Fixed Income Weekly Review & Preview

Transcription

1 Fixed Income Weekly Review & Preview June 1, 2004 Fixed Income Research Joseph W. Jasper, CFA Director, Fixed Income Strategy & Marketing Private Client Research After rallying for the past three weeks off oversold conditions, we believe the bond market has now reached the opposite extreme. We believe a heavy economic calendar, including the May employment report, and specter of the June FOMC meeting will temper support for bond prices near term. HIGHLIGHTS Treasuries Yields fell for the third straight week, but appear to be stalling amid the weight of negative sentiment. Mortgages The recent widening of MBS spreads has created decent buying opportunities in all manner of MBS products. We suggest short CMOs for investors looking for yield and structure. Agencies We continue to see value in discounted callable bonds as an alternative to both corporates and MBS. Corporates We are growing increasingly uneasy over the current tight spreads offered by corporates. Our outlook for modestly rising rates and increased volatility would suggest increasing widening pressures for corporate spreads. Note: the Next Fixed Income Weekly Review and Preview will be published on Monday, June 14. Piper Jaffray does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decisions. This report should be read in conjunction with important disclosure information, including an attestation under Regulation Analyst Certification, found on the back pages of this report or at the following site: Fixed Income Weekly Review Page 1 of 6 Piper Jaffray

2 YIELD, COMMODITY PRICE, CURRENCY, AND STOCK MARKET CHANGES FOR THE WEEK LAST WEEK PRIOR WEEK CHANGE (BP) 3 Month 1.07% 1.02% 5 2 Year 2.54% 2.55% (1) 5 Year 3.79% 3.90% (11) 10 Year 4.65% 4.76% (11) 30 Year 5.34% 5.46% (12) Curve 2s-10s (10) Curve 2s-30s (11) CRB Crude Oil (0.05) Gold Yen (2.14) Euro Wilshire ,794 11,150 (356) Dow Jones Ind. Avg. 10,185 9, NASDAQ Comp. 1,985 1, Source: Bloomberg ECONOMIC HIGHLIGHTS Last week was a mixed bag on the economic front. May s consumer confidence number was essentially unchanged versus April, increasing just 0.2 points to Meanwhile the University of Michigan Consumer Sentiment Index for May was revised down four points to 90. Durable goods orders experienced broad-based declines as the index fell a larger than expected 2.9%. Finally, initial jobless claims rose to 344,000 last week, above expectations, although continuing claims remained below 3 million for the fourth consecutive week. On the positive side, Q1 GDP was revised up from 4.2% to 4.4%, on more robust inventory building, exports and public spending. Finally, the Chicago PMI jumped way past expectations, and countered the recent trend of weakness seen in other regional manufacturing surveys. This week holds a number of meaningful indicators, the most important of course being Friday s May employment report. Given the consensus forecast for decent moderation in the payroll numbers, and a significant amount of tightening already priced into the market, any number in the low +200s should be a nonevent for bonds. LAST WEEK S ECONOMIC RELEASES DAY STATISTIC ACTUAL CONSENSUS ESTIMATE Tuesday Consumer Confidence Existing Home Sales 6.64M 6.46M Wednesday Durable Goods -2.9% -0.9% Less: Transportation -2.1% -1.0% New Home Sales 1,093,000 1,200,000 Thursday GDP 4.4% 4.5% Personal Consumption 3.9% 3.9% GDP Deflator 2.6% 2.5% Fixed Income Weekly Review Page 2 of 6 Piper Jaffray

