to Treasuries, municipal bonds continue to richen, especially at the shorter-maturities. Two-year AAA-rated municipal bonds now yield just 70% of 2-year Treasuries, as Treasury yields rose this week across the curve.
• By Friday, the California legislature appeared close to a budget deal. While the new budget may allow the state to tap the short-term capital markets and ease its cash flow problem temporarily, the budget plan may come at the expense of schools, local governments and agencies. The state’s GO bonds received a boost this week though, with both tax-exempt GOs and taxable GOs narrowed in spread to high grade state GOs and US Treasuries, respectively, as investors anticipated the budget’s approval over the course of the week.
• New deals this week included the $800 million New York City Transitional Finance Authority (TFA) tax secured bonds (Aa2/AAA/AA+). The 2038 offered a maximum maturity of 5.04%.
HIGH-YIELD BONDS ____________________________________________________________
• The high yield market has regained some momentum, which had dissipated in the latter half of June 2009. The Merrill Lynch BB/B high yield constrained index is up 2.1% in July to-date. Reacting to a strong start to the second quarter earnings season, with major equity indices up 10% since July 10, the high yield market has been bid up again with some of the quarterly earnings season uncertainty now removed. Most of the larger, bellwether high yield issuers will not report second quarter earnings until somewhat later but the earnings trend has been positive for the larger Fortune 1000 companies and is expected to carry-over into high yield land. The more solid tone to the high yield market has resulted in the new issue market remaining open in late July, a historical rarity as the market by this stage of the summer typically begins to wind down. Slightly in excess of $1 billion in new deals were issued this week, with the Los Angeles-based homebuilder, KB Homes, issuing $265 million of 8 year bonds with a 9.1% coupon and a spread of 575 basis points over comparable duration Treasuries. The new deals this week were generally well received and most of the deals traded up at break. The high yield market continues to receive inflows, with inflows this week into high yield mutual funds totaling a significant $566 million, a sizable increase from last week’s sub $100 million inflow print.
INTERNATIONAL MARKETS:
WESTERN EUROPEAN EQUITIES __________________________________________________
• European stocks went up this week by +11%. French building materials company Saint Gobain
(+15.6%) gained on news of a EUR 400 million cost-cutting program. French construction company Alstom (+12.4%) also gained after it won a EUR 110 million contract to supply metro cars to Brazil.
Among the companies that did not do as well were Finnish mobile telecommunication equipment company Nokia (-0.5%) on a negative downgrade from Fitch. French food processing company Danone (+1.5%) failed to match the market rally despite announcing that profit for first half of 2009 was up 3% on lower milk prices and better sales.
EASTERN EUROPEAN EQUITIES __________________________________________________
• The CECE index of equities traded in Central Europe (Czech Republic, Hungary, and
Poland) gained +10.3% this week, while the Russian stock index RTS went up +9.5%.
• Iceland, the European country which fell as one of the first victims of the global financial crisis, may seek European Union (EU) membership. Despite its historical opposition to EU accession, it appears that the tide is shifting in favor of the organization after the combination of overleveraged banking sector and a major global recession led to massive sell-offs in the country’s stock and currency markets and a political crisis. As the country’s level of economic development is far superior to other Eastern European countries that are waiting to become members (Turkey, Macedonia, Albania, etc.), it is likely that Iceland will bypass them to become the Union’s twenty-eighth member.
GLOBAL BONDS AND CURRENCIES _____________________________________________
• Major non-US sovereign bond markets extended their recent losses in the past week, as risk
aversion continued to subside and equity markets approached their highest levels this year.
Although the latest European business sentiment surveys data showed stronger-than-expected
rises in confidence amongst manufacturers and other firms, Bund market losses were modest, as were those in the Japanese market, with yields rising only a few basis points across the curve in both cases. UK Gilt yields rose more sharply, thanks to some surprisingly strong retail sales data, a more upbeat tone in the latest minutes from the Bank of England’s Monetary Policy Committee (MPC) and comments from an MPC member which reinforced fears that the Bank would announce the suspension of its quantitative easing program at its August meeting. News that second quarter UK GDP contracted by 0.8% (-5.6% annually), twice the forecast decline, provided some support for Gilts late in the week, but yields still finished the week up about 16 basis points across the curve.
• Risk aversion remained the dominant theme in currency markets in the past week, weakening the US dollar and the yen against the major crosses. High yield currencies such as the Turkish lira and the Australian and New Zealand dollars were the main beneficiaries, with the latter two further supported by steadily rising commodity prices. Sterling also rose against the greenback following the rise in retail sales figures, the improvement in the tone of the MPC minutes and speculation that quantitative easing may be coming to an end.
EMERGING-MARKET BONDS ____________________________________________________
• Emerging market dollar-pay debt spreads tightened this week supported by improved investor sentiment and the rally in equities and commodity prices. New issuance appetite remained very strong as companies in Colombia, Brazil, Chile, Korea and Russia tapped the international capital markets successfully.
• Monetary easing continues in emerging markets but central banks are signaling the end of the cycle is close. The Central Bank of Brazil reduced the SELIC benchmark rate by 50 basis points to 8.75% as expected. The 8.1% unemployment rate in June was lower-than-expected indicating the recent improvement in industrial production and retail sales is also making its way to the labor markets. The market does not expect any more rate cuts this year.
• Moody’s raised Philippines’ foreign currency debt rating to Ba3 from B1, citing the relatively high degree of resiliency of the country’s financial system and external payments position to the global financial crisis. The rating agency remains cautious on the Philippines’ budget deficit, but expects it to be financed from domestic and foreign sources.
NEXT WEEK'S ECONOMIC RELEASES
July 27 New Home Sales, Hungarian Central Bank Meeting
July 28 Consumer Confidence, S&P/Case-Shiller Home Price Index, Poland CPI
July 29 Federal Reserve’s Beige Book, Poland Central Bank Meeting
July 31 GDP
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