Fixed Income Weekly Review & Preview

Transcription

1 Fixed Income Weekly Review & Preview October 6, 2003 Fixed Income Research Joseph W. Jasper, CFA Director, Fixed Income Strategy & Marketing Portfolio Strategy Group Bonds made an abrupt about face after a much better than expected September employment report gave rise to fears that the economy is improving more than many had expected. We believe this report, much like the smaller than expected Fed rate cut in June, will mark another turning point in bond market sentiment. While we still view the Fed as on hold for some time, we encourage investors to rebalance accounts towards a more defensive posture given the still low absolute level of yields. HIGHLIGHTS Treasuries Treasuries retreated on Friday as the September employment report prompted mass selling of bonds. Mortgages Mortgages ended the week mixed with Friday s sell-off erasing the sector s earlier gains. With yield spreads approaching two-year lows, we have moved to a neutral allocation to mortgages, and suggest that the sector may again be under widening pressure should yields back up again. Corporates Corporate spreads finished mixed last week with industrials mostly loosing ground. Utiltities and oil and gas credits however, tightened five basis points. Preferreds We encourage investors to reduce durations in preferred holdings amid the increasing potential for higher yields in the coming months. Municipals Municipal yields rose marginally last week. We believe the steep shape of the yield curve provides tremendous value to investors maintaining a laddered portfolio strategy. U.S. Bancorp 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 8 U.S. Bancorp Piper Jaffray

2 YIELD, COMMODITY PRICE, CURRENCY, AND STOCK MARKET CHANGES FOR THE WEEK Last Week Prior Week Change (BP) 3 Month 0.93% 0.94% (1) 2 Year 1.64% 1.58% 6 5 Year 3.10% 2.92% Year 4.20% 4.02% Year 5.09% 4.96% 13 Curve 2s-10s Curve 2s-30s CRB Crude Oil Gold (11.8) Yen (0.85) Euro Wilshire ,990 9, Dow Jones Ind. Avg. 9,572 9, NASDAQ Comp. 1,881 1, Source: Bloomberg Economic Highlights Reports released last week on the pace of economic activity were quite a contrast. On one hand all of the high frequency reports suggested a tempering of the pace of growth while the September employment report surprised everyone by revealing the first additions to payrolls in eight months. Of the more noteworthy releases were the Chicago PMI which was reported to have dropped to 51.2 from 58.9, well below the consensus Consumer confidence also fell, falling by more than four points to 76.8, and well below the consensus The September ISM fell one point to 53.7, while the September ISM nonmanufacturing index sank to 63.3 from 65.1, just above the 63.0 consensus. Lastly, jobless claims rebounded, rising 13,000 to 399,000. As mentioned earlier, the surprise of the week came on Friday in the release of the September employment report. Payrolls during September rose 57,000 the first time in eight months while the unemployment rate held steady at 6.1%. The consensus forecast was for a drop in payrolls of 25,000. The increase followed a revised 41,000 decline in August, also much better than expected. One reason the unemployment rate held steady is that a smaller percentage of the population was in the labor force. The labor force participation rate fell to 66.1 percent, the lowest since December The stronger than expected report overshadowed an other report by the Labor Department showing the economy lost 145,000 more jobs than thought in the 12 months ended in March Employment in service-producing industries rose 74,000 last month after falling 12,000 during August. The increase was led by a 33,200 rise in temporary-help jobs. The Manufacturing sector shed 29,000 jobs last month, the 38th straight decline. The manufacturing workweek expanded to 40.4 hours from 40.2 in August and overtime rose to 4.2 hours from 4 hours. Fixed Income Weekly Review Page 2 of 8 U.S. Bancorp Piper Jaffray