3 DAY STATISTIC ACTUAL CONSENSUS ESTIMATE Initial Jobless Claims 344, ,000 Continuing Claims 2,948,000 2,923,000 Friday Personal Income 0.6% 0.5% Personal Spending 0.3% 0.2% U. of Michigan Confidence Chicago Purchasing Mgr Source: Bloomberg THIS WEEK S ECONOMIC RELEASES DAY TIME STATISTIC CONSENSUS PREVIOUS (CDT) ESTIMATE Tuesday 9:00 Construction Spending 0.5% 1.5% 9:00 ISM Manufacturing Wednesday Total Vehicle Sales 16.6M 16.4M Domestic Vehicle Sales 13.3M 13.1M Thursday 7:30 Non-Farm Productivity 3.7% 3.5% 7:30 Unit Labor Costs 0.3% 0.5% 7:30 Initial Jobless Claims 339, ,000 7:30 Continuing Claims 2,935, :00 Factory Orders -1.1% 4.3% 9:00 ISM Non-Manufacturing Friday 7:30 Avg. Hourly Earnings 0.2% 0.3% 7:30 Avg. Weekly Hours :30 Unemployment Rate 5.6% 5.6% 7:30 Non-Farm Payrolls 215, ,000 7:30 Manufacturing Payrolls 23,000 21,000 Source: Bloomberg FIXED INCOME STRATEGY Macro Themes We are more negative on the market then our last report two weeks ago. The mid- March Mid-May sell off left the market pricing in more than 100 basis points of Fed tightening, a bit more than we felt was appropriate at the time. Selling did reach a capitulation however after the April employment report and the ensuing three week rally has taken a good portion of the oversold feel out of the market, coincidentally just in time for Friday s employment report. As such, the significant negative sentiment suggests that we are now at the opposite extreme and at the low end of our newly defined range: 4.60% % on 10s. We believe the market is likely to remain in this range until the conclusion of the June FOMC meeting on the 30 th. Two factors could add upside risk to the range, another blowout employment report, and any upside surprise to inflation data. Beyond what we believe is a certain 25 basis point hike in June however, it is important to acknowledge the significant amount of non-fed tightening that has already occurred over the past two months. For instance, Treasury yields are up nearly 100 basis points, while forwards have priced in the equivalent of a 25 basis point tightening following each of the remaining 04 FOMC meetings. As a result of these changes, and stronger economic data, the Dollar has rallied off its lows. Also Fixed Income Weekly Review Page 3 of 6 Piper Jaffray

4 note that mortgage refi activity has collapsed, shutting off a major source of incremental disposable income. Lastly, fiscal stimulus has run its course. We still expect the Fed to raise their overnight lending rate to between 1.50% and 2.00% by year s end which should keep upward pressure on yields, though not nearly to the extent witnessed during the 94 cycle. While a shorter duration stance is still in order on the eve of a Fed tightening campaign, we continue to caution against remaining too underinvested for fear of a repeat of the bond market of 94. GRAPH 1 HISTORICAL TREASURY SLOPE Source: Bloomberg, Piper Jaffray Off-the-runs On-the-runs Swap Yields STRIPS Treasuries The market was supported by new threats of domestic terrorist plots, mixed economic news, and month end index extension buying. The Treasury s two-year auction was well bid, with a strong 2.38 bid/cover ratio, and solid support from indirect bidders. Agencies The recent widening of swap spreads has drawn out agency spreads in sympathy. While there is continued likelihood that spreads will widen further, callable agencies are at a point where their yields provide a compelling alternative to both high-grade corporates and mortgages. We continue to believe that discount callables offer the best relative value, trading cheap to bullets but offering the upside of a call feature. Many callable issues that were trading near par a couple months ago are now deeply discounted, offering investors a combination of both generous yield spread, and upside price potential. Discounted callables often have superior total return profiles relative to bullets in a rising rate environment for both parallel and flattening yield curve shifts. Fixed Income Weekly Review Page 4 of 6 Piper Jaffray

