Bond Outlook [by bridport & cie, November 6th 2002]

Go with the crowd, or fight it? We have tried recently to go against the crowd and have been proven wrong. A fortnight ago we said we were considering shortening recommended average maturities, then last week we proudly announced we were glad we had not. This week we must admit it would have been better to have followed our first instinct. The stock market rally has been massive over the last month, although not enough for the Dow and S&P500 to reach the previous peak of mid-August (the Nasdaq has). The success of the Republicans in controlling both Houses of Congress, combined with the probable latest Fed cut this evening, are very likely to reinforce the bullish tendency. There is therefore a continued trading opportunity in stocks over bonds, and shortening, better late than never, seems the best move as of today.


We expect the BoE and ECB to follow the Fed's lead, not least because a weak dollar is not what Europe really wants. The relative, but not extreme, weakness of the dollar, combined with rate cuts and a likelihood of more tax cuts, will help the stock markets, but not the economy, although that seems not to matter to the US Administration.


Allow us to stress the trading nature of our recommendation today to take profits on bonds. We can claim, by the way, that over the cycle of our recommendation to lengthen and today's recommendation to shorten, there are indeed good profits to take. We are not sure whether this stance is the start of a long-term trend. The rate cut cannot in itself revive industrial investment. Corporations do not decide to make an investment because of a modest cut in financing costs; they decide as a function of demand vs. capacity. Demand is not growing, and of capacity there is plenty. Marginal profit improvement is being achieved through cost cutting, not from revenue growth. Whether the cut will restore consumer confidence and spending remains to be seen. That is what the Administration wants, and damn the increased internal and external deficits and their long-term effects.


Just how long this trading opportunity will last is anybody's guess. We are confident that the economy has to worsen before improving, and that the latest developments can do nothing to obviate the long-term need for the US economy to find internal and external balance. May we again point out that, with PEs on the S&P500 at 33, the ratio of possible upside gain to downside risk looks distinctively unattractive. The change in sentiment back to bearishness could come at any time and very quickly.


Index-linked US $ bonds (TIPS) are gaining in value as yields move up on Governments. To that extent, and despite our scepticism below about what professional investors really believe, there is some consistency in US market behaviour: a recovery would imply more inflation in due course. In Europe, however, index-linked bonds are still deteriorating in price. Readers must decide whether this implies a worse economic outlook for Europe, or whether it just means that European investors are less inclined to ignore fundamentals than American ones.


To spot the return to renewed bubble unwinding, we expect a good indicator to be corporate debt. The pressure on corporate bonds has eased now. When it returns we shall see the spreads again move out. The spreads on emerging markets have also come in. It really is as if the world were coming nicely out of its turndown and the financial markets are reflecting this. The only trouble is that there is no recovery, and the economies have not shown their worst. All the data this week, on both sides of the Atlantic, show increasing unemployment, decreasing industrial orders and production, and declining retail sales. Only the service industries are not in decline, but their growth is miniscule. Are financial markets anticipating a recovery in six months? Maybe, but that argument has been trotted out at every rally since early 2000!


Comparisons with 1999 and the end of the hi-tech bubble come to mind. However, there is a major difference. Then, "everyone" believed the nonsense about a new economy. The sceptics, like ourselves, were just occasional voices crying in the wilderness. This time round, there are so many data and so many commentators pointing out the awful fundamentals, that no investor has the excuse of not knowing about them. That points to a cynical and self-fulfilling prophecy: the crowd wants the markets to go up, so the professionals, even ourselves in our own limited way, are running with them. Yet every professional must be ready at any moment to turn and run back again to the safe haven of bonds.


This is a traders' market, and the fundamentalists will have to lie low till their day returns.



Recommended average maturity for bonds in each currency.
Shorten as a trading opportunity.

As of 10.07.02
As of 06.11.02

Dr. Roy Damary

Currencies (by GNI)


The Republican victory in the US midterm election will most probably pave the way for additional tax cuts and soaring deficits over time. Short term, however, this event is logically interpreted as positive and pro business, which should help at least the equity markets.


For today, all eyes are on the FED. A cut of at least 0.25% rate cut is already priced in. Much more important will be the message given to market by the FED officials to see of how they judge the current state of the economy.


The question remains open as to whether the ECB and the BoE will follow suit tomorrow. The weekly close on all currencies is going to be decisive in seeing whether the recent weakening of the US unit is going to be confirmed, or whether it is once again only a false breakout with regard to the hopes of seeing the euro establishing itself above parity


EUR/USD: The topside at 0.9950 was finally broken and a high so far of 1.0030 was reached. Only a weekly close above parity would favour further euro gains. The next resistance is 1.0080, then 1.0150, followed by 1.0230. Support is coming in at 0.9930 and 0.9880.


USD/CHF: Here as well, short-term speculation has pushed the US unit through support at 1.4750 and managed to trigger further stops to reach a low around 1.4535. The next big supports are coming in at 1.4480, 1.4430 and 1.4350. A close above 1.4800 would abort any further attempts at the downside.


USD/JPY: All our objectives on the downside have been met with the subsequent breaks of 123.80, 123.30 122.50 to reach a low of around 121.30. A close above 123.00 is needed to abort any further downside attempts. A broad trading band of 120.50 to 125.50 is the most likely outcome over the next couple of weeks.


EUR/JPY: Same comment: a 120.50 to 122.50 range is in place. Major support is at 119.50. The trend remains towards the upper side.


USD/CAD: 1.5650 looks to cap any attempts to the upside for the time being. A loss of major support at 1.5480 would again speak for a substantial appreciation of the CAD.


AUD/USD: It looks like a solid support zone is starting to be built around 0.5480/0.5530. As long as the exchange rate stays above this level, further gains might be possible, with resistance at 0.5630, 0.5680 and finally 0.5750



Current spot level
Current spot level
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