3 While average weekly hours worked held at 33.7 hours in September, incomes decreased. Workers' average hourly earnings fell 0.1 percent, or 1 cent, after a 0.2 percent increase the previous month. Economists had expected a 0.2 percent increase in hourly wages. Average weekly earnings fell to $ last month from $521 in August. LAST WEEK S ECONOMIC RELEASES Day Statistic Actual Consensus Estimate Mon. Personal Income 0.2% 0.3% Personal Spending 0.8% 0.8% Tues. Consumer Confidence Chicago Purch. Mgr Wed. ISM Manufacturing Thurs. Initial Claims 399, ,000 Continuing Claims - 3,673,000 Factory Orders -0.5% 1.6% Fri. Unemployment Rate 6.1% 6.2% ISM Non-manufacturing Source: Bloomberg THIS WEEK S ECONOMIC RELEASES Day Time Statistic Consensus Previous (CDT) Estimate Thurs. 7:30 Initial Claims 395, :30 Continuing Claims 3,662,000 3,673,000 Fri. 7:30 PPI 0.1% 0.4% 7:30 PPI Less: Food & Energy 0.1% 0.1% Source: Bloomberg FIXED INCOME STRATEGY Macro Themes The better than expected September payroll data is likely to be another inflection point for bond market investors, taking some of the wind out of the market as investors again refocus on the recovery story. While we do not expect to see a repeat of the convexity hedging led sell-off of July, clearly the stronger than expected employment report has implications for a more convincing recovery and improved Q3 corporate profitability. Against this backdrop and with yields still roughly 50 basis points below their September highs, we encourage accounts to examine portfolios with an eye toward rebalancing to more defensive postures. We still do not expect the Fed to raise rates until mid-2004, however a shift in market sentiment towards stronger economic growth could cause a further back up in rates across the curve. While we are not calling for dramatically higher rates over the balance of 2003, we suggest accounts consider the following defensive strategies designed to limit portfolio price volatility. Shorten duration. We believe trading accounts should look to shorten portfolio durations, or average maturities, by taking profits in longer-dated positions. Fixed Income Weekly Review Page 3 of 8 U.S. Bancorp Piper Jaffray

4 Specifically, we suggest accounts lessen exposure to year bonds and begin adding to one to ten-year positions. Shortening average portfolio maturities reduces price volatility during volatile interest rate environments, and offers a measure of principal protection relative to longer-duration portfolios. Ladder maturities. We continue to recommend a laddered portfolio structure, which takes advantage of rising interest rates. Ladders can be easily constructed by simply dividing investable dollars evenly among progressively longer-term securities that mature at regular intervals, for example, every six months or once a year. As shorter-term securities mature, proceeds can be reinvested in longer-term, higheryielding bonds. Trade up in coupon. Environments of lower interest rates can result in an abundant supply of premium bonds in the bond market. A bond trades at a premium when its coupon is higher than prevailing interest rates. Compared to similar bonds priced at par, premium bonds offer investors the advantages of higher current income, higher current yield and lower price volatility, and should be viewed as an opportunity to enhance investment returns. Perhaps most importantly, the prices on premium bonds tend to decline more slowly than those of par or discount bonds when interest rates rise, thereby offering downside price protection. Step-up securities. As an alternative to premium bonds, we believe investors should also consider step-up securities. Step-ups are securities in which the periodic coupons reset at progressively higher levels. Step-ups offer the advantage of providing increasingly higher coupon income relative to fixed-rate bonds. Step-ups are offered in a wide array of maturities and have varying degrees of call protection. GRAPH 1 HISTORICAL TREASURY SLOPE Off-the-runs On-the-runs Swap Yields STRIPS Source: Bloomberg, U.S. Bancorp Piper Jaffray Treasuries Treasuries tumbled last week, with the ten-year note posting its biggest decline in more than two months, after the September employment report showed the U.S. Fixed Income Weekly Review Page 4 of 8 U.S. Bancorp Piper Jaffray