5 Mortgages Yield spreads on MBS products have widened meaningfully since the middle of May, prompting a continued overweight recommendation in the sector. We suggest investors looking for structure should consider short average life CMOs, which have also cheapened and offer an attractive means of adding yield while limiting extension risk. Refi Index / Mortgage Applications The Mortgage Bankers Association s index of mortgage applications declined 3.3% to The purchase index fell 1% to The refinancing index dropped 6.7% to Corporates We have been pessimistic about the prospect for further corporate spread tightening for some time, mostly due to tight absolute levels. We believe our outlook for modestly rising rates and increased volatility adds further support to this argument. It is widely accepted that spreads tend to widen as rates rise and volatility increases, and against this backdrop, we now expect corporate spreads to become susceptible to widening. Within this framework, we continue to emphasize lower-rated credits over double and triple-a credits. GRAPH 4 MOODY S BAA CORPORATE BOND SPREADS 'Baa' Rated 'A' Rated 'AAA' Rated 0 Jan- 99 Sep- 99 May- 00 Jan- 01 Sep- 01 May- 02 Jan- 03 Sep- 03 May- 04 Source: Bloomberg, Piper Jaffray Fixed Income Weekly Review Page 5 of 6 Piper Jaffray

6 MUNICIPAL CONSENSUS YIELD CHANGES FOR THE WEEK MUNICIPAL CHANGE % TO TREASURY YIELD (BP) LAST WEEK PREVIOUS 5-YEAR AVG. WK Year % 0.0% 77.1% 5 Year % 0.0% 80.4% 10 Year % 0.0% 85.4% 30 Year % 0.0% 94.3% Source: Municipal Market Advisors CORPORATE MARKET DETAIL CORPORATE RATINGS CHANGES Issuer Ratings Action Rating To From Moody s / S&P Beckman Coulter Inc Positive Stable Baa3/BBB Burlington Northern Santa Fe Corp Stable Negative Baa2/BBB+ Enterprise Products Operating L.P. Baa3 Baa2 Baa3/BB+ Fidelity National Financial Inc. Review for Upgrade -- Baa3/BBB Tesoro Peteroleum Corp. Positive Stable Ba3/BB USF Corp Negative Stable Baa1/BBB+ Dynergy Inc. Positive Developing B3/B Swiss Reinsurance Co. Aa2 Aa1 Aa2/AA Aetna Inc. Positive Stable Baa2/BBB Goodyear Tire & Rubber Co. B- B B3/B- Apogent Technologies Inc. Watch Negative -- Ba2/BB+ CVS Corporation A3 A2 A3/A- Lend Lease Corp. Review for Upgrade -- Baa2/BBB Wisconsin Power & Light Co A- A A1/A- Prime Property Fund A3 A2 A3/A Herbst Gaming, Inc. B1 B2 B1/B2 Mohawk Industries Inc BBB+ BBB Baa2/BBB+ Martin Marietta Materials Inc BBB+ A- A/BBB+ SELECTED NEW ISSUES FROM LAST WEEK Issuer Coupon Maturity Spread Amt. Rating (bp) (MM) Moody s S&P TERPHANE HOLDING CORP NA 6/15/2009 NA 7 B3 CCC+ TERPHANE HOLDING CORP /15/ B3 CCC+ CITIGROUP INC NA 6/4/2007 NA 1000 Aa1 AA- BANK OF AMERICA CORP /15/ Aa2 A+ FINLAY FINE JEWELRY CORP /1/ B1 B+ MAAX CORP /15/ B3 B- HERBST GAMING INC /1/ B3 B- CSG SYSTEMS INTL INC 2.5 6/15/2024 NA 200 NA NA NAVISTAR INTERNATIONAL 7.5 6/15/ Ba3 BB- JP MORGAN CHASE & CO NA 6/2/2006 NA 1100 A1 A+ BAYERISCHE LANDESBANK NY NA 6/24/2005 NA 2000 Aaa AAA AUTOCAM CORPORATION /15/ B3 B- Fixed Income Weekly Review Page 6 of 6 Piper Jaffray

