Transcript Document

Outlook & Opportunities
Terry Sandven
Christian Heitzman
April 2007
Since 1895. Member SIPC and NYSE.
1
First Quarter Review & Outlook
Overview
•
•
•
•
•
•
•
2
2
Performance
Housing
Economic growth/inflation
Oil
Interest rates
Earnings, valuation & consumer confidence
Employment
Performance
Market and Sector Performance
Total Return
Index
S&P 500
Dow Jones Industrials
NASDAQ Composite *
Russell 2000
MSCI EAFE
MSCI Emerging Markets
Lehman U.S. Aggregate
Lehman U.S. Govt. & Credit - Intermediate
Lehman U.S. Govt. & Credit - Long
Lehman U.S. Short Treasury - Bills
Lehman Municipal Bond
Close
3/30/07
1,420.86
12,354.35
2,421.64
800.71
2,147.51
929.03
1,211.13
1,315.72
1,784.40
85.34
636.33
Q1
2007
0.6%
-0.3%
0.3%
1.9%
4.1%
2.3%
1.5%
1.6%
1.0%
1.2%
0.8%
2006
15.8%
19.0%
9.5%
18.4%
26.9%
32.6%
4.3%
4.1%
2.7%
4.8%
4.8%
2005
4.9%
1.7%
1.4%
4.6%
14.0%
34.5%
2.4%
1.6%
5.3%
3.1%
3.5%
Percent of
S&P 500 Sector
S&P 500
Consumer Discretionary
10.5%
-0.7%
18.6%
-6.4%
Consumer Staples
10.3%
2.2%
14.4%
3.6%
Energy
9.9%
2.1%
24.2%
31.4%
Financials
21.5%
-2.8%
19.2%
6.4%
Health Care
11.8%
1.0%
7.5%
6.5%
Industrials
10.6%
1.1%
13.3%
2.3%
Information Technology
15.1%
-0.9%
8.4%
1.0%
Materials
3.1%
9.0%
18.6%
4.4%
Telecommunication Services
3.6%
7.3%
36.8%
-5.6%
Utilities
3.6%
9.3%
21.0%
16.8%
* NASDAQ Composite performance calculated by percent change; excludes dividends.
Source: Piper Jaffray & Co.
3
3
Housing
Delinquencies
•
4
4
Housing—sub-prime deterioration—remains a
predominant concern.
Housing
New Home Sales & Housing Starts
•
5
5
Both new home sales and housing starts continue to
decline.
Housing
Pending Home Sales of Existing Homes
•
Pending sales of existing homes unexpectedly rose 0.7% in
February after dropping 4.2% in January.
– Considered a leading indicator because it tracks contract signings.
6
6
Economic Growth/Inflation
Gross Domestic Product (GDP)
•
•
7
7
Economic expansion continues.
Final fourth quarter GDP annualized rate was 2.5%; for all
of 2006, the economy grew 3.3% versus 3.2% in 2005.
Economic Growth/Inflation
CPI & PCE
•
•
8
8
CPI & PCE are two inflation indicators favored by the Fed.
Both suggest economic expansion remains intact.
Economic Growth/Inflation
CRB Commodity Index
•
•
9
9
Commodity prices tend to move in opposite direction of
bonds.
Trend line is largely inconclusive.
Economic Growth/Inflation
Institute for Supply Management (ISM)
•
10
10
Both manufacturing and non-manufacturing appear at risk.
Economic Growth/Inflation
Index of Leading Indicators
•
11
11
Biased toward weakness.
Oil
Crude Oil
•
•
12
12
Oil is wildcard.
Any sustained increase puts the economy at risk.
Interest Rates
U.S. Treasury Yield Curve
•
•
13
13
Appears to be moving toward a more normalized rate.
Upward sloping typically implies inflationary pressures.
Interest Rates
China’s Holdings of U.S. Treasuries
•
14
14
If the trade deficit narrows and/or if protectionism
policies become more widespread, it becomes logical to
expect China’s appetite for U.S. Treasuries to decline.
Earnings, Valuation & Confidence
S&P 500 Earnings Projections
•
•
15
15
S&P 500 earnings are projected to grow but at a lower
rate.
Valuations are reasonable.
