On spotty-nosed equity analysts and the Fed doing its bit
I had an entertaining exchange this morning with a chum in Switzerland who responded to my flash morning greeting of “Morning all – Chubby Checker back at Number One!” with “U want to explain that for some of our younger viewers? morning!”
Well, for the benefit of those youngsters, Chubby Checker was a mega star in the early 1960s with his hit “Let’s Twist Again”, the Twist being one of the first free forms of dancing in which one writhed around without holding one’s partner. The Fed’s original Operation Twist and Mr Checker’s smash hit pretty much coincided and I just wonder which one took its name from the other. For those with a cultural gap, I’m sure YouTube can help.
Alas, the Fed has done its bit to bring long yields yet lower with the long bond down 40bp over two days and closing below 3% for the first time in what I would term as being the course of normal trading – we had a decrease to 2.55% in the immediate aftermath of the Lehman Brothers collapse. In the three months since June 30 – that is pretty much the course of Q3 – the 30-year Treasury bond has rallied just under 29 points, which happens also to represent just under 29%; in the same time-frame the Dow has dropped 11.61%.
Let the numbers do the talking
Equity people might still suggest that stock valuations are cheap but having underperformed bonds by 40% in a single quarter we can let the numbers do the talking. For those smart enough to have had on the long bond trade – it has knocked gold’s 18% price appreciation over the quarter into a cocked hat (and by more you add the accrued 4-3/8% coupon as well) – the temptation might be to take profit. However, looking at the benchmark of the zero-growth economies, Japan, with its 30-year bond yield at 1.86%, there looks to be quite a bit of room left in the US yield curve and possibly up to another 25 points of price appreciation in the long bond. That is, of course, unless the economy effects a rapid turnround but that looks to be progressively less likely.
The FOMC in its written statement confirms that “…economic growth remains slow…” as opposed to its August phrasing of “…economic growth so far this year has been considerably slower than the Committee had expected…” Perhaps the most concerned words are to be found in: “Moreover, there are significant downside risks to the economic outlook, including strains in global financial markets.”
These are easy words for the likes of myself to use but in the carefully weighted world of FOMC statements it is explosive stuff. So long yields are down in an effort to bring Joe Sixpack to the bank to refinance his mortgage at a lower rate and to free up disposable funds in order to consume, proper monetary stimulus to add to the President’s fiscal stimulus which will never happen.
However, into the middle of all of this we got the downgrading by Moody’s of Citicorp, Wells Fargo but most notably of Bank of America, the latter by two notches from A2 to Baa1. Increasing the demand for mortgages is one thing, but if the cost of funding for the banks is rising as fast or faster than the Fed can bring underlying rates down, then all is for nought.
I heard a lovely story of a friend who is an MD at BofA and of more than 20 years standing. He returned to the US after a long stint in London and bought a home for his family. He applied to BofA for a mortgage but faced untold hurdles in getting an approval. If he struggles to get a loan, what chance does the rest of the population have?
At the same time, the Bank of England’s MPC let it be known that it was considering another round of quantitative easing. The struggle to put some life back into the economy continues although there is still no hard and fast evidence that QE actually works and certainly not when the country is in lock-down mode. However, it is clearly inflationary and so the strategy of accumulating inflation-linked gilts still looks valid.
And for some good news
On a different front, we enjoyed a busy day in Europe credit markets with three large issues coming out of France for Danone, Saint-Gobain and RCI. The deals were sensibly priced and sensibly syndicated – a nice change – but it looks as though the drive by corporate treasurers to release themselves from dependency on banks for short-term liquidity is on again. For that to begin in France is no great surprise given the banking issues; there is a new national sport developing in second-guessing how the big banks are going to be restructured.
I understand that the current bet seems to be that Societe Generale will be broken up and split between BNP Paribas, Credit Agricole and other takers, but I have no firm or repeatable view on the subject. Nevertheless, corporate borrowers should be active in the next couple of months in building up cash and I repeat for the benefit of spotty-nosed equity analysts, this money is not here to be used for acquisitions or to be redistributed to shareholders, it is here to keep your companies flexible and solvent. Bonds are not only for cowards and wimps.