7 Issuer Coupon Maturity Spread Amt. Rating (bp) (MM) Moody s S&P HERTZ CORP /15/ Baa2 BBB- METLIFE INC /15/ A2 A AZTAR CORP /15/ Ba3 B+ METLIFE INC 5.5 6/15/ A2 A COMERICA BANK 5.7 6/1/ A2 A- HEADWATERS INC /1/2016 NA 150 NA NA SAMSONITE CORP NA 6/1/2010 NA 100 B1 B+ WILD OATS MARKETS INC /15/2034 NA 100 NA NA DIGITAL RIVER INC /1/2024 NA 175 NA NA HANOVER COMPRESSOR CO 9 6/1/ B3 B ERAC USA FINANCE COMPANY 6.7 6/1/ Baa1 BBB+ WORLD SAVINGS BANK FSB 4.5 6/15/ Aa3 AA- WORLD SAVINGS BANK FSB NA 6/1/2007 NA 600 Aa3 AA- PRECISION DRILLING CORP /1/ NA BBB+ SAMSONITE CORP /1/ B3 B- JOHN DEERE CAPITAL CORP /25/ A3 A- CONCENTRA OPERATING CORP /1/ B3 B- REPUBLIC OF SOUTH AFRICA 6.5 6/2/ Baa2 BBB Source: Bloomberg Fixed Income Weekly Review Page 7 of 6 Piper Jaffray

8 Analyst Certification Joseph W. Jasper, CFA The views expressed in this report, including the Key Points and Risk sections in particular, accurately reflect my personal views about the subject Company and the subject security. In addition, no part of my compensation was, is, or will be directly or indirectly related to the specific recommendations or views contained in this report. Research Disclosures The following disclosures apply to stocks mentioned in this report if and as indicated: (#) Piper Jaffray was making a market in the Company s securities at the time this research report was published. Piper Jaffray will buy and sell the Company s securities on a principal basis. (^) A Piper Jaffray analyst who follows this Company or a member of the analyst s household has a financial interest (a long equity position) in the Company s securities. (@) Within the past 12 months, Piper Jaffray was a managing underwriter of an offering of, or dealer manager of a tender offer for, the Company s securities or the securities of an affiliate. (>) Piper Jaffray has either received compensation for investment banking services from the Company within the past 12 months or expects to receive or intends to seek compensation within the next three months for investment banking services. (~) A Piper Jaffray analyst who follows this Company, a member of the analyst s household, a Piper Jaffray officer, director, or other Piper Jaffray employee is a director and/or officer of the Company. (+) Piper Jaffray and its affiliates, in aggregate, beneficially own 1% or more of a class of common equity securities of the subject Company. Disclaimer Piper Jaffray research analysts receive compensation that is, in part, based on revenues of Piper Jaffray Equities & Investment Banking which include overall investment banking revenues. Piper Jaffray research analysts who follow this Company report to the Head of Investment Research who, in turn, reports directly to the Chief Executive Officer of Piper Jaffray. This material is based on data obtained from sources we deem to be reliable; it is not guaranteed as to accuracy and does not purport to be complete. This information is not intended to be used as the primary basis of investment decisions. Because of individual client requirements, it should not be construed as advice designed to meet the particular investment needs of any investor. It is not a representation by us or an offer or the solicitation of an offer to sell or buy any security. Further, a security described in this release may not be eligible for solicitation in the states in which the client resides. Officers or employees of affiliates of Piper Jaffray & Co., or members of their families, may have a beneficial interest in the Company's securities and may purchase or sell such positions in the open market or otherwise. Notice to customers in the United Kingdom: This report is a communication made in the United Kingdom by Piper Jaffray & Co. to market counterparties or intermediate customers and is exclusively directed at such persons; it is not directed at private customers and any investment or services to which the communication may relate will not be available to private customers. In the United Kingdom, no persons other than a market counterparty or an intermediate customer should read or rely on any of the information in this communication. Securities products and services offered through Piper Jaffray & Co., member SIPC and NYSE, Inc., a subsidiary of Piper Jaffray Companies. Additional information is available upon request. No part of this report may be reproduced, copied, redistributed or posted without the prior consent of Piper Jaffray & Co Piper Jaffray & Co., 800 Nicollet Mall, Suite 800, Minneapolis, Minnesota Fixed Income Weekly Review Page 8 of 6 Piper Jaffray