Bond Outlook [by bridport & cie, September 5th 2001]

Clutching at straws or a herald of a recovery? The NAPM data can be and are being taken both ways. Even the US markets became confused, with the "knee-jerk" rally largely dissipating by the end of the day, and European markets today continuing their weakness.


An opportunity to become the biggest computer company in the world or desperation measures? The same extreme "either/or" doubts arise about interpreting the HP/Compaq merger.


The second question is the easier to answer. Most mergers reduce shareholder value. The last merger involving Compaq did this very well, while destroying jobs and engineering skills even in a booming IT market. Why on earth should it be any different this time? In fact, the shareholder wealth destruction began the very moment of the announcement. It has only just begun.


But to return to the first question. It is worthwhile recalling that every bear market has the occasional rally. Moreover, fundamentals have not improved. The only "good" data are that inflation is under control, but even that may be hiding a threat of deflation. Profit margins on industrial and consumer products are being relentlessly squeezed - volume without margin. Where is US manufacturing finding new orders? It cannot be IT, as even Dell struggle. It cannot be telecom as over-investment by customers combines with over-indebtedness by suppliers. It cannot be automobiles as sales in August continued to decline. It must be furniture and house parts. Is this enough to build an economic recovery? Forgive our scepticism.


Consider also the DJIA and its average PE, which has now gone up to over 25. It has only gone up because share values have not fallen enough to keep up with falling profits. It will take a serious improvement in profits to justify a stock price rally. Profits are still falling and even to guess at an improvement in Spring 2002 can only be based on faith.


The dollar has reversed (temporarily) its declines with this renewed hope (however ill-founded) for a stock price rally. Yet again the fundamentals (notably the trade gap and the M&A flows) speak against a sustained recovery of the USD. We have no reason to change our positive expectations about the "euro in the pocket" from next January.


All of which leads us to the question of where to go in fixed-income investments. Clearly investors, frustrated at their inability to make gains in equities, are looking to bonds for returns that have the merit of at least being in positive territory. However, they still want yield, even in an environment of corporate down-grading. We believe this to be the explanation of the narrowing of corporate spreads so far this year. It is not so much that investors like to take on credit risks, but they can see no better way to achieve that extra 1% or so in yield. At bridport we remain as cautious as ever about corporate bonds, because of the way increased risk can be revealed overnight (that said, we did see and we warned of the telecom dangers well ahead of the collapse). For extra yield, we favour sovereign bonds in the emerging market. Our long-term faith in this view has actually been reinforced by yet another IMF bailout of Argentina. Not that we recommend Argentinean bonds, as we suspect that this a case of problem postponed, not solved. However, the IMF decision to bailout rather than "ring fence and let go" shows the international will to prevent default in sovereign bonds. Admittedly there is a huge gap between the bonds of developed countries and emerging markets (Mexico is the only intermediate quality and its bonds are very expensive). Our thinking is that selective bond picking in Latin America, Eastern Europe and Russia is the better way to match risk and return.


Our own clients are still clearly fixed on lengthening and on increasing the proportion of euros in their portfolio. Lengthening is certainly the right approach faced with a risk of deflation.


Already our hope expressed these last two weeks that Europe can either lead or jointly lead the way out of recession looks more fragile as KPN, Marconi and Swissair all compound the severity of their problems. Nevertheless, the reduction of German unemployment is encouraging. The British public are not yet willing to slow their spending on goods and housing. The parallel with the US overspend is all too glaring.


Recommended average maturity for bonds in each currency (changed 08 and 15.08).


No change to the long maturities we now recommend.

As of 08.08.01
As of 15.08.01

Dr. Roy Damary

Currencies (by GNI)


Last week the ECB finally cut its rates by 0.25 %. The downward pressure on the US equity markets had a negative impact on the dollar, as well as on the European stock markets. However, the EUR/USD failed to break its major resistance zone at 0.9230/50, neither did USD/CHF have a weekly close below its major support at 1.6510/30.


Finally yesterday (after a long weekend in the USA) there were some encouraging NAPM numbers for August (at 47.90 vs. expected 44), with new orders at 53.1, back above the key 50-level not seen since last June. Production is back at 52.20, the highest since July 2000. After the strong housing figures last week, these are the first signs that the US economy is starting to turn around.


Such numbers gave the dollar a great boost, putting USD/CHF back above 1.7000, with EURO/USD below the psychological barrier of 0.9000 at 0.8850.


No change on Japan, more and more capital flows are being detected going back home in context with the book closing end of September and also covering up losses from a battered Nikkei. Repeated verbal interventions by monetary officials to weaken the yen are still without effect.. Only a rapid move below USD/JPY 118.00 might provoke the BoJ to step into the market.


No change regarding Japan. More and more repatriated capital flows are being detected in the context of the book closing end of September, and of covering losses from a battered Nikkei. Repeated verbal intervention by monetary officials to weaken the yen remain ineffective for the moment. Only a rapid move below USD/JPY 118.00 might provoke the BoJ to step into the market.


EUR/USD: After breaking the 0.9000 support area, our first target of 0.8850 was reached. Next objectives on the downside are 0.8820 followed by 0.8710 while 0.9010 is acting now as a formidable resistance.


USD/CHF: The decisive break above 1.6800 triggered a lot of S/L and the dollar is now comfortably above the psychological barrier of 1.7000. Next targets 1.7130 followed by 1.7350 with 1.6950 acting as a big support zone now.


USD/JPY: Same comment: the verbal interventions by the Japanese have put a floor around 119.00 but sooner or later capital flows might bring about a test of the BoJ. Any loss of the support area at 118.00 should cause a rapid move direction 115.00. USD/JPY 121.30 still acts as a major break out level on the topside with first target of 123.


EUR/JPY: As capital repatriation continues, a lot of pressure forced the EURO/YEN below 108.50 and S/L there triggered a move down to 105.50. The next target is 103.50 but, contrary to USD/JPY, which is behaves in a fairly stable manner these days, market participants should remain very careful about intervention by the BoJ (who do not like rapid moves). Topside limited to 108.50, followed by 111.-.


USD/CAD: We have been stopped at 1.5480 on our short position est. at 1.5480. Large trading range expected in 1.5350 to 1.5650. Any excessive weakness above 1.57 should be used to buy CAD.


AUD/USD: After breaking 0.5280, the Aussie nearly tested 0.5400. However, it could not confirm its advance and gave up gradually most of its gains as it went back down to 0.5200. The next support is at 0.5150 (major 0.5050), while 0.5280 remains the upside resistance level. We remain positive medium term and see a higher AUD.


GBP/CHF: The pound easily broke resistance at 2.4350 and nearly reached 2.47. This cross will remain very volatile with 2.4980 and 2.5100 as next targets. Support comes in at 2.4460, major 2.4350. -.

Current spot level
Current spot level
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