RATES: Let's start this week's letter with an announcement of a different kind. I will be going on a trip to Australia for almost 3 weeks. Thanks to the wonderful world of technology, hopefully I will be able to stay in touch with what is happening and still publish my weekly comments without missing a beat. I will check my email on a regular basis, so if you need to get hold of me, send me a note and I will try my best to reply. I will be back on November 6.
The economic data is persistently disappointing. While September Retail sales were reported at 1.5% (0.7% expected), one has to wonder how much more below cost car companies are willing to discount their product to keep them moving off dealer lots. The new problem the automakers will face sooner than later is the loss of momentum in their profitable financing operations. Even with 10 year Treasuries within a whisker of 4%, refinancing volumes declined close to 15% last week and are way off the highs last year. The present business model the automakers have, whereby they give away cars at a loss to make some money in their financial operations might not be viable going forward. All the sentiment surveys are declining and Leading Indicators are hinting that this trend will continue. While most consumer surveys are already negative and getting worse, business surveys are losing altitude and should turn negative late 2004 or early 2005. And while we might get another quarter of above trend growth, the data will be skewed to the upside by the hurricanes and by inventory build. Oil continues to break new ground to the upside. While Master Al doesn't seem to be overly concerned, here is the way I see the energy influence going forward: We had a fair bit of belly-aching in the spring when gasoline prices were going to the moon. While oil prices progressed from setting new highs through $40 in May to $55, gas prices at the pump are still lower than the levels seen in May in the US and way below the May highs in Canada. Heating oil has been keeping pace with crude, but heating season has not even started yet, so the consumer has not seen a real pinch from the bottom line yet on that front. This is about to change though as we head into the winter. That will just be another negative item for the consumer.
Fixed income portfolio managers staying bearish last week (RT survey up marginally to 42% bullish). Specs are long 58k contracts in the 10-year Note futures. This is a headwind. Bonds bounced from their 50-day moving average, and it looks like the path of least resistance is for prices to go up and yields to decline. Seasonals are mixed for the next week, and very positive until the middle of November after that.
US Long Bond futures closed at 113-00, up almost a dollar last week, while the yield on the US 10 year bond declined 8 basis points to 4.05%. I recommend a slightly long position for fixed income portfolios. The Canada - US 10 year spread closed at 50, out 1 on the week. Canada is cheap to the US, buying Canadian 10 year bonds to sell US 10 year notes and pick up 50 basis points was recommended a few weeks ago. Although not much is happening yet on this front, this trade has a positive carry, so no change is good news. The March05 BA futures position I bought at 97 closed at 97.11, up 11 cents this past week. The belly of the Canadian curve was stable versus the wings last week, but it is still cheap to the wings. This is another positive carry trade. As the curve continues to flatten, the belly should continue to outperform. Overweight the belly is still the best trade idea I have. Assuming an unchanged curve, considering a 3-month time horizon, the total return for the Canada bond maturing in 2012 is the best risk weighted value on the curve. This has changed from the 2011 Canada bond in the past few weeks. I expect that unless the curve shifts due to other dynamics, the 2012 area will be the inflection point going forward.
CORPORATES: Corporate bond spreads bounced back somewhat last week. The buy side is way long this sector. Long TransCanada Pipeline bonds were in 2 to 120, while long Ontario bonds were in .5 to 46.5. A starter short in TRAPs was recommended at 102 back in February. Car paper spreads were wider on credit downgrades to GM after the company reported a negative earning surprise and revised their outlook down. I am tempted to return to my earlier recommendation to short this sector again. I definitely would not get caught with a long exposure.
BOTTOM LINE: I still like bonds on a longer term, fundamental basis. An overweight position in the belly of the curve is strongly recommended. Short exposure for the corporate sector was advised since February. A long position was established in the March05 BAX futures under 97. Long Canada - Short US 10 year position was established at +50.
GENERAL COMMENTS: Newsflash: a major glut is developing in the LCD, flat panel TV market. According to reliable sources, there is in excess of 4 million units sitting in warehouses worldwide, waiting to be processed. LCD prices are off 21% this quarter, and one should be able to get a decent deal in the upcoming after-Christmas sales. How about 6 year, 0% financing to boot?