Weekly market Update August 28, 2009

MARKET LEVELS
Friday* Last week Dec. 31, 2008 One year ago
Dow Jones Industrial Avg 9,520 9,506 8,776 11,715
S&P 500 1,025 1,026 903 1,301
NASDAQ 2,020 2,021 1,577 2,412
Russell 2000 578 582 499 748
DJ STOXX Europe 600 (€) 238 235 198 287
Nikkei Index (¥) 10,534 10,238 8,860 12,768
Fed Funds Target 0%-0.25% 0%-0.25% 0%-0.25% 2.00%
2-Year Treasury Yield 1.01% 1.09% 0.77% 2.36%
10-Year Treasury Yield 3.45% 3.57% 2.21% 3.78%
U.S. $ / Euro 1.43 1.43 1.40 1.47
U.S. $ / British Pound 1.63 1.65 1.46 1.83
Yen / U.S. $ 93.59 94.38 90.64 109.50
Gold ($/oz) $955.66 $953.85 $882.05 $834.05
Oil $71.93 $73.29 $44.60 $115.59
*Levels reported as of 10:00 am Pacific Standard Time
MARKET RETURNS
Year-to-date (1/1/09-8/28/09)* Year-to-date (1/1/09-8/27/09)
Dow Jones Indus Avg. 8.47% 90 Day T-Bill 0.16%
S&P 500 13.51% 2-Year Treasury 0.76%
NASDAQ 28.07% 10-Year Treasury -7.89%
Russell 2000 15.67% ML High Yield Index 39.16%
MSCI World Index 17.99% JPM EMBI Global Diversified 21.81%
DJ STOXX Europe 600 19.74% JP Morgan Global Hedged 0.27%
*Returns reported as of 10:00 am Pacific Standard Time
RECAP OF THE WEEK'S ECONOMIC RELEASES
August 25 Consumer Confidence – The Conference Board’s confidence index rose for the first time in three
months, climbing from 47.4 in June to 54.1 in July. The increase, which beat forecasts, was
largely a result of government programs such as “cash for clunkers” and extended jobless
benefits
S&P/Case-Shiller Home Price Index – The 20-city composite index declined 15.4% from year ago
levels, the smallest drop since April 2008. On a month-over-month basis, the measure rose by
the most in four years.
August 26 Durable Orders – Orders for durables jumped by 4.7% in July, the largest increase in two years. The
core rate, which excludes transportation, posted its third consecutive gain, rising 0.8% during the same
month.
New Home Sales – New home sales climbed to a seasonally adjusted annual pace of 433,000 homes in
July, a 9.6% increase over the prior month and the largest increase since February 2005. On a yearover-
year basis, however, sales were down 13.4%.
August 27 Commerce Department Revisions – Gross domestic product (GDP) fell at a seasonally adjusted 1.0%
annual rate in the second quarter, unrevised from the estimate month ago. Business inventories fell
more than previously reported, with the second quarter cut revised from $141.1 billion to $159.2 billion.
The decline in consumer spending over the April to June period was revised from 1.2% to 1.0%.
August 28 Personal Income and Spending – Consumer spending rose 0.2% in July due to increased durable-goods
spending, likely a product of the “cash for clunkers” program. Personal income was unchanged in July
and fell 1.1% in June, a downward revision from the originally reported 1.3% drop.
OVERVIEW ___________________________________________________
The housing market showed further signs of recovery this week. New home sales increased
for the fourth straight month and 18 of the 20 cities comprising the S&P/Case-Shiller Home
Price Index posted modest price gains. Hard-hit metropolitan areas such as Los Angeles,
Miami, and Phoenix registered slight increases in home prices, underscoring the view that the
real estate market has bottomed. The Federal Housing Finance Agency’s house price index
also rose, climbing 0.5% in June on a month-over-month basis. New home inventories fell to
271,000 in July, a 7.5-month supply at the current sales rate that is significantly lower than the
8.8-month supply in June. Continued declines in inventories may boost future housing starts
as construction firms begin building homes again. Improvement in the real estate market will
likely support overall economic recovery, as banks may be able to stabilize their balance
sheets more quickly.
US MARKETS:
TREASURIES ________________________________________________________________________________
• US Treasuries rallied this week, backed by better-than-expected auctions in 2-year, 5-year,
and 7-year bonds. Five-year on-the-run Treasury yields finished the week 13 basis points
(bps) lower and 30-year yields rallied 17 bps. Trading volumes and liquidity in the Treasury
market was very low this week as most market participants are still on vacation. The market
continues to trade directionless and remains event driven, i.e. dealers position themselves
for Treasury auctions and Treasury buybacks and offer limited liquidity in between.
• US agencies recovered from their temporary sell-off over the last couple of weeks, when
spreads widened 10-15 bps across all maturities. Decreasing supply and the Federal
Reserve increasing their re-purchases helped spreads to recover and tighten back 5-8 bps.
• With Libor continuing to set lower each day, US swap spreads were able to benefit, with
shorter dated spreads tightening 8 bps. Spreads of longer dated swaps tightened up to 4
bps.
LARGE-CAP EQUITIES___________________________________________________________
• The stock market was relatively quiet for the week on mixed economic data and lighter