5 economy unexpectedly added jobs last month. The report fueled speculation that the Federal Reserve will be drawn off the sidelines and raise interest rates sooner than the mid-2004 time frame many investors had been expecting. In addition to the details of the report, which indicated that payrolls grew for the first time in eight months, several Fed officials made a number of bond-unfriendly comments during public appearances last week. Comments made in speeches last week by Fed Governors Bernanke, Moskow and McTeer all hinted that while there is still some risk that the rate of inflation slows further, growth next year will be stronger than it will be this year. For the week, yields rose six to 17 basis points, with the heaviest losses suffered in the intermediate portion of the curve. Twos to fives steepened 10 basis points on the week and twos to tens steepened 12 basis points, as the 2-year yield rose 6 basis points to 1.64%, the five-year yield jumped 17 basis points to 3.10% and the ten-year yield rose 17 basis points to 4.20%. Mortgages Yield spreads on both 30-year and 15-year pass-throughs have tightened in recent weeks, with 30 year pass-through yield spreads moving to near their tightest levels versus Treasuries in two years. In previous Weeklys we had advocated an overweight of 30-year pass-throughs relative to 15-year pass-throughs as it became increasingly apparent to us that the Treasury market had stabilized and was setting up a new trading range. With the Treasury market s recent rally, bringing the yield on the ten-year note down to near 4.0%, we see increased risks to the mortgage sector and advocate a neutral position within both 30- and 15-year positions. Given the current backdrop of lower interest rates, historically tight yield spreads, and attractive opportunities in other asset classes, we move to a more cautious position on the sector. GRAPH 2 FNMA 30-YR AND 15-YR MORTGAGE SPREADS VS. TREASURIES FNCL vs. 10-Yr Treasury FNCI vs. 5-Yr Treasury 170 Spread (in basis points) /28/01 12/28/01 3/28/02 6/28/02 9/28/02 12/28/02 3/28/03 6/28/03 9/28/03 Source: Bloomberg, U.S. Bancorp Piper Jaffray Fixed Income Weekly Review Page 5 of 8 U.S. Bancorp Piper Jaffray

6 Refi Index / Mortgage Applications The Mortgage Bankers Association s index of mortgage applications rose 1.1% to The purchase index fell 1.1% to The refinancing index rose 3.2% to Corporates Corporates finished mixed last week with industrials generally widening five basis points, while utilities and oil and gas names tightened by the same amount. In new issues, U.S. borrowers sold just under $9 billion in new debt. Berkshire Hathaway sold $1.5 billion of notes in two parts. Centex, the second largest U.S. homebuilder offered $300 million of a 5.125% 10-year note and Pepsi Bottling Group Inc., the world's largest distributor of Pepsi-Cola soda, boosted an issue of three-year notes to $500 million from $300 million. Preferreds We recommend accounts lower the duration of their preferred stock portfolios by buying seasoned, higher coupon paper. Accounts that are less concerned about price volatility and more interested in income may wish to continue focusing on lower coupon, par preferreds with longer call protection. However, we believe seasoned preferreds make more sense from a total return perspective in this environment, given their lower price sensitivity to interest rate changes and generally higher spread pickup. Municipals Municipals handily outperformed Treasuries last week with yields rising only one half to one third of the week s move in Treasuries. We expect municipals to cheapen this week as the sector plays catch up with Treasuries. In terms of value the curve remains very steep, which continues to make the cost of remaining in money market investments considerable. As in other sectors we suggest investors to maintain a laddered maturity structure to take advantage of the shape of the curve, while mitigating price volatility relative to a bullet strategy. MUNICIPAL CONSENSUS YIELD CHANGES FOR THE WEEK Municipal Change % to Treasury Yield (bp) Last Week Previous Wk 5-Year Avg. 2 Year % 75.9% 77.1% 5 Year % 81.2% 80.4% 10 Year % 90.8% 85.4% 30 Year % 97.8% 94.3% Source: Municipal Market Advisors Fixed Income Weekly Review Page 6 of 8 U.S. Bancorp Piper Jaffray

