Archive for February, 2008

Pimco March Investment Outlook

Kurt Brouwer February 27th, 2008

Bill Gross and bond fund giant Pimco have just released the March Investment Outlook and it is actually somewhat optimistic. Based on this commentary and other indicators, I think the folks at Pimco are seeing buying opportunities these days [emphasis added]:

Investment Outlook — No Country For Old Maids (PIMCO, March 2008, Bill Gross)

“…The investor’s task, however, is not to pillory or even desert the game, but to accomplish three primary tasks: 1) continue to ask “Who’s got the Old Maid?”, 2) understand and forecast the game’s economic and policy consequences, and 3) formulate a portfolio (to paraphrase Will Rogers), that maximizes the return on capital as well as the return of capital.

To elaborate on #2, it seems obvious that players are getting tired of playing games and that a prolonged period of risk aversion and deleveraging of our global shadow banking system lies ahead. Tighter lending standards, reduced risk budgets, and increased regulatory scrutiny all promise to produce a reduction in the growth rate of lending…

…Slow credit growth is a harbinger, however, for slow economic growth (if any) and that in turn leads to the necessity for low short-term interest rates for an extended period of time. I think Ben Bernanke knows that restarting the U.S. growth engine almost by definition requires nominal GDP growth of 5%. He’d prefer that nominal rate be composed of 3% real and 2% inflation, but desperate times sometimes require compromise: 2% real and 3% inflation may be the best he can hope for in 2009 as soaring commodity prices and a declining dollar add to the equation’s complexity. If so, a bond investor should expect a prolonged, several year period of low short-term rates (Fed Funds averaging 2½%) with vulnerability on the intermediate and long-term portions of the U.S. curve due to inflationary fears and the diminishing support of foreign central banks and SWFs. If, as a bond investor, I expected 3% inflation (2% in 2008 - higher in the out years), a 3% 5-year Treasury would not seem very appealing. Nor, I should add, would a 3.80% 10-year or a 4.65% 30-year bond.

I think you can read this to mean that Gross does expect 3% inflation this year and he is investing accordingly (see below).

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Wall Street Breathes A Sigh Of Relief

Kurt Brouwer February 25th, 2008

We had a solid rally today primarily due to good news on the monoline insurance companies — Ambac & MBIA. These companies began insuring municipal bonds and always did well in that field. They shifted to ensuring other more dicey offerings tied to subprime loans and ran into difficulties. Despite the problems, Standard & Poor’s re-affirmed Ambac’s rating as an insuror and that was all the good news Wall Street needed [emphasis added below]:

Stocks Rise As Ambac Rating Affirmed (Associated Press, February 25, 2020, Joe Bel Bruno)

“Wall Street bolted higher Monday after Standard & Poor’s affirmed its ratings for Ambac Financial Group Inc. and MBIA Inc., raising hopes that troubled bond insurers will emerge from the credit market crisis on solid footing. The Dow Jones industrials rallied nearly 190 points.

The news came as a relief to a market that has fallen sharply in recent months on any negative news about the insurers; investors feared that a downgrade of the insurers’ credit ratings would lead to billions of dollars in write-downs of securities held by already troubled banks and investment firms. Rating agencies including S&P have been under pressure to downgrade the insurers after they weakened their financial positions by insuring subprime mortgage securities that later collapsed.

There has been speculation that Ambac might find sufficient capital early this week to hold onto the stellar “AAA” rating it needs to remain in the municipal bond business. Municipalities and companies use these insurers to back bonds, allowing them to get higher ratings and cheaper financing.

“This is essentially evidence that S&P has signed off any tentative deal,” said Charlie Smith, chief investment officer at Fort Pitt Capital Group, of the rating agency’s announcement.

…The Dow rose 189.20, or 1.53 percent, to 12,570.22.

Broader stock indexes also closed with a solid advance. The Standard & Poor’s 500 index rose 18.69, or 1.38 percent, to 1,371.80; and the Nasdaq composite index added 24.13, or 1.05 percent, to 2,327.48…”

This is a relief rally so it remains to be seen how far it goes. Nonetheless, the rating affirmation on Ambac is good news.