trading volume. The S&P 500 index finished the week unchanged. The Russell 2000 index,
an index used to gauge small-cap stocks, underperformed large-cap stocks. In terms of
style, large-cap value stocks marginally outperformed large-cap growth stocks. The best
performing sector was financials and the worst performing sector was utilities. In the
headlines this week, the US government ended its highly successful “Cash for Clunkers”
stimulus program on Monday as funds allocated to the program were exhausted. Shares of
Ford Motor Company (Ticker F) fell over 4% on the news. On earnings news, Dollar Tree
reported quarterly earnings of 63 cents per share, which beat analysts’ estimates of 53
cents per share. The company attributed the strong quarter on better operating margins and
an increase in sales. Shares of DLTR rallied over 1% on the news after speculators drove
the stock higher over 4% prior to the announcement.
CORPORATE BONDS _____________________________________________________________
• Investment grade primary activity was muted, with a few benchmark deals providing those
not taking a late summer vacation a chance to invest some idle cash. The deals priced this
week were well received by investors, as the entire slate of new issuance finished the week
tighter. Consumer products giant Proctor & Gamble brought a two-tranche deal that sold out
as quickly as ice cream cones on a sultry summer afternoon. With next week being the
unofficial final week of summer, expectations are for a light, if not non-existent, new issue
calendar.
• Investment grade corporate spreads were flat to slightly tighter in fairly active trading given
the season. Trading desks were thinly staffed, as many participants were away trying to
wring the last bit of value out of their summer share. The underlying tone was positive, with
a bit of a "stealth-rally" feel to the week. The Barclays Credit Index Option-Adjusted Spread
(OAS) finished the week at +212, tighter by 9 basis points.
MORTGAGE-BACKED SECURITIES _______________________________________________
• It was calm in the mortgage market this week as market participants enjoy the last days of
summer. With Treasuries rallying on air, mortgages underperformed in light trading.
Agency pass-through spreads leaked wider by 3 to 5 basis points as steady supply trumped
demand from Asian central banks, money managers, and the Federal Reserve. Most of the
action, if any, was in the commercial mortgage market as spreads narrowed on a healthy
demand for term-asset backed loan facility (TALF) eligible CMBS bonds. The Treasury’s
release of acceptable collateral of CMBS collateral was warmly received by investors. For
the week, the 30-year current pass-through versus the 10-year Treasury closed at 103 basis
points.
MUNICIPAL BONDS _____________________________________________________________
• Lack of new tax-exempt issuance, led by seasonal calendar effects and Build America
Bonds taxable issuance (which account for about 15% of municipal issuance year-to-date
through July) continues to put downward pressure on longer-maturity municipal bond yields
as investors fight for bonds. Two-year AAA-rated GO bond yields are pinned down at 0.71%
and 30-year AAA-rated GO bonds fell to 4.47%-lower by 7 basis points on the week. Thirtyyear
yields have dropped 25 basis points during August.
• This trend is also having spillover effects on lower-rated credits, where investors have
shifted demand due to pick-up in yield over expensive high grade credits. This difference in
yield though continues to “narrow,” represented by strong demand for tobacco securitization
bonds and gas pre-payment bonds this week. Based on secondary market trades on Friday
morning, this trend is set to continue as we head into September. Next week is already set
up to be very quiet in the primary market. New issuance volume is expected to be in the $1
billion range – 20% of a normal week’s new supply hitting the market. This may mean a
pick-up in secondary market activity (as money managers look to reinvest September 1
maturities) and more downward pressure on yields in the municipal space.
• The biggest deal of the week was the seasonal issuance of the Texas Tax and Revenue
Anticipation Notes (TRANs) as part of the state’s annual cash-flow management. Totaling
$5.5 billion, the notes held the highest short-term rating from all three ratings agencies, and
were traded at yields as low as 0.43% following the competitive deal. Other highlights
included the $77 million Oconee County, South Carolina, Pollution Control Facilities - Duke
Energy Carolinas Project bonds. The A1/A revenue bonds offered 3.60% in the bullet 2017
maturity.
HIGH-YIELD BONDS ____________________________________________________________
• It was another relatively quiet week on the high yield front. Similar to last week, there was no
new issuance in the high yield market and it is likely that we will not see any deals until after
the US Labor Day holiday September 7th. Most market participants are expecting relatively
