Tuesday, February 10, 2004
Issue Contents:
| 09:00 | Good Morning The day ahead. |
| 09:06 | Daily Swing Trade Today's stock picks. |
| 13:48 | Economic Data Summary of key releases. |
| 13:58 | Current Events Junky bonds. |
| 16:16 | Active Trader Transcript Real time forum log. |
| 16:52 | Later... For tomorrow. |
As we work our way toward Wednesday and Thurday, the two big days on this week's U.S. Economic Calendar, we'll continue to do big picture reviews for a number of stocks with earnings announcement pending.
I am having a bit of a late start after a 22-hour day yesterday, and will proceed directly to the Daily Swing Trade right now.
P.S. The good news is that Sydney will be getting her braces off next month, so I won't need to go down to Seattle on a monthly basis anymore. Fingers crossed!
Let's update Monday's picks first.
BIIB/Biogen - Continues toward the first overhead target, but we need to see if push up with volume like it really means business, particularly at this point. Suggest moving stop losses up to around yesterday's low.
CPWR/Compuware - Hesitation in the form of an inside bar yesterday at Target 1. Again, it needs to push up with volume to show the sellers who appeared here on February 2 that it means business, or else they'll be tempted to come out again shortly.
IBM/Intl Business Machines - Stopped out.
ETR/Entergy - Bar 4 of the bull flag is formed. Traders looking to continue stalking this buy setup should move the buy alarm down to Monday's high. If the buy stop is elected, the initial stop loss should be placed just above Monday's low.
HAL/Haliburton - Holy Grail buy setup is elected on break of last Friday's high. Suggest moving the stop loss to just above Monday's low.
FLEX/Flextronics - Formed a potential reversal pattern here on the daily chart. Pass for now on the buy side unless you are trading intraday.
GM/General Motors - Formed Bar 4 of a bear flag. Trader stalking this short sale should move their sell alarm up to Monday's low. If the trade is made today, the initial stop loss should be placed just under Monday's high.
JDSU/JDS Uniphase - Big ugly pattern to start with and some sellers appeared at the gap zone from the February 4 high. Similar in look to BIIB.
JNJ/Johnson & Johnson - Bar 2 of a bull flag is formed. Traders looking to buy should move their buy alarm down to Monday's high. If the trade is made today, the initial stop loss should be placed just above Monday's low.
LTD/Limited Brands - One more inside day. Traders looking to buy should move their buy alarm down a touch to Monday's high. If the trade is made today, the initial stop loss should be placed just above Monday's low.
NXTL/Nextel Communications - This is basically the more expensive version of the JDSU chart. Tried to "break out" but there is some hesitation. If this one can move up, best to look for intraday entries.
ICSC-UBS Store Sales 1+.8%
(Econoday.com) - Eastcoast consumers went out shopping for new winter clothes to lift retailer sales in the week ended Feb. 7. The ICSC-UBS retail chain store index rose a sharp 1.8 percent compared with the prior week. Year-on-year sales were up a very sharp 5.9 percent. But through much of January, both the weekly ICSC-UBS and Redbook reports understated what proved to be a strong month for retailers.
Redbook +0.4%
(Econoday.com) - Redbook reported a modest 0.4 percent rise in the pace of retailer sales for the week ended Feb. 7 compared with the full month of January. The year-on-year rise in the week is also modest, up 4.4 percent. Though soft, the Redbook still described sales as "buoyant", noting high spirits among retailers as spring merchandise begins to roll in.
4-Week Bill Treasury Rate 0.895%
(Econoday.com) - The 4-week U.S. Treasury bill was awarded Tuesday at a rate of 0.895 percent, unchanged from the prior week. The bid-to-cover was 2.27 vs. 2.66 last week. The steady rate on the 4-week bill, like rates on the 3-month and 6-month bills auctioned Monday, reflects investor certainty that the Federal Reserve will not raise overnight interest rates anytime soon.
3-Year Note Auction Yield Awarded 2.250%
(Econoday.com) - The U.S. Treasury auctioned $24 billion of 3-year notes today with a coupon rate of 2.25 percent and an awarded yield of 2.33 percent. The coupon rate is down 0.375 percent from the November auction but the yield is down by a smaller amount.
Two related articles from the Economist, February 5, 2004 print edition.
Bond Markets: Too close to the sun?
Bonds issued by riskier borrowers have soared as investors sought alternatives to American government bonds. But have they flown too high? This article looks at American corporate debt; the next, at emerging-market bonds.
WITH a change of just two words, the Federal Reserve has sent the first real shivers through rising parts of America's financial markets, since they touched bottom in late 2002 and early last year. In previous announcements, the Fed had said that it would keep rates on hold for a “considerable period”. Now it says merely that it will be “patient”.