Dodge & Cox Hedges Foreign Currency Risk

Kurt Brouwer February 22nd, 2008

(Images Source: Wikipedia)

This short piece from Morningstar [emphasis added] makes an interesting point. In fact, I think this is a pretty smart move on the part of Dodge & Cox. The venerable San Francisco money manager is hedging its international fund’s currency risk. The dollar has been declining against the Euro and the British pound for several years and now the management team apparently thinks those currencies have appreciated too much:

Fund Times: Dodge & Cox’s Latest Moves (Morningstar, February 22, 2020, Andrew Gunter)

“Dodge & Cox thinks the euro and pound may be significantly overvalued versus the United States dollar. That was the gist of a page’s worth of management discussion in Dodge & Cox International Stock’s (DODFX) 2007 end-of-year annual report. As a result, it has decided to hedge assets denominated in those currencies. Dodge & Cox came to this decision by closely evaluated the long-term fundamentals of the aforementioned currencies. Their multiyear rise against the U.S. dollar benefited absolute returns in recent years, but it also means the fund now carries more currency risk than in the past. Dodge & Cox isn’t a shop to make this sort of move without being very confident in its outlook for these currencies and a belief that they are significantly overheated…”

For more on how the dollar fluctuates against other currencies (see The Unloved Dollar and How Far Has the Dollar Fallen? And Why?).

Update: By prospectus, Dodge & Cox International can only hedge up to 25% of the portfolio. So, this announcement from Morningstar may overstate how much they are betting against the dollar.

Stock Market Turns Around

Kurt Brouwer February 22nd, 2008

U.S. Stocks Gain, Erasing Decline, on Report Of Ambac Bailout (Bloomberg, February 22, 2020, Michael Patterson)

“U.S. stocks rose, erasing earlier declines, on speculation Ambac Financial Group Inc. may be bailed out next week.

Ambac, the second-largest bond guarantor, led a rebound in financial stocks after CNBC said bankers working on the deal have made “significant” progress in shoring up the company’s finances. The Dow Jones Industrial Average fell as much as 129 points earlier on concern that profits at brokerage firms will decline and dropping demand for mortgages will curb growth at Fannie Mae and Freddie Mac.

“If Ambac gets bailed out it would imply that the market’s not going to zero and the world’s not coming to an end,” said Andy Brooks, head equity trader at T. Rowe Price in Baltimore, which has more than $300 billion in assets.

The Standard & Poor’s 500 Index climbed 10.26 points, or 0.8 percent, to 1,352.79 at 3:58 p.m. in New York, erasing a weekly decline. The Dow Jones Industrial Average added 93.95, or 0.8 percent, to 12,378.25. The Nasdaq Composite Index increased 1.74, or 0.1 percent, to 2,301.52 About two stocks gained for every one that fell on the New York Stock Exchange. Shares in Asia and Europe fell.

Ambac climbed $1.62, or 18 percent, to $10.85 after CNBC on-air editor Charles Gasparino said the bailout may be announced on Monday or Tuesday, citing bankers working on the deal. Gasparino also said “the entire deal could fall apart.”…

Not exactly my idea of a high quality rally, but it was quite a comeback there at the close.

There were two timeless quotes in the article. For example, the stirring cry of the T. Rowe Price guy, “…it would imply the market’s not going to zero…” I also like Gasparino’s comment at the end, “…the entire deal could fall apart.”

No doubt. Although I would guess that this kind of a rally suggests that the deal is pretty solid. We’ll see.

Recession Unlikely, Housing Sector Correction Nearly Over

Kurt Brouwer February 21st, 2008

This report is essentially an interview with Gail D. Fosler, the chief economist for The Conference Board. This is the organization that brings us surveys such as The Consumer Confidence Index and the Index of Leading Economic Indicators. Had I seen it earlier, it would have been a solid addition to the Good News On The Economy post. Oh well.

This piece makes two important points — that a recession is still unlikely and that the slump in housing is nearly over [emphasis added]:

Recession Unlikely, Housing Sector Correction Nearly Over (The Conference Board Straight Talk Newsletter, February 20, 2020)

“Despite continuing turmoil in the housing and financial markets, a U.S. recession is not imminent, The Conference Board reports today.

“While the correction in the financial sector is just beginning, the correction in the housing sector is nearly over,” declares Gail D. Fosler, President and Chief Economist of The Conference Board. Her analysis appears in StraightTalk, a newsletter designed exclusively for members of The Conference Board’s global business network.

While the U.S. economy has weakened, business activity and corporate profits continue to rise. Consumer spending is continuing at a rate of 2 to 2.5 percent a year, and with the exception of the auto industry, the economy is showing gains virtually across the board.

“Exports are booming and imports and import penetration are down,” says Fosler. “While there is continuing uncertainty about the economic outlook, economic shocks from the contracting financial sector are not enough to tip the U.S. economy into recession.”

It is certainly true that exports are one of the bright spots in our economy. The point about consumer spending is also true. Both of these factors are positive, which puts them at odds with the picture that the entire economy is falling apart and a recession is imminent.

…Housing Market Correction About Over

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