heavy issuance in September as cash continues to build and there is strong demand for
new well-structured and well-priced deals. After a small outflow last week, high yield mutual
funds this week received inflows of $351 million and this will add to the buying pressure in
September. The Merrill Lynch BB/B high yield index is up just under 1.5% for August, with
much of the price appreciation in the financial sector, in particular the insurance sub-sector.
The insurance high yield sub-sector has rallied as the market outlook on AIG debt and
equity has improved over the past few weeks. In line with the past five months, the riskiest
segment of the high yield market, CCC- and below rated bonds, continued to rally the
strongest, with the CCCs up almost 4% in August and up 70% year-to-date 2009.
INTERNATIONAL MARKETS:
EASTERN EUROPEAN EQUITIES __________________________________________________
• The CECE index of equities traded in Central Europe (Czech Republic, Hungary, and
Poland) gained +2.8% this week, while the Russian stock index RTS went up +3.7%.
• Poland, the European Union’s only eastern member to escape a recession since the
credit crisis began, expanded an annual 1.1% in the second quarter of 2009 on the
heels of +0.8% growth in the first quarter of the year. Net exports were the major
driver, as exports declined by only 1% year-over-year, while imports were down -
11.6% versus last year. Investment also surprised on the upside. Since the global
recession started the country’s relatively large internal market, stimulated by cuts in
personal taxes, has helped compensate for a decline in external demand, while a
depreciating zloty early in the year cushioned the fall in exports.
GLOBAL BONDS AND CURRENCIES _______________________________________________
• Major government bond markets ended the week stable to firmer, supported by the good
reception to the week’s heavy US issuance. In the UK, Gilts benefitted from persistent
speculation that the Bank of England will impose negative interest rates on banks’ reserve
holdings to encourage them to lend. However, two-year Bunds outperformed, with yields
closing the week down about 10 basis points as the European Central Bank reiterated its
intention to keep rates low for the foreseeable future. On the data front, news from the UK
was mixed. House prices rose robustly in August and revisions showed that the contraction
in Q2 GDP was less dramatic than initially estimated. However, UK business investment
slumped a staggering 10.4% in Q2. In Europe, the rise in industrial orders exceeded
expectations and the latest round of business and consumer sentiment surveys all
registered further improvement, but Japan’s data was unremittingly disappointing.
Household spending contracted further, unemployment jumped unexpectedly and deflation
worsened. However, Japanese government bonds only managed to finish unchanged ahead
of this weekend’s general election, which is widely predicted to see the ruling Liberal
Democratic Party lose its 60-year grip on power to the opposition Democratic Party of
Japan.
• In currency markets, the focus was on sterling, which extended its recent losses against the
US dollar in response to talk of negative UK rates. The suggestion by the head of the UK
financial markets regulator that the government should impose a tax on financial
transactions to deter short term speculation also undermined confidence in the pound. The
Canadian dollar closed off its highs after an official suggested that the central bank may
intervene to sell the currency, whose recent appreciation is perceived as a drag on growth
and an obstacle to the central bank’s efforts to meet its inflation target. The Australian dollar
edged higher against the greenback on mounting expectations that rates will rise as soon as
October, but the US dollar ended only marginally weaker against the yen and unchanged
against the euro.
EMERGING-MARKET BONDS______________________________________________________
• Emerging market dollar-pay debt spreads were marginally wider this week as liquidity and
trading volumes declined. Economic data continued to surprise on the upside with Q2 GDP
and industrial production better-than-expected in all emerging market regions.
• Israel surprised the markets by being the first country to hike interest rates globally. Bank of
Israel raised rates by 0.25% to 0.75% on the back of increasing inflation expectations and
an improvement in macroeconomic data. Short-date local yields sold off by 25 basis points
as the curve was pricing in no change in interest rates.
• As expected, the Monetary Policy Council (MPC) in Poland left its benchmark interest rate
unchanged at 3.5% citing signs of economic recovery in Poland as well as the global
economy. The MPC’s inflation forecast is lower than its medium-term target of 2.5% (+/-
1%), meaning it maintained an easing bias.
NEXT WEEK'S ECONOMIC RELEASES
Sep 1 ISM Manufacturing Index, Construction Spending, Pending Home Sales
Sep 3 ISM Non-Manufacturing Index, Turkey August Inflation
Sep 4 Unemployment Rate