Earnings, Valuation & Confidence
S&P 500 Valuation Levels
S&P 500 Ind ex (Operating Basis) (SPX)
Pr i ce ( Ri g ht)
FY 1 Pr i ce/E arni ng s Rang e ( Left)
Aver ag e ( Left)
1500
28x
1400
1300
26x
1200
24x
1100
22x
1000
20x
900
18x
800
16x
14x
97
98
Data Source: First Call Estimates
99
Source: FactSet Research Systems Inc.
16
16
00
01
02
03
04
05
06
Earnings, Valuation & Confidence
S&P 500 Valuation Levels
Historical Price-to-Earnings Ratio of S&P 500
and Yield on 10-Year Treasury Bond
50x
18%
45x
16%
40x
14%
35x
12%
30x
10%
25x
P/E
8% 10-Year
Treasury
6% Yield
20x
15x
4%
10x
2%
5x
0x
0%
'50
'55
'60
'65
P/E (As Reported Earnings)
'70
'75
'80
'85
P/E (Operating Earnings)
'90
'95
17
'05
Yield on 10-Year Treasury Bond
Data Sources: Standard and Poor's, FactSet Research Systems Inc. and Piper Jaffray
17
'00
Earnings, Valuation & Confidence
Consumer Confidence Versus Performance
•
•
18
18
Consumer confidence remains favorable.
If consumer confidence weakens, it seems reasonable to
expect equity prices to soon follow.
Employment
U.S. Employment
•
•
19
19
Employment is paramount, arguably the most telling
indicator of future economic conditions.
Stable employment and wage growth imply that
consumers have the financial wherewithal to support
generally high debt levels and continued spending.
Employment
Jobless Claims
•
•
20
20
Jobless claims are a leading indicator.
Should jobless claims accelerate, the prospects of a
recession would seemingly increase.
Conclusion
Summary
•
Pro-growth thesis remains intact.
– Inflation will remain contained.
– Economic expansion will continue, albeit at a slower rate.
– Fed is not likely to move until second half of 2007; should subprime deterioration continue, next move is likely to cut; Fed is
not under any immediate pressure to change its stance.
– Bonds and stocks will likely trend within a relatively narrow
trading range, with an upward bias.
•
21
21
While overall risks have increased, unless deterioration
in employment becomes more evident, we remain
biased toward a pro-growth economy.
Fixed Income Investing
Current Environment
•
•
•
•
•
•
•
22
22
Talk of a Fed ease appears to be over done
Curve should remain near where it is
Opportunities may exist in some option structures
Credit fears seem to remain
Look for widening where it doesn’t belong
Cash flow characteristics are important
Municipal Market could be in for change
Fed Funds Futures
• Fed Funds Futures are currently implying a 25% chance
of a cut at the June meeting. This is down from a high
probability of over 70% in early March. In our view this
may be too high. We look for the Fed to be on hold
though most of 2007.
CURRENT FED FUND FUTURES (4/ 03/ 07)
5.50
50%
25%
5.25
0%
-25%
5.00
Prob 25 bp
decrease
Fed funds
Apr
May
Jun
-2%
-4%
-8% -22% -44%
23
Aug 7
5.245 5.240 5.230 5.195 5.140
Source: Piper Jaffray & Co., Bl;oomberg
23
Jul
-50%
Agency Market
Current State
•
•
•
Multi call and single call options seem to be separating
out a bit
Trading volumes in all classes have been good,
particularly in shorter maturities
Spreads have been actively moving
Outlook and Opportunities
•
•
•
24
24
Adding optionality may be worth the risk depending on
portfolio structure
Bullets out to 5 year sector appear to offer some total
return potential
Be aggressive in managing your portfolio
Agency Market
Value of Calls and Bullets
• Bermuda Calls are beginning to offer some value versus
European calls. We think that this is a development that is
worth the attention of investors.
CURRENT TREASURY & AGENCY YIELD CURVES
6.00
5.50
5.00
4.50
Treasury
Bullet Agcy
European (1x) Callable
Bermudan Callable
4.00
0
2
4
6
Yrs to Mat
Source: Piper Jaffray & Co., Bl;oomberg
25
25
8
10
Agency Market
The Volatility Wild Card
•
•
Volatility has been steadily decreasing since 2003
An increase in volatility would hurt any bond with
embedded options – including callable agencies and
MBS product
MERRILL LYNCH OPTION VOLATILITY ESTIMATE
INDEX
190
MOVE Index
170
150
130
110
90
70
50
2002
2003
2004
Source: Piper Jaffray & Co., Bl;oomberg
26
26
2005
2006
2007
Corporate Market
Current State
•
•
•
Corporate balance sheets in good condition
Limited evidence for a turn in the credit cycle
Relative credit spreads are still tight
Outlook and Opportunities
•
•
•
27
27
We feel staying short is warranted
Watch out for “headline” risk
Look for bonds that are fundamentally sound, but have
widened in sympathy on sub-prime woes
Corporate Market
Corporate Credit Spreads
• Corporate spreads still remain tight relative to where they have
been in the recent past. Relative value among ratings classes may
still be too tight to compensate for the increase in risk. We are
wary about spread performance going forward.
