July 31, 2009
MARKET LEVELS
Friday* Last week Dec. 31, 2008 One year ago
Dow Jones Industrial Avg 9,164 9,093 8,776 11,378
S&P 500 987 979 903 1,267
NASDAQ 1,987 1,966 1,577 2,326
Russell 2000 559 548 499 715
DJ STOXX Europe 600 (€) 225 220 198 284
Nikkei Index (¥) 10,357 9,945 8,860 13,377
Fed Funds Target 0%-0.25% 0%-0.25% 0%-0.25% 2.00%
2-Year Treasury Yield 1.12% 1.00% 0.77% 2.51%
10-Year Treasury Yield 3.52% 3.66% 2.21% 3.95%
U.S. $ / Euro 1.42 1.42 1.40 1.56
U.S. $ / British Pound 1.67 1.64 1.46 1.98
Yen / U.S. $ 94.66 94.79 90.64 107.91
Gold ($/oz) $951.25 $951.35 $882.05 $914.07
Oil $67.80 $66.55 $44.60 $124.08
*Levels reported as of 10:00 am Pacific Standard Time
MARKET RETURNS
Year-to-date (1/1/09-7/31/09)* Year-to-date (1/1/09-7/30/09)
Dow Jones Indus Avg. 4.42% 90 Day T-Bill 0.14%
S&P 500 9.28% 2-Year Treasury 0.30%
NASDAQ 25.99% 10-Year Treasury -9.37%
Russell 2000 11.98% ML High Yield Index 35.90%
MSCI World Index 12.88% JPM EMBI Global Diversified 18.93%
DJ STOXX Europe 600 13.39% JP Morgan Global Hedged -0.98%
*Returns reported as of 10:00 am Pacific Standard Time
RECAP OF THE WEEK'S ECONOMIC RELEASES
July 27 New Home Sales – New homes sales rose 11% to a seasonally adjusted annual rate of 384,000 in June,
surpassing expectations of a 350,000 annualized rate. This increase marks the fourth straight month
that new homes sales have risen, underscoring views that the housing market may be bottoming.
July 28 Consumer Confidence – Confidence among US consumers fell for the second consecutive month
in July, reflecting concerns about the rising unemployment rate. The Conference Board’s
confidence index dropped to 46.6, down from 49.3 in June.
S&P/Case-Shiller Home Price Index – The S&P/Case- Shiller home price index rose 0.5% in May, the
first gain since July 2006. While house prices were still down 17% from a year earlier, the month-tomonth
increase is evidence that the housing downturn may be easing.
July 29 Durables Orders - New factory orders for durables fell 2.5% in June due to a plunge in civilian aircraft
orders. Though the decline was worse than the 0.5% forecasted drop, the core measure of new orders,
which excludes transportation, advanced 1.1% in the month, following a 0.8% rise in May.
Federal Reserve's Beige Book – The Fed reported that though the pace of economic contraction has
moderated and begun to stabilize, aggregate employment is still declining, loan demand remains weak,
and business and consumer spending growth is sluggish.
July 31 Gross Domestic Product (GDP) Second-quarter GDP declined at a 1.0% annual rate, largely due to
weak consumer spending and business investment. The result was above market expectations and
represented a dramatic improvement from the prior two quarters.
Euro Zone Unemployment Rate - The jobless rate in the nations that use the euro currency rose to 9.4%
in June, its highest rate in ten years. The number of unemployed has risen by more than 3 million
workers over the past year.
Euro Zone Consumer Price Index - The flash estimate for annual headline inflation dropped to -
0.6% in July from -0.1% in June. This is the second negative reading since the launch of the
euro.
OVERVIEW ___________________________________________________
The Commerce Department reported that US economy shrank at an annual rate of -1% in the
second quarter of 2009. Real gross domestic product (GDP) has now declined for four
consecutive quarters for the first time since the Commerce Department began keeping records
back in 1947. Still, the second quarter was a dramatic improvement over the prior two quarters
when the economy contracted at annual rates of -5.4% in Q4 2008 and -6.4% in Q1 2009 after
revisions.
Looking forward, there is good reason to believe that real GDP growth will turn positive in the
current quarter as businesses move to rebuild inventories adding to the already positive effects
of a shrinking trade gap and increasing government spending. Beyond that, the question will be
whether a sustainable rebound in private demand will materialize before the impact of the
trillions in fiscal and monetary stimulus fade in late 2010.
US MARKETS:
TREASURIES ________________________________________________________________________________
• US Treasuries were mixed this week, with shorter dated maturities under pressure due to
weak auctions in the 2-year and 5-year part of the yield-curve. Two year on-the-run
Treasury yields finished the week 12 basis-points (bps) higher, 5-year yields ended 5 bps
higher.
