Bond Outlook
[by bridport & cie, October 23rd 2002]
When, as a commentator on financial markets, you are subject to the
criticism of being too pessimistic, where do you turn? A possible answer
is to Stephen Roach of MS, who bravely sticks to his guns when all around
him are saying that all is now well. "While Japan has a sense of the
urgency to reform", writes he, "America remains the land of denial". The
question facing all investors is whether the recent stock market rally of
some 15% since early October is just another manifestation of denial, or
is it a harbinger of economic recovery? Accordingly, we have searched
extra diligently this week for positive economic data. We have found two
examples: |
|
- US housing starts,
which reached a 16-year high in September.
- An increase in the
S&P500 average rolling EPS of about 4%.
|
|
Unfortunately these two observations are subject to dampeners, in
that: |
|
- Combined new and
existing home sales are on a downward trend, as are new mortgages
- PEs have gone up
again, to 33.3 on the S&P500 (see "Bigcharts"), a figure so far
above historical levels of 14-16, that only the expectation of a massive
increase in future profitability could justify it.
|
|
The game plan of the US authorities has been and still is to keep
the consumer spending until industrial demand picks up. However, all the
indicators confirm slower industrial activity, and a poor outlook for the
recovery. One index, called "The Risk of Recession" rose dramatically in
September to it highest point in over a year. If the knight in shining
armour of industrial expansion is coming to the rescue, he is dallying
somewhere en route! |
|
American consumers are still consuming: witness the housing starts
and the increasing trade deficit. Every time we thought that they had had
enough, we have been proven wrong. Nonetheless, data on retail sales are
again poor, and, in the words of a car dealer commenting on his sales,
"It's as if the tap were turned off on 1st October". It
requires massive incentives (basically free financing) to sell cars in the
USA today. |
|
In Europe, the economic situation is scarcely better. A little
encouragement may be drawn from the 0.6% increase in euro zone production
in August, but overall there is little growth in Euroland. We admire
Romano Prodi for his outspoken criticism of what The Economist calls the
"Instability and Depression Pact". The sooner the euro zone has its
straitjacket removed to allow Governments to compensate for private sector
recession, and the earlier the ECB replaces its fixation on a low
ceiling for inflation with a slightly higher target, the
better. Ironically, the Pact, designed to give strength to the euro, is
now a major cause of its weakness. |
|
A recent analysis by Bridgewater of relative market capitalisation
in the developed world vs. earnings leads to the conclusion that Japan is
very overvalued, the USA significantly overvalued, Canada and Australia
about right, while the whole of Europe is highly undervalued.
Justification of low European valuations would require European company
earnings growing at a much slower rate in $ terms than the rest of the
developed world. Either that, or European shares are "incredibly
attractive". It makes you want to shout "Get out of the way, ECB and
Maastricht fans, we've got a chance to get somewhere in
Europe!" |
|
The Norwegian Krone has done very well, but even the Norwegians are
warning that investors may have gone over the top. The exit will be very
crowded and difficult if all flee at once. |
|
The UK continues to navigate well in turbulent waters. The
firemen's strike could, however, be very damaging, especially if other
sectors withdraw labour on safety grounds. |
|
If the stock market rally in the USA continues, and if it
re-ignites consumer confidence, it will not imply that the USA is
out of the woods. It will however mean that the Fed will not dare lower
rates, as this would signal that they too have noticed the poor data
issued by the Government's own statistical department. That in turn would
suggest that the prime reason for remaining in long maturities in US bonds
had disappeared and we would have to recommend shortening. We cannot yet,
however, make such a recommendation, and will return to this subject next
week. In the meantime, we still expect the ECB to lower rates, so we are
not even considering shortening for bonds in euros. |
|
Recommended average maturity for bonds in each
currency. Remain long across the board, except in
Sterling. |
Currency: |
USD |
GBP |
EUR |
CHF |
As of
10.07.02 |
2012
(under review) |
2007 |
2012 |
2012 |
|
|
Is the rally in equities over the last ten days a short-term
correction in a still bearish trend, and have US interest rates seen their
lows? The majority of market participants remain negative towards equities
but are starting to think that no more rate cuts are going to take place
in the US. On Iraq, an imminent attack looks still unlikely. In Europe,
there was big relief after the Irish vote, but Mr. Prodi's outspoken
comments that the stability pact is "stupid" speaks for further easing of
the rules in an already very "shaky" environment. In Japan, it has to be
seen if Mr. Takenaka has enough support to go ahead with radical reforms
to the banking system. The most likely outcome is that some range trading
is going to continue. |
|
EUR/USD: The euro continues to develop
"sideways", range bound between 0.9950 and 0.9650. Only a weekly close
outside this range should announce new targets (0.9600 and 1.0150). We
incline to the bearish scenario. |
|
USD/CHF: As for the euro, even if
some daily moves are interesting, the medium-term pattern is not very
exciting. The exchange rate remains between 1.5150 and 1.4750. It still
looks like there is buying interest below 1.4800 and that sellers are
coming in above 1.5150. |
|
USD/JPY: The first resistance at
124.80 has been triggered and 125.50 nearly tested. It seems that
125.30/50 might be difficult to break short term. Good supports are at
123.80 and 123.30. A move below 123.10 would abort the JPY bearish
scenario. |
|
EUR/JPY: Consolidation is in a 120.50
to 122.50 trading range. Major support is at 119.50. The trend remains
towards the upside. |
|
USD/CAD: We unfortunately missed establishing a
short USD/CAD position around 1.5900, and major support subsequently broke
at 1.5780. Most probable consolidation is now between 1.5580 and
1.5780. |
|
AUD/USD: Despite the fact that 0.5550
has again been tested, it might be difficult to see any further sharp
gains in the Aussie. It is nevertheless well supported, with first support
coming in at 0.5480 and 0.5430. |
|
|
USD/CHF |
EUR/USD |
EUR/CHF |
USD/JPY |
EUR/JPY |
Resistance/Breakout |
1.5050 |
0.9830 |
1.4730 |
125.50 |
122.50 |
Current spot
level |
1.5000 |
0.9780 |
1.4680 |
124.15 |
121.45 |
Support/Breakout |
1.4910 |
0.9730 |
1.4610 |
123.80 |
120.30 |
|
AUD/USD |
NZD/USD |
USD/CAD |
GBP/USD |
XAU/USD |
Resistance/Breakout |
0.5550 |
0.4850 |
1.5780 |
1.5550 |
318.50 |
Current spot
level |
0.5530 |
0.4835 |
1.5680 |
1.5490 |
314.00 |
Support/Breakout |
0.5480 |
0.4780 |
1.5630 |
1.5390 |
312.00 |
|
|