Bond Outlook [by bridport & cie, July 3rd 2002]

Economic fundamentals and market sentiment have again parted company, with US production and GDP data looking attractive but with a near total loss of confidence reigning in stocks. Where once we said markets were well ahead of fundamentals, now they are well behind, or, rather, moving in the opposite direction. Can all the blame be put on the unexpected events of terrorist fears and crooked corporate management? Had these events not occurred, would the bull market have continued scarcely abated? We think not, because, as we have repeatedly pointed out, the imbalances of the US economy were present long ago. Moreover, false accounting is a symptom more than a cause of the artificiality present in the USA. Little by little now, that artificiality will be corrected. O'Neill, with his "the strong dollar is good for us" refrain, has been told to quieten down. Economic commentators have rediscovered the virtues of profits based on organic growth and are advising investors to steer clear of "serial acquirers". Senior figures in the world of financial regulation, such as Arthur Levitt, former Chairman of the SEC, are stating publicly that principles-based accounting such as those of the International Accounting Standards could indeed be better than the US rule-based system (also known as the "laundry list approach").


IAS is mainly built around accountancy practices in the UK, where there is a certain self-satisfaction that an "Enron or a WorldCom could not happen here". We hope they are right, because if the UK cannot keep decent accounts, no one can. It is no use looking to France, for example, where "serial acquirer" Vivendi may yet also prove to have been over-creative in financial reporting, as well as L'Oréal, Alcatel and others. It is no use looking to Germany, where the very idea of transparent accounting for investors is still new. For once, we can applaud the European Commission for imposing IAS throughout the EU. (One day a story of successful UK lobbying may come out.) Obviously the UK Government is anxious to reinforce the UK's reputation for top-quality accounting. They are seeking to reform the accounting profession, including full separation of consultancy and accountancy and auditor rotation every seven years. The scandals are in the USA, but their remedy is in the UK!


Back in the bubble days we would often argue that the share of corporate profits in the overall "GDP cake" could not vary greatly over time, and that therefore stock valuations based on huge future increases in future profits were just not credible. What we did not realise was that even then evidence was present of inflating reported profits. Research (by GFC Economics) published by the BBC points out that the rise in reported profits 1995 to 1999 was 96%, but that the parallel US Government data were showing only 36%. A case of "don't bother me with the facts, I've made up my mind", so far as stock analysts were concerned! It may now be that investors in US securities, at least foreign investors, may also have made up their mind, despite positive GDP data. Foreigners are estimated (by Bridgewater) to have lost $ 400-600 billion in marking asset prices to market. That is enough to make anyone think twice before committing more funds. There must be a lot of euro cash accumulating from the disenchantment with the dollar, for it is hardly rushing into European stock markets!


Financial markets and fundamentals have partly disconnected, and the US economy is now at a fascinating juncture. Will badly performing markets pull the economy down with them? If they do, the old "double dip" scenario of Stephen Roach at MSI will be proven right. Our point of view is that rebalancing is under way, but that it will take years of a lower dollar and working off excess production capacity and corporate debt. Double-dip or not, we are doubtful about GDP expansion and very sceptical about profits growth. Long-term low inflation and interest rates face both the USA and Europe. Our recommendation on long average maturities therefore remains, and, as if to support a scenario of low expectations for returns, the Swiss Government has just lowered the minimum return on pension funds from 4% to 3%.


Likewise, our recommendation to focus on quality bonds, with great attention to currency, must also stand as Brazil takes a further twist down its spiral (debt downgraded and the real at new lows) and corporate defaults approach levels last seen in 1991/2. Sidgmore/WorldCom's triumph of form over substance is unlikely to avoid Chapter 11 for his company and that will lead to a still greater rate of corporate defaults.


New Zealand has raised its bank rate (25 bps to 5.75%), but, with Norway, seems the odd man out. Look to the UK to raise rates before either the Fed or the ECB as the property boom continues unabated, along with rising consumer debt. Such booms always end in tears.


So the Japanese Government is to help banks over bad debts? What an original idea!


Recommended average maturity for bonds in each currency
No change since 12 June.

As of 12.06.02

Dr. Roy Damary

Currencies (by GNI)


The flight to quality in bonds or cash by the majority of investors, with the equity markets under continuous pressure, questionable US accounting practices and the "laissez faire" policy on the dollar by the Bush Administration, has helped the euro to test parity.


With no immediate help from the IMF for Argentina, contagion is starting seriously to affect Brazil, with the real testing an all time low of 2.8950 to the dollar. In Asia, the BoJ continues to intervene, even via the ECB and the FED, in an attempt to weaken the yen and keep at least their export industry alive.


EUR/USD: After testing parity, this is the first time that the euro is starting to correct, even with stock markets under pressure. Supports are at 0.9780, 0.9740, 0.9680 and 0.9550, and resistances at 1.0020, 1.0100, and 1.0220 (consolidation expected).


USD/CHF: In this uncertain market environment, the CHF remains king. Consolidation has been taking place below 1.5000 so far, and strong support is coming in at 1.4780. The down-trend clearly remains intact, but a break of 1.50 could trigger some stop losses and open the door for 1.5150. Supports are 1.4730, 1.4650 and 1.4550.


USD/JPY: It looks like that the BoJ is serious with its intervention and is trying to fend off further JPY gains. Consolidation is in a 118.00 to 121.00 range for the time being. Any loss of 117.80 would be catastrophic and send the USD/JPY immediately down, direction 115.50.


EUR/JPY: Key support at 117.80 broke this morning, but not convincingly. A weekly close below would open the door for 115.50. Above this, any advances would most probably be limited to 119.50/120.


USD/CAD: All commodity currencies continue to be well supported, and have entered a period of consolidation. 1.5150 to 1.5450 looks like the range for the Canadian.


AUD/USD: Consolidation in a 0.5500 to 0.5750 range is to be expected. A break of support at 0.5480 would suggest a deeper correction in the direction of 0.5350, but we see this as most unlikely.


GBP/CHF: Consolidation in a broad 2.2550 to 2.2950 range is expected. The risk remains on the downside.



Current spot level
Current spot level
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