• A different scenario turned out in the long end of the US Treasury curve, with 10-year and
30-year Treasuries rallying 15 and 20 bps respectively on the back of a surprisingly strong
7-year auction and a higher-than-expected Q1 2009 GDP downward revision to -6.4%. 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-year notes and 10-year bonds
tightening by 27 bps over the last five trading days.
LARGE-CAP EQUITIES___________________________________________________________
• The stock market rallied for the third consecutive week and continued to reach new highs for
the year due to strong corporate earnings. The S&P 500 index rose about 1% for the week.
Large-cap stocks underperformed small-cap stocks. In terms of style, large-cap growth
stocks underperformed large-cap value stocks. The best performing sector was financials
and the worst performing sector was energy. So far this earnings season, about 66% of the
S&P 500 companies have reported earnings with approximately 75% of these companies
beating estimates. The most notable companies that surprised on the upside this week
were ConocoPhillips, Amgen and Visa. In the headlines this week, Microsoft and Yahoo
reached a 10-year search agreement. The agreement will require Yahoo to exclusively use
Microsoft’s search engine Bing.
CORPORATE BONDS _____________________________________________________________
• Investment grade primary activity reverted back to normalcy as earnings continue to
dominate investors’ attention. There were several large infrequent issuers who tapped the
market this week. Macquarie Group LTD, an international investment bank, came to the
market with a $1 billion five-year priced at +475bps over the five-year Treasury. Capital
One also came to the market with a $1 billion 30-year that priced at +586bps over the 30-
year Treasury. Both deals were well oversubscribed confirming there is not enough bond
supply to meet the voracious demand.
• Investment grade corporate spreads tightened once again as light issuance and betterthan-
expected earnings added to the positive sentiment most investors have of the
economic outlook. The imbalance between supply and demand continues to be a major
factor contributing to the tightening we have experienced recently. The Barclays Credit
Index Option-Adjusted Spread (OAS) finished the week at +231, tighter by 16 basis points.
Financials tightened by 16 basis points (banks -14, insurance -28); industrials tightened by
20 basis points (telecom -24, consumer non-cyclical -13, basic materials -24, capital goods
-21, energy -17); and utilities tightened by 15 basis points.
MORTGAGE-BACKED SECURITIES _______________________________________________
• Agency mortgages love a range bound interest rate environment. Mortgage spreads on 30-
year pass-throughs continue to grind tighter as supply was absorbed by steady buying from
the Federal Reserve and Asian central banks. Lower volatility and an improving
prepayment story also helped mortgages outperform Treasuries and agencies. Within the
sector, favorable technicals have lifted Ginnie Mae mortgages over their Fannie Mae and
Freddie Mac conventional cousins. For the week, the 30-year current coupon versus the
10-year Treasury narrowed by 3 basis points to 90 bps.
MUNICIPAL BONDS _____________________________________________________________
• Another month comes to an end and investors in the municipal bond market remain
undeterred from owning high quality, short maturity municipal bonds. Case in point: the twoyear
AAA-rated general obligation (GO) bond yields are just 56% of comparable US
Treasury yields—their lowest level versus Treasuries on record. While part of this is driven
by a rise in Treasury yields, strong demand remains in the front end of the municipal yield
curve. Meanwhile, ten-year AAA-rated GO bond yield held steady this week at around
3.00%.
• The California Legislature resolved its 2009-2010 budget crisis – at least on paper – and the
Governor signed it into law this week. The market responded with elation. Yields on
California GO bonds dropped dramatically compared to high grade GO bonds, with the
difference between CA GO bond yields and AAA-rated GO bond yield narrowing by nearly
50 basis points to 120 bps through Thursday. This spread measure had surged as high as
200 bps at the height of the crisis last month.
• New deals this week included the $250 million Metropolitan Water District of Southern
California, Water Revenue Build America Bonds (BABs). The Aa2/AAA/AA+ credit offered
yields of +220 bps to 10-year US Treasuries for the 2025 maturity and +200 bps to the 30-
year Treasury for the 2039 maturity (which has a par call in 2019). Next week also could be
interesting with the North Texas Toll Authority set to issue $800 million in BABs with a
single, 40-year bullet maturity. Early price talk on this issue is in the +250 bps range to the
30-year Treasury.
HIGH-YIELD BONDS ____________________________________________________________
• After a slow start to the month of July, the high yield bond market has regained
momentum and finished the month in strong form. The Merrill Lynch high yield index is
up 5.3% for the month. The recent rally has been driven, in large part, by the strong
monthly performance of global equity markets, with major US equity indices, such as the
S&P 500, up over 12% since July 10. The recent equity and credit market rally has been
based on generally strong second quarter 2009 earnings from the large US corporations.