Market Reflections 8/27/2009

Second-quarter GDP was unrevised at minus 1.0 percent, a bit better than expected but still a fourth straight decline. Initial jobless claims point to no help for the August jobs report, coming in at 570,000 and showing no improvement for the last two months. Company news included a year-end date for the Boeing 787 test flight, now delayed for more than two years. Stocks initially retreated in the session but then rallied with the S&P fractionally higher at just over 1,030. Oil firmed about $1 to end at $72.50 but the gain didn't help natural gas which hit a 7-year low at $2.70 following another rise in inventories and on heavy shorting as the hurricane season has yet to threaten the U.S. Gulf.

Market Reflections 8/26/2009

Wednesday's economic data point very directly to recovery. Durable goods orders bolted higher showing nearly across-the-board strength. New home sales confirm a host of other indicators pointing with certainty that the real estate market is accelerating. Even with the all strength, the jobs market remains weak and indications on consumer spending are not showing the same strength. Atlanta Fed President Dennis Lockhart says he's in the camp calling for a slow recovery and he said it's still early to talk about rate hikes.

The economic news couldn't fire up the market as the S&P was nearly unchanged ending just under 1,030. Oil fell back 50 cents to $71.50 after weekly inventory data showed a small build in crude. Early talk, citing weak demand and limited refinery runs, is calling for a larger build in next week's data. The dollar index firmed 0.4 percent to 78.61.

Market Reflections 8/25/2009

The re-appointment of Fed Chairman Ben Bernanke ends the risk of delays that a new chairman would face in learning the post, specifically how the Fed is going to unwind quantitative easing. Consumer confidence data shows improvement, not striking improvement but an end to two prior months of disappointment. Budget forecasts from the administration and Congress say weak growth and heavy benefit spending will just about double the nation's deficit to nearly $20 trillion over the next 10 years. Stocks showed little reaction with the S&P rising 0.2 percent to 1,028. Commodities were little changed though oil edged back from recent highs ending at $72. The dollar index ended fractionally higher at 78.24.

Market Reflections 8/24/2009

Markets were quiet Monday, reacting to overnight gains in Chinese markets that were reacting to Friday's big report on existing home sales and upbeat comments from Ben Bernanke. But stocks gave up early gains with the S&P ending fractionally lower at 1,025. Most commodities were fractionally higher with oil ending just below $75. The dollar index rose 0.3 percent to 78.25.