Bond Outlook [by bridport & cie, July 17th 2002]

Very early in 2000 we wrote that the new decade would be one of slow growth, modest returns and of rebalancing of the US economy. More recently we expressed the hope, rather against our better judgement, that the rebalancing, including the fall of the dollar, would not be too wrenching. We were, however, denying the near inevitability of markets to succumb to crowd psychology and to move drastically once sentiment changes. Each time the market stages a short-term recovery, it is a reflection of the hope of a bottom being found. Many analysts are now preaching the "oversold" message. We find little argument in their favour. There is nothing to say that equity valuations over time in the 21st century should be very different from in the 20th. When, even after the recent falls, average PEs are at 23 for the DJIA and 36 for the S&P 500, versus a 20th century PE average of 16 and 12 respectively, then it is difficult to conclude that the market correction is over. We rejoice that Greenspan can reassure investors that the US economy is fundamentally sound in terms of production. That does not alter the need for a weaker dollar and debt reduction among households and corporations. Neither does it change the issue of irrational stock valuations.


We hold to the view that neither terrorism nor accounting fraud is the prime cause of the present malaise. To be sure, the former has changed the pattern of US Government spending, but cheating at high levels is better understood as a symptom of delusion, including belief in an economy with new rules, and the ability to spend on credit without a day of reckoning. Understanding current events may be better helped by seeking basic changes in the economy, and it is in this regard that the feedback effect of financial markets on the real economy can be relevant.


Baby boomers are coming up to retirement. That is already making them more conservative in their investments - the natural result of preferring protection of assets already earned over taking risks to expand them further. In addition, this large group of investors has had its fingers seriously burnt since early 2000 and has just about had enough. They are unlikely to jump back into the markets yet again even when it is apparent that the bottom has been found. A rerun of the 1990's bull market is therefore off the agenda for years.


If "once bitten, twice shy" is one aspect of human behaviour, another is the tendency to shift blame from oneself to others. We have very mixed feelings about this in the context of investors suing financial advisers. On the one hand it is clear that advice was often frivolous or self-seeking, but, on the other hand, mature adults are meant to have sufficient discernment to decide for themselves. The iniquitous US contingency fee system is allowing all manner of lawsuits for investors seeking someone to blame. Such "let's blame someone" lawsuits are spreading to the UK under "Conditional Fees", allowed since 2000. Fortunately the new UK rules are not so extreme as to allow the absurdities of the US legal system.


New issues of corporate bonds have dropped to a trickle, and spreads generally widened. It could hardly be otherwise in a time of rapid readjustment. Besides, the watchword now is "debt reduction", economic expansion is modest and merger mania has been more or less tamed (exception: Pfizer/Pharmacia).


Greenspan sang his cheery refrain, but his listeners had heard it many times before. The President and the Administration just lack all credibility when it comes to getting tough on accounting fraud. Nevertheless, more regulation is inevitable since self-criticism and proactive improvement by the US audit profession seems very unlikely. We take our hat off to Coca-Cola for biting the bullet on expensing options (as we do, by the way) and giving the lie to those who resist this practice on the grounds that it is too complicated.


The UK is very serious about enhancing its reputation on corporate reporting. New proposals will impose a duty on management to offer any information that might be relevant, and gives auditors the right to demand data. The USA is nowhere near that. Incidentally the same UK White Paper aims at freeing small businesses from excessive regulations. Tighter regulations for public corporations, looser for small, private businesses - makes sense to us!


Among the "sideshows" in Europe is the relative strengthening of the Hungarian Florint and the high yields available in Hungarian Government short-term debt.


Recommended average maturity for bonds in each currency
Stay long across the board, except in Sterling.

As of 10.07.02

Dr. Roy Damary

Currencies (by GNI)


Mr. Greenspan's testimony has clarified one very important point. Do not count on the FED to lower interest rates anymore, even in this shaky stock market environment. He sees a sustained economic recovery taking place, with the adjustment in the hi-tech sector coming to an end. He thinks that officials can only regain credibility and confidence by creating a stable economic environment.


Monday's 400 point rally in the Dow before the close could well be attributed to a special task force created years ago in order to counteract disorderly market conditions.


In Europe, all EU officials are happy that the euro has finally reached parity with USD, although the Japanese are getting more and more worried about the current dollar weakness jeopardising their export industry.


EUR/USD: Do not fight the trend. Corrections are still minor and the buy-on-dips strategy remains the best bet for the time being. Parity was finally broken, and the next resistance to be taken out is 1.0145. This would spur additional buying with targets of 1.0230, 1.0280 and 1.0350. Supports are at 1.0020, 0.9980 and 0.9850.


USD/CHF: Same comment: in this uncertain market environment, the CHF remains king. Strong support at 1.4780 has been taken out and our objective of 1.4550 has already been reached. A new low of 1.4440 has been seen. 1.4350, followed by 1.4280, are the next supports.


USD/JPY: Here as well, the strong support at 117.80 has been broken and our objective of 115.50 nearly reached. The BoJ must be aware that in this still very anti-USD environment, any intervention would merely give market participants a better selling opportunity. The BoJ is therefore waiting until the market is least expecting action. Any break of 114.80 would send USD/JPY immediately down to 113.50. The topside has kept just below 117.00. We still expect some BoJ action soon


EUR/JPY: The key support of 117.80 has been broken and our objective of 115.50 has been visited, with a low close to 115.00. In the meantime, however, this cross has recovered well and stopped just below 117.80. A very broad consolidation range of 114.50 to 119.50 is the most likely outcome.


USD/CAD: It looks like that the recent sharp appreciation of the commodity currencies has stopped and that a period of consolidation has begun. The range should be quite broad: 1.51 to 1.55. Only a clear break of 1.5050 on a weekly basis would speak for further CAD strength.


AUD/USD: Consolidation in a 0.5500 to 0.5750 range may be expected.


GBP/CHF: 2.2850 remains the magic pivotal point: below this would open the door for 2.2550 and above for 2.3150.



Current spot level
Current spot level
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