10 YEAR COMPOSITE INDEX SPREADS TO
TREASURIES
10 YEAR AAA, AA, A, & BBB-RATED COMPOSITE
SPREADS TO TREASURIES
175
250
150
200
125
150
100
100
75
50
50
25
Mar03
Sep03
Mar- Sep04
04
Banks
Industrial
Mar05
Sep05
Mar- Sep06
06
Utilities
Composite
Mar07
0
Mar03
Sep03
Mar04
Sep04
AAA
A
Source: Piper Jaffray & Co., Bl;oomberg
Source: Piper Jaffray & co., Bloomberg
28
28
Mar05
Sep05
AA
BBB
Mar06
Sep06
Mar07
Mortgage-Backed Market
Current State
•
•
•
Prime collateral continues to perform well
Sub-prime debacle not over yet, but remains contained
Issuance could slow down – tighter spreads possible
Outlook and Opportunities
•
•
•
29
29
Look for good collateral – continue to avoid sub-prime
Mitigate extension risk with structure
Principal portion of cash flows may be valuable in this
rate environment
Mortgage-Backed Market
Mortgages versus Alternatives
• Mortgages appear to remain attractive versus some of their
closer substitutes. The incremental pick up in yield and repricing principal flows may be attractive to many investors.
YIELD CURVES – TREASURY, AGENCY, SWAP, & PAC
Tsy
Agy
Sw ap
5.5% PAC
5.80
5.60
5.40
5.20
5.00
4.80
4.60
4.40
4.20
4.00
2yr
3yr
Source: Piper Jaffray & Co., Bloomberg
30
30
5yr
7yr
10yr
Municipal Market
Current State
•
•
•
Supply is the primary driver in the market at the moment
We feel tax equivalent yields remain good
Relative credit spreads appear tight
Outlook
•
•
•
31
31
New credit derivatives have the potential to change the market
Look for increased volatility
Secondary market may offer some value
Municipal Market
Municipal Supply – Q1 2007
• Supply in the first quarter was up almost 50% versus the first
quarter of 2006. This has focused underwriters and dealers on
the primary market and offered some selective opportunities in
the secondary market.
BOND BUYER 30 DAY VISIBLE SUPPLY (4/ 03/ 07)
18000
16000
Bond Buyer 30 Day Visible Supply
14000
30d moving avg
12000
10000
8000
6000
4000
2000
Source: Piper Jaffray & Co., Bloomberg.
32
32
3/
1/
20
07
12
/1
9/
20
06
10
/1
0/
20
06
8/
1/
20
06
5/
23
/2
00
6
3/
15
/2
00
6
1/
4/
20
06
0
Disclosures
This material is a product of Piper Jaffray Institutional Sales, Trading and Portfolio
Strategies Groups and should not be construed as impartial research or a research report.
For disclosure information with respect to companies mentioned in the material, please
visit:
http://www.piperjaffray.com/researchdisclosures.
The material regarding the subject companies is based on data obtained from sources
deemed to be reliable; it is not guaranteed as to accuracy and does not purport to be
complete. This report is solely for informational purposes and is not intended to be used as
the primary basis of investment decisions. Because of individual client requirements, it is
not, and it should not be construed as, advice designed to meet the particular investment
needs of any investor. This report is not an offer or the solicitation of an offer to sell or buy
any security. This material is not directed to, or intended for distribution to or use by, any
person or entity if Piper Jaffray is prohibited or restricted by any legislation or regulation in
any jurisdiction from making it available to such person or entity. Additional information is
available upon request.
Since 1895. Member SIPC and NYSE. Securities and products are offered in the United
Kingdom through Piper Jaffray LTD., which is an affiliate of Piper Jaffray & Co.,
incorporated under the laws of England and Wales, authorized and regulated by the
Financial Services Authority, and a member of the London Stock Exchange.
33
33