Bond Outlook [by bridport & cie, February 27th 2002]

Once there was a process of choosing stocks to build a portfolio called "value investing". Readers may remember: the idea was to weigh up likely future earnings and cash flow, all in the context of the underlying economy, and put a price on present value. Then came "momentum investing". This involved ignoring fundamentals and arguing that share prices would go up further because they had gone up so far that nothing could stop them. This approach took the NASDAQ to over 5,000. Ever since the partial correction to the stock markets that began in early 2000, the markets have behaved skittishly. Generally, good news is highlighted more than bad news, with the result that fundamentals are still largely being ignored, but the momentum has fizzled out. Today, encouraging news, like the continued buoyancy of the housing market in the USA, can shift markets up by over a percentage point in a day, while poorer news, like declining consumer confidence or a new dose of "Enronitis" can send it right back down again. We have been wondering what term best describes the appropriate investment strategy, and thought that "pendulum investment" might be appropriate, but that "whipsaw investment" would be an alternative!


The sense of disenchantment amongst investors is spreading. The publication from the London Business School questioning the faith that equities always perform better than other instruments over the long run has been perfectly timed to reinforce investors' doubts. The booming house market in the USA, far from heralding a turnaround, may simply reflect a preference by the public for bricks and mortar over securities (or should that be "timber and plaster", given the preferred building materials in the USA?). Almost every commentator has now noticed that the great imbalances of the American economy have not actually been repaired, so the recovery may be a "little hampered". As we mentioned last week, pension funds are shifting their allocations from equities to bonds.


So what is happening? Is the disenchantment being overdone? Sometimes we think so. We see the securities of a major engineering company being massively discounted, possibly in excess of its problems and apparently without serious credit analysis. We see the vindictiveness created by the squirming and the silence of Enron directors being directed against many an innocent, and not-so-innocent, corporation and bank. Yes, there is a case for suggesting the disenchantment is overdone and that there are now investment opportunities.


We cannot, however, "buy" this case. Our sense is rather that the investment world is going through massive sea change, which might be called "return to reality". For a future period to be measured in years, not months, the economy will grow much more slowly, inflation and interest rates will remain low, and corporate profitability will gradually return, but then grow only at the pace of GDP expansion. Corporate profits will be more accurately presented (finished off-balance sheet fiddles, writing off goodwill direct to equity instead of through earnings, throwing non-repetitive earnings in with regular earnings, and "pro forma" earnings outlooks). These accounting changes will alone make profitability more modest. The age of the "quick buck" is over. The time for capital protection and assured steady return has returned. Moreover, all this is in the context of pension responsibilities being thrown back by governments onto individuals and the private sector just when returns on capital are going to remain low for years to come. A lot of people will not be retiring at 65!


Japan provided a surprise this week with a big rise in the Nikkei, apparently because the Government does not like investors selling short and has said it will buy the shares being sold by the insurance companies. It all sounds like market manipulation and smoke, certainly enough smoke to hide any sign of reforms!


Germany has produced positive IFO figures even as unemployment goes up and the country has been declared to have passed through an "official" recession (two quarters of GDP decline). France is now reaping the (negative) rewards of its 35-hour week. Switzerland is decidedly unhappy with itself in the aftermath of Swissair and a series of corporate disappointments. The United Kingdom astonishes everyone, including the British, on its economic strength. Any confidence we might have had on Europe finding strength independently of the USA has long been dashed. The best we can currently hope for is a return to gentle growth and moderate returns on investment.


Recommended average maturity for bonds in each currency
Some of our clients are already moving to bar-belling, but others are just staying with short maturities. That remains our position.

As of 05.12.01
As of 30.01.02

Dr. Roy Damary

Currencies (by GNI)


In the US, there are still mixed signals on the economic front. The equity markets continue their sideway trading, but Treasury and Fed officials remain optimistic that recovery is under way. It will be seen whether today's testimony by Mr. Greenspan might reinforce that view. In Japan, the prime minister's popularity has reached a new low, and the package to announced today to tackle the deflationary environment shows no concrete measures to reform the still very sick banking and insurance sectors. Public funds continue to be poured into the stock market to maintain the Nikkei artificially above the critical 10,000 level ahead of the book closing at the end of March. The government interference into the BoJ's monetary policy inspires no confidence at all. In Europe, Germany showed an increase of the IFO index for the 4th consecutive month, suggesting that the worst might be over and recovery under way.


EUR/USD: The euro continues to be under pressure. Only a clear break of 0.8830 would change our still negative outlook and speak for a recovery up to 0.9030. We are carefully watching the extremely important support zone around 0.8500. A weekly close below 0.8480 would be catastrophic and provoke the next down move, direction 0.8350.


USD/CHF: So long as we stay above 1.6750/80, the dollar remains clearly in an up-trend, with key resistance level of 1.7250. Only a weekly close below 1.6750 would put the bullish outlook into doubt and speak for a deeper correction, down to 1.6550 first.


USD/JPY: The yen is still in its range of 131.50 to 135.30. We expect a continual weakening of the yen, with our first target of 136.90 followed by 141.00


EUR/JPY: We are keeping our wait and see stance. We would reopen 50% of a long EUR/JPY position below 115.00. Consolidation in 114 to 118 trading range may be expected.


USD/CAD: We are keeping our short position USD/CAD at 1.5955 with a S/L at 1.6300. The price objective is still around 1.5650.


AUD/USD: The Aussie remains under pressure. A move below the psychological barrier of 0.5000 would be catastrophic and erase the Aussie potential to appreciate in the short term. A clear breakout of 0.5350 would be needed for a sustained rally towards 0.5500.


GBP/CHF: Continued high volatility at the moment with no clear trend. The exchange rate is still in its wide range of 2.3850 to 2.4450, and may be expected to remain there unless the USD starts to trend lower.



Current spot level
Current spot level
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