A subtle change, perhaps, and while no one expects America's central bank to put up rates sharply and quickly, markets are starting to think that short-term rates might rise from their 45-year lows a bit sooner than they had expected. A market that has more to lose than most from rising interest rates is one that has also been one of the most effervescent in recent months: the corporate-bond market. It has already dropped a bit since the Fed's announcement. Is this a brief sell-off, or a sign of worse to come?
Having been rattled by the uncertainty about companies' finances following the shenanigans at Enron, WorldCom and the like in 2002, the markets' confidence—and the desire for yield—returned in force. The investment-grade and high-yield (more commonly known as junk) bond markets both had their fastest rally on record last year, which is a little surprising, given investors' fears about how ravaged companies' balance sheets had become.
The extra amount that investment-grade bonds yield compared with Treasuries has fallen by two-thirds from their high. But the prices of junk bonds have risen still more spectacularly. Over the same period, the spread offered on bonds rated Caa (ie, hugely speculative) has fallen from 19 points to five, enabling the most aggressive investors in junk (meaning those willing to buy the dodgiest credits) to turn in fabulous performances, and the investment banks that have been selling so many of them to make billions of dollars in profit.
Companies, especially those with stretched finances, have benefited hugely from the renewed appetite for their debt. Take Nalco an unprofitable company. In November, Nalco was able to issue bonds at 9%, notwithstanding a junk rating of a particularly lowly sort—a yield that could not have been matched by a company with a top-notch junk rating in 2002. No matter: the issue was more than four times oversubscribed and Nalco took advantage of unsatisfied demand by raising another $450m on January 15th on similar terms. Between March and December of last year, the spread of bonds issued by firms with the same rating as Nalco halved, to under five percentage points.
It is not just bond investors that have been falling over themselves to lap up any bond with a sniff of yield; banks have again joined the fray, too. At the end of 2002, with credit scarce and demand for it high, banks were able to push through much tougher lending terms. They started to reduce the maturity of their loans from five years to three and often to one, and to charge more for them. They also raised the price of guarantees to provide funds to companies unable to tap the short-term commercial-paper market. These guarantees had been woefully underpriced since companies typically resorted to them only when they got into trouble.
Banks' new-found toughness did not last long, however: demand for loans has been falling sharply, and they have been keen for business. By the middle of last year, says Meredith Coffey of the Loan Pricing Corporation (LPC), a research firm, the number of companies able to push the length of their loans to five years had jumped from about 15% of the total to 30%. Now the figure is higher still, the average number of banks participating in syndicated loans has jumped sharply, and all thoughts of charging a decent price for a loan have evaporated.
As with the bond market, the generosity of bankers has been a boon for troubled companies. Last year, according to the LPC, at least a dozen companies refinanced far more cheaply loans which they had taken out only recently. The car parts division of TRW, a big conglomerate, is one. This was spun off in a leveraged buy-out early last year. As a business, it leaves much to be desired, since it relies on a limited number of buyers and had a not-especially-good junk rating. Yet in July, only months after being spun off, it refinanced $1.1 billion in debt, lowering the interest charge from four percentage points over LIBOR (the benchmark rate at which the best banks lend to one another) to three, saving $11m in annual interest costs. By December, the market had improved enough to enable the company to refinance again, this time lopping another half point off its interest costs, and saving another $5m a year in interest.
To be sure, there has been a sharp fall in the risks run by lenders of any sort and hence the returns they require. For one thing, default rates for junk have dropped to 5% of outstanding bonds over the past 12 months compared with their peak of 23% in November 2002. Given the strong economy, defaults should drop further. But these are a lagging indicator of risk. A better measure is to look at forward-looking market indicators. These, too, have improved. Equity prices have risen for many companies, thus reducing their leverage, as measured by the price of their equity compared with their outstanding debts. The latter have fallen somewhat, too, because companies have been using record profits to pay off some debt.
Default's an option
More important has been a fall in the uncertainty about profits and share values. Bond investors hate an uncertain profit outlook because it means they are less likely to get their money back. But corporate profits surged 23% last year, helping to make investors far more comfortable. A good way of measuring this is to look at the options market, where prices have fallen dramatically. A commonly used measure is the VIX index of implied volatility (roughly, how much shares are likely to move around), which has fallen from a high of over 40% in October 2002, to a low of 14% last month—its lowest level since 1996. Because of the fall in both leverage and volatility, Moody's KMV, a subsidiary of the big ratings agency, predicts that the likelihood of an average company defaulting over the next year has fallen to just over 1%—a dramatic fall from two years ago.Will risks rise when interest rates do? They have already done so a bit: the VIX has risen to just shy of 18%. But if the overall fall in volatility is the result of bumper company profits and enthusiasm for shares, it may rise higher still. Shares are still expensive by most historic yardsticks, and the fall in volatility sits ill with the wide range of year-end targets for the S&P 500 index for the end of the year.