7 CORPORATE MARKET DETAIL SELECTED NEW ISSUES FROM LAST WEEK Issuer Coupon Maturity Spread Amt. Rating (bp) (MM) S&P Moody s ALLSTATE FIN GLOB FND II /22/ NA NA BE AEROSPACE /1/2010 NA 175 B3 B+ BERKSHIRE HATHAWAY INC /15/ Aaa AAA BERKSHIRE HATHAWAY INC /15/ Aaa AAA BOTTLING GROUP LLC /16/ A3 A- CAMP PENDELTON/QUANTICO /1/ Aaa AAA CAMP PENDELTON/QUANTICO /1/ Aaa AAA CENTEX CORP /1/ Baa2 BBB DYNEGY HOLDINGS INC /15/ B3 B- DYNEGY HOLDINGS INC /15/ B3 B- ENCANA CORP /15/ Baa1 A- ENERGEN CORP 5 10/1/ Baa1 A- ENSCO OFFSHORE CO /15/ NA NA GILROY ENERGY CENTER LLC 4 8/15/2011 NA 302 Aaa AAA HOUGHTON MIFFLIN CO 0 10/15/ Caa1 B HUNTINGTON NATIONAL BANK /15/ A1 A IMCO RECYCLING INC /15/ B3 B- INTRAWEST CORP /15/ B1 B+ J PAUL GETTY TRUST /1/ Aaa AAA KOPPERS INC /15/ B2 B LBI MEDIA, INC 0 10/15/ NA NA NORSKE SKOGINDUSTRIER /15/ Baa3 BBB NORSKE SKOGINDUSTRIER /15/ Baa3 BBB ONEAMERICA FINL PARTNERS 7 10/15/ Baa2 A- PARKER DRILLING CO /1/ B2 B- PEMEX PROJ FDG MASTER TR NA 10/15/2009 NA 500 Baa1 BBB- PHARMACEUTICAL RESRCS /30/2010 NA 200 NA NA POPULAR NORTH AMER INC /1/ A3 BBB+ POWER RECEIVABLES /1/2012 NA 432 Baa2 BBB POWER RECEIVABLES /1/2012 NA 22 B1 BB+ SCOTTS COMPANY /15/ Ba3 B+ SOUTHWESTERN PUBLIC SRV 6 10/1/ Baa1 BBB UNION ELECTRIC CO /1/ A1 A- UNIVERSAL CORP /15/ Baa1 A- VERIZON NEW ENGLAND INC /1/ Aa3 A+ VIDEOTRON LTEE /15/ Ba3 B+ WEATHERFORD INTL INC /15/ Baa1 BBB+ Source: Bloomberg Fixed Income Weekly Review Page 7 of 8 U.S. Bancorp 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 its fixed income securities. 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 fixed income securities mentioned in this report if and as indicated: (#) U.S. Bancorp Piper Jaffray (USBPJ) was making a market in the Company s securities at the time this research report was published. USBPJ may buy and sell the Company s securities on a principal basis. (^) A USBPJ 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, USBPJ 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. (>) USBPJ 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 USBPJ analyst who follows this Company, a member of the analyst s household, a USBPJ officer, director, or other USBPJ employee is a director and/or officer of the Company. (+) USBPJ and its affiliates, in aggregate, beneficially own 1% or more of a class of common equity securities of the subject Company. (=) One or more affiliates of U.S. Bancorp, the ultimate parent company of USBPJ, provided commercial banking services (including, without limitation, loans) to the Company at the time this research report was published. Disclaimer Nondeposit investment products are not insured by the FDIC, are not deposits or other obligations of or guaranteed by U.S. Bank National Association or its affiliates, and involve investment risks, including possible loss of the principal amount invested. USBPJ research analysts receive compensation that is, in part, based on revenues of USBPJ Equity Capital Markets which include investment banking revenues. USBPJ research analysts who follow this Company report to the Head of Equity Research who, in turn, reports only to the Head of Equity Capital Markets. 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. Affiliates of U.S. Bancorp Piper Jaffray, including U.S. Bancorp and their respective officers or employees, 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 U.S. Bancorp Piper Jaffray 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 U.S. Bancorp Piper Jaffray, member SIPC and NYSE, Inc., a subsidiary of U.S. Bancorp. Additional information is available upon request U.S. Bancorp Piper Jaffray, 800 Nicollet Mall, Suite 800, Minneapolis, Minnesota Fixed Income Weekly Review Page 8 of 8 U.S. Bancorp Piper Jaffray