Bond Outlook October 22nd

Investors the world over have moved from panic to shell-shock. This Weekly has been written in India, where equity investors have typically lost half the value of their portfolio, and are now digesting that harsh fact before making further moves. The euphoria of last year gave way to panic these last three weeks, but few could get out of the market as so many were participating via investment funds. Now the sense is that the damage has been done, it should not get much worse, and in due time there will be a recovery. Independent financial planning, with all it implies about a balanced portfolio matching the risk and age profile of the client, can now move forward to become a mainstay of the investment community in India. We stress “independent” because the cases of blatant misselling make examples in the West seem quite mild.

The point we wish to make in referring to India is that after shell-shock comes more prudent investment. Until recently some of our clients would tell us that they could not expand their bond portfolio as equities were giving such returns. The “some” should now join the “many” among our clients who maintain balance even in times of excessive exuberance.

Fortunately it is not our task to advise investors on equities. We must however provide guidance on fixed income. In that regard we suspect that investors are not making a clear distinction between:

• The capital market crisis, which can be addressed by government intervention, and is well on the way to a solution
• The economic recession, which can only be solved by months or years of adjusting to lower levels of Western demand for goods and a rebalancing both of debt to spending by households and also of world consumption and production

Thus we believe that banks have been brought back from the brink and are now almost as safe a fixed income investment as government bonds, for the very simple reason that they have government participation and guaranties just about everywhere (at least in the G10). Last week we suggested that financials were at a point where bond investors could and should move back in. We stand by that recommendation.

In general bond trading has freed up to a degree over the last week. Bid/Ask spreads are continuing to come in, and the TED spread is narrowing. The additional hundreds of USD billions made available from the Fed for both 3-month commercial paper and the money market have a feel of reinforcing the flow rather than stemming the tide.

The recession now underway is a very different matter. Ever since Greenscam killed the last natural economic adjustment post 9/11 with his cheap money and his encouragement of reckless borrowing, we have been forecasting this outcome. It is a good thing that the presidential candidates are not seriously debating the economy, as a reality check would spoil the chances of whoever faced it. Reality can wait until after 20th January.

Our puzzlement as to the reasons has not at all slowed the USD strengthening! The weakness of the GBP is more understandable, but only adds to our puzzlement on the USD. Basically the UK has followed the same irresponsible path as the USA complete with a housing bubble, living beyond its means at national, government and household level and letting its banks go way over the top in leveraging. Gordon Brown might be a hero with his bail-out approach, but he has a lot to answer for in allowing the economy to run on so much debt and inflated property prices.

Focus

(!) Hungary: repo rate held at 8.5% on 20 October

(–) UK: deficit reached GBP 12.6 billion in September versus GBP 8.7 billion this time last year and expectations by economists of GBP only 10.3 billion

(?) South Korea: government guaranty up to USD 100 billion for interbank lending plus an injection of USD 30 billion immediately to stabilise its financial system

(+) Sweden: government proposes EUR 152.2 billion to assist the financial sector to deal with the crisis

(!) Canada: target rate dropped from 2.5% to 2.25%

(!) Switzerland: UBS rescued by BNS

(+) positive for bonds (–) negative for bonds (!) watch out (?) begs the question

Recommended average maturity for bonds.

Currency:

USD

GBP

EUR

CHF

As of 8.10.08

2015

2015

2015

2015

As of 16.07.08

2015

2010

2015

2015

Dr. Roy Damary