Moreover, cheaper borrowing costs have (among other things, such as low taxes) clearly flattered profits, especially those at financial firms, which account for a third of all profits. And though companies have paid off some debt, they have not paid off as much as some might like to believe. In part, this is why the rating agencies are still downgrading more companies, with the exception of financial firms, than they upgrade. The recent surge in mergers and acquisitions, some of it financed with debt, suggests that companies are again more concerned with boosting returns than with the state of their balance sheets. All of this is bad news for bondholders.
Emerging-Market Bonds: Priced for perfection
Invest in emerging-market bonds at your peril
JUST like Victorian vicars preaching temperance, it is always easy for those who warn of the intoxicating perils of investing in emerging markets to find sad victims, shadows of their former selves, who have fallen prey to the temptation of high-yielding paper. The greatest victims today are holders of bonds issued by the Republic of Argentina. Since late 2001 Argentina has been in default on these, to the tune now of $100 billion. That is the largest-ever unpaid debt, though the country may soon beat its own record. For in coming months, a nasty game of blackmail with the International Monetary Fund may end with Argentina doing the unspeakable: defaulting on $30 billion or so of debts to the Fund and other multilateral institutions.
But who listens to such admonitions? While Argentina proposes to keep nine-tenths of the money it owes to bondholders, the market for bonds issued by its neighbour, Brazil, has been on fire. Brazil's bonds account for about one-fifth of J.P. Morgan's EMBI+ index of emerging-market bonds. Anyone lucky enough to have piled into Brazil's dollar debt in October 2002, the month that Luiz Inácio Lula da Silva was elected president, at a spread of 23 percentage points over American Treasury bonds, would last month have been able to sell it at a spread of about four points. They have benefited, too, from the fall in Treasury yields. Total returns on Brazilian bonds from October 2002 to the end of last year were an intoxicating 124%.
Brazil had its own story to tell. Mr da Silva was a leftist campaigner who scared the markets. Yet when he took office in January 2003, he quickly made clear that he intended to pay every penny of Brazil's debt and was prepared to put the economy through the wringer to do it. His new finance minister delivered a “credibility shock” to the markets by voluntarily raising the target for the primary budget surplus (ie, before interest payments) from the 3.75% of GDP mandated by the IMF to 4.25%. Inflation came down fast, the currency stabilised, and the Brazilian economy may this year grow some 3-4%.
Brazil's bonds are exceptional only by degree, for those of almost every other emerging market have been blessed of late. Last year, emerging-market bonds returned 28%. Since October 2002, the EMBI+ index has seen spreads tighten against American Treasuries by around six percentage points. With average emerging-market spreads now four points above Treasuries, they are about as low as they have ever been—only a tiny bit higher, indeed, than just before the Asian crisis in the summer of 1997.
A wealth of positive news has driven down spreads: higher commodity prices for developing-country exporters, a buoyant world economy pulled along by a recovering America, and less-profligate governments—all against the benign backdrop of low worldwide interest rates. As a result, according to the Institute of International Finance (IIF), net non-bank private-sector lending to emerging markets (mostly in the form of bonds) hit a five-year high last year, of $45 billion. Investors in the rich world have shown a particular taste for emerging-market funds.
Other “crossover” investors (ie, those not used to thinking of emerging bonds as a suitable investment) are jumping in. Investment bankers talk of a “new asset class”—ie, something previously dodgy that is now eminently respectable. They point to a virtuous circle: as the credit quality of more issuers has climbed, so has the pool of potential investors. That is because many mutual funds, pension funds and insurers are forbidden from buying paper that does not carry an investment grade.
Developing countries are understandably keen to take advantage of this enthusiasm, and issued $13.7 billion of bonds last month, according to Thomson Financial. This is the highest monthly figure in six years. Mexico, Turkey (twice), Poland, Brazil, Hungary and Venezuela: all issued more than $1 billion of foreign-currency bonds. More is probably on the way. After all, the Federal Reserve recently gave notice that it may raise short-term interest rates sooner than previously thought.
So the current bond market has been a playground for emerging-market issuers, but what on earth is now in it for investors? With interest rates much more likely to rise than to fall, and spreads near record lows, it seems reasonable to think that investors will be more discriminating. Perhaps Brazil and Turkey, another country whose government has shown admirable restraint of late, justify tight spreads. But why should the bonds of Ukraine, hardly a byword for stability, trade at just three percentage points over Treasuries? Tight spreads for Ecuador, Venezuela and Peru are equally hard to explain.
What could pop the bubble? The IIF mentions some possibilities: backsliding by governments, rising interest rates, a slowdown in the American recovery. Emerging markets are, as a senior American official recently put it, priced for perfection. The upside, in other words, is limited; the downside isn't.
Real time forum log.
Click on the title above to expand this document.
I am going to rest a little here, since I had a 22-hour day yesterday. Will upload market internals and update the major indices overnight.