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