Bond Outlook [by bridport & cie, September 25th 2002]

Dear Readers,


Your discontent has reached our ears. Several of you have told us clearly that you are unhappy with our regularly presenting bad news and a pessimistic outlook in our Weekly. Believe us, we sympathise with you and we wish we could write differently. However, we must ask this question, "Is it better to feed readers with ungrounded optimism ( la Paul O'Neill, perhaps?), only to be proven wrong, or to try to give you fair warning of when the economy is going wrong and to draw reasonable conclusions regarding securities?".


Forgive us for pointing out that those of you who have agreed with our views on stock market overvaluation, dollar weakness, slow growth, and an outlook for low interest rates, have really benefited from our basic recommendation to focus on long-dated government bonds with emphasis on the euro. That said, we are acutely aware of the risk of hubris and of pride before a fall. We shall therefore continue to focus on facts and logical conclusions drawn from them, avoiding mere "feeling".


When bad news comes, don't shoot the messenger! Seek rather the folk who are the cause of the bad news, although it may be difficult to shoot them! The trouble the world is now in is due mainly to the unwillingness of governments and central banks to face reality about past mistakes and to take appropriate measures to correct them. Indeed, so far is the US Administration from taking corrective measures, that it does not even recognise the importance of imbalances in international trade, domestic budgets, overvalued stocks and the debt burdens of households and corporations. The Japanese Government is in total denial, although we find a tragic humour in the BoJ attempting to wake up other authorities over the massive bad debts on banks' books. The German Government, after four years of non-reform and economic decline, has been given a further four years to make a still bigger mess. The ECB stubbornly sticks to a 2% inflation ceiling, when the risk faced now is deflation more then inflation. We rather think future historians will wonder at how so much irresponsibility and incompetence could arise at much the same time in the world's three largest economies.


Stock markets have been extremely slow to catch on that the runaway bull of the late 1990s was leading to a future price that would have to be paid eventually. However, two and a half years of stock declines seem at last to have got the message across! There will probably be, in due course, an overshoot on the way down. We cannot see that happening yet, so long as PEs are so high for the US markets: a massive 33 for the S&P 500, 20 for the DJIA and, as usual, unspecified for the Nasdaq, but certainly very high. At least the 20 for the Dow suggests a glimpse of light at the end of the tunnel towards the long-term average of around 16. In Europe the historical averages may not be so far away, but, unfortunately, European stock markets are quite unable to break their dependency on New York.


As we lamented this morning on the losses incurred by so many of our clients on the stock markets, we wondered whether a sense of despair had spread so far that it could be a sign of a forthcoming turnaround. Currently, we do have a major client who has put that view into practice by taking his profits on bonds and getting ready with cash to re-enter stocks. We think him brave but too early. Our real problem in looking for signs of renewed bullishness is that the rules we ourselves laid down in early 2000 (basically that the US imbalances, listed above, must be corrected) are far from being met. The only step towards rebalancing has been the dollar decline, but this has not yet washed through to the US current account deficit. Moreover, the Bush Administration has introduced a massive new imbalance in the form of the internal deficit. There is a plentiful supply of bonds, the Bond Market Association tells us, as if that were all that is needed. Too bad, that there is a huge swing from corporates to government and mortgage-linked bonds, i.e. from productive investment to non-productive.


So we end up, Readers, with having to take the same line: protect yourself against the incompetence of politicians by staying long in top-quality bonds, and, if you want yield, try Russia.


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

As of 10.07.02

Dr. Roy Damary

Currencies (by GNI)


Growing tension between the US and Iraq, with the UK clearly defending the American position and trying to win support from the rest of Europe, is still hanging over the market. The narrow victory by Schroeder is catastrophic for Germany, which so desperately needs reforms. The proposal by the EU Commission to postpone the date to achieve balanced budgets from 2004 to 2006 clearly shows that the whole of the euro zone is still faced with very high unemployment and meagre growth. The sooner the ECB acts, the better.


In Japan, it needs to be seen if the new measures announced by the BoJ are going to have a lasting weakening effect on the JPY, as the growth of reserves by the BoJ on a yearly basis (reflecting the trade surpluses) is well in excess of the amounts involved for the proposed equity purchases.


EUR/USD: A broad trading range of 0.9580/0.9610 and 0.9980/1.0020 still looks valid. A clear break on either side would be good for at least 150 to 200 points.


USD/CHF: Here, it looks like that the market has some interest in buying USD at around 1.4700 and in selling between 1.5250 and 1.5330. Only a clear break on either side would open the door for a move of at least 200 pts.


USD/JPY: The 120.30/50 level is becoming major support and any break would speak for a return to the old trading range of 115.50 to 120.00. As stated last week, the 123.50 to 124.00 zone is acting as strong resistance, with strong selling interest by the export community.


EUR/JPY: The market finally managed to break the 119.60 resistance zone and confirmed the break out of its old trading range of 115.50 to 119.50. However, the air is getting thin above 122.00 and most probably some consolidation will be seen between 120.00 and 122.00.


USD/CAD: The CAD continues its weak behaviour and is struggling to establish itself above its support of 1.5780, still eyeing the 1.6000 area. We prefer to wait to establish our long CAD short USD position until we have a clearer view of how the USA is performing economically.


AUD/USD: Same comment: it looks like the Aussie is struggling to sustain levels above 0.5500 for any time. Consolidation in a 0.5350 to 0.5550 range is to be expected until further notice.



Current spot level
Current spot level

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