It is never straightforward predicting outcomes, but today’s investors face even more challenges as the war against terrorism continues.
Capital markets seem to be entering new realms and for most investors, even quite seasoned ones, it is pretty much unchartered territory. The US yield curve was the steepest it had been for almost 10 years (pre-October 31, see below); we are witnessing the first global recession in 20 years; official rates, in the US back down to where they last got over 40 years ago; and the lowest National Association of Purchasing Managers’ Prices-paid index in 52 years.
Investors are nervous enough, and so the US Treasury’s (very) surprise announcement that issuance of the 30-year Treasury was to be discontinued caused a severe reaction in the market. In fact the Long bond had its biggest ever price move in one day – bigger than the leap on the Black Monday in October 1987. The move was exaggerated by a great short covering scramble, as many curve steepening trades were unwound.
The announcement has not been greeted with much pleasure by market participants who dislike being caught wrong-footed and who felt that the Treasury ought to have given at least a hint in order not to rattle already severely-battered confidence.
Martina Kocksch, fixed income fund manager at Commerz Asset Managers, argues that it has served to make investors even more wary. She goes on: “It has added to the sense of uncertainty hanging in the air with the anthrax scares making everyone so nervous. The economic fundamentals are already poor, and the market really does not need shocks like this one from the US Treasury.
“We are expecting more bad news on the economic front, although there is a lot priced in to the market right now. There will be a recovery and the US economy should get a substantial boost from both fiscal and monetary policies. Our base scenario is for a recovery no sooner that the second quarter of next year.”
There is little doubt that recovery will follow the certain recession, but many investors believe that downside risks still outweigh the chances of positive surprises for the economy. For Hans Peters, at Fortis Investment Management, his own expectations match those priced into current yields, but he is wary of sounding too optimistic. “We are quite worried about the rebound as the pace of negative data seems to be accelerating and we suspect there will be more to come.
“Our baseline scenario however is still for a V-shape pattern of recovery. As for the European economies, they follow the US, and have much further to fall. That recent IFO survey was a lot weaker than expected, and there will be more potential for rates to fall on this side of the Atlantic - another 50 basis points from the European Central Bank before year-end.”
With considerable worries about the depth and length of recession across the developed world, it comes as little surprise that credit markets have not been bouncing quite as high as the sovereign markets. Christophe Tamet is in charge of credit at Fortis Investment Management and suggest that he and his team are not alone in being very risk averse right now. “Although spreads are as wide as they have been for a decade, we are still cautious. The top quality credits have done well as the equity markets have recovered, but I am not surprised that the rest have not responded. The risk/reward profile of a fixed income corporate bond offering only a 10 to 50 basis point pick up with the possibility that you could still lose all your money holds zero appeal compared to an equity investment.
“Even though the stock market has bounced, it is still not easy for companies to issue stocks and deleverage. And with spreads so wide it is expensive for companies to be issuing debt, but they do need the money. It is also difficult for investors to switch out of old issues and into new ones, as there are so few buyers for the old issue.”
Kocksch believes that the market is more invested in credit than it should be and that selling pressures could increase as the year-end approaches and players close their books. “We are actually getting more and more cautious about credit. We are still comfortable with our AAA paper, Pfandbriefe and such like. I don’t believe that the market as a whole is particularly long in Sovereign paper, but I am sure there are many investors out there who do not want to go into the year end with quite as much credit paper as they currently have on their books,” she warns.
Tamet argues that this period of heightened risk aversion could last another three to four months, but that eventually valuations and spreads will prove too compelling to ignore. “At the moment we are slightly underweight credit as a whole, but we may go to market weight when we feel that the economic sentiment has developed a better tone. We do not expect a sharp tightening move but we think it is wise to be getting ready to expect something.”

Topics