Similar to earlier periods, the high yield rally has been concentrated in the more risky
CCC-rated end of the market; CCC and below rated bonds are up 9.5% in July and up
62% year-to-date 2009. It appears that the risk rally of April and May 2009 has resumed
in July. Despite the late stage in the summer cycle, the high yield new issue market
remains relatively active, with over $4 billion in deals pricing just this week. Ford Motor
Credit, the finance arm of Ford Motor and a high yield rated company, issued $1.75 billion
of bonds with a three year maturity. The Ford Motor Credit bonds were priced to yield
10.9% at issue. The high yield market continues to receive significant cash inflows, as
investors are attracted to the asset class. High yield mutual funds received $530 million of
inflows this week, the fifth straight week of inflows.
INTERNATIONAL MARKETS:
WESTERN EUROPEAN EQUITIES __________________________________________________
• Western European stocks went up this week by +2.3%.
• Stocks in Western Europe climbed to their highest point since last-year’s post-Lehman selloff
on expectations of better earnings as the global recession’s grip gets looser. In the
meantime, European consumer prices fell by -0.6% as compared to last year on lower
energy prices, beating analyst expectations of a -0.4% fall, while unemployment rose to
9.4%. The combination of lower prices and continued slack in the economy highlighted that
the risk of deflation in Europe is still on the agenda.
EASTERN EUROPEAN EQUITIES __________________________________________________
• The CECE index of equities traded in Central Europe (Czech Republic, Hungary, and
Poland) continued to rally, gaining +5.8% this week, while the Russian stock index
RTS went up +0.5%.
• Bad news continued to come out of the Baltics. Lithuania’s GDP contracted by -22.4% in the
second quarter of the year, significantly worse than first quarter’s revised -13.3% contraction
and consensus expectations. The worst GDP decline for the European Union is a sobering
reversal of fortune for the Baltic country, which, together with Latvia and Estonia, made up
the Union’s fastest-growing “troika” earlier in the decade. The country’s stock market has
significantly lagged its peers so far this year, despite a strong rally in emerging markets
elsewhere.
GLOBAL BONDS AND CURRENCIES _____________________________________________
• Most major non-US sovereign bond markets managed to make gains in the past week, even
as global equity markets hit fresh highs for the year. The bulk of their progress was made
late in the week following the release of the US second quarter GDP data, which showed
unexpectedly persistent weakness in personal consumption. Month-end purchases to rebalance
indexed bond portfolios also helped to push yields lower. The week’s data was
mixed. Unemployment climbed to new cyclical highs and deflationary pressures persisted in
both Japan and Europe. Indeed in Europe, the flash estimate for annual CPI dropped to -
0.6% in July from -0.1% previously, whilst the slowdown in money supply growth continued
apace. However, on the positive side, Japanese industrial production rose for the fourth
consecutive month, the European Commission’s latest economic sentiment surveys all
showed further steady improvement, while UK house prices continue to rise from their lows
and mortgage lending expanded further. By the end of the week, 10-year Bund and Gilt
yields were about 16 basis points lower. Japanese government bonds made more modest
gains, in part due to the outperformance of Japanese stocks over the week and in part
because the Japanese market was closed for the week before the release of the US GDP
data.
• Currency markets spent a relatively subdued week, leaving the dollar slightly weaker against
the euro, the yen and sterling after investors focussed on the disappointing aspects of the
US GDP data. The greenback was also lower against most of the commodity currencies as
commodity prices recovered and the People’s Bank of China provided assurance that it
would maintain its current easy policy stance. The New Zealand dollar proved the exception
however. It underperformed after the central bank warned that rates may fall further.
EMERGING-MARKET BONDS ____________________________________________________
• Emerging market dollar-pay debt spreads widened marginally this week on the back of profit
taking and a lighter new issue calendar.
• The Central Bank of Hungary surprised the market with a larger-than-expected 100 basis
point cut of its benchmark interest rate from 9.5% to 8.5%. Most analysts had been
expecting a cut of 50 basis points. The strengthening of Hungary’s currency, the Forint, over
recent months in line with improved risk appetite has allowed the Central Bank to deliver a
cut of this magnitude in order to address the poor domestic growth scenario.
• In Brazil, the minutes from the Central Bank’s meeting released this week, revealed that
inflation expectations remain below or at the center of the of 4.5% target and indicated that
the Central Bank will be on hold for the foreseeable future. They cited continued idle
capacity in both the industrial sector and the labor market as reasons for the benign inflation
outlook. Local bonds remained stable, while the Real was one of the best performing
currencies of the week.
NEXT WEEK'S ECONOMIC RELEASES
Aug 3 Construction Spending, Auto Sales, July PMI (Hungary, Czech Republic)
Aug 4 Personal Income and Spending, Pending Home Sales
Aug 5 Factory Orders
Aug 7 Nonfarm Payrolls, Unemployment Rate
©2009 Payden & Rygel. All rights reserved
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