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Bond Market Commentary by Mike Petersen

It’s the most wonderful time of the year
By Zach Berg
November 16, 2009

It’s nearly that time of year again. With approximately 38 shopping days remaining to Christmas and less than two weeks away from Black Friday, the madness of the holiday shopping season is right around the corner. Starting this week and continuing in to the upcoming weeks, the Bond Market Commentary will be focusing in on various sectors of the corporate bond market. This week we will shine the light on the retail sector. However, before we jump into that, let’s take a look back at the past week in the markets. The Veteran’s Day holiday observance on Wednesday had bond markets closed, which lead to a disjoined week of trading across all markets. Equity markets rallied significantly on Monday, but that momentum stagnated during the rest of the week. The S&P 500 increased 2.2%, while the Dow Industrial moved up nearly 250 points on low volume from the holiday-interrupted week. The dominant story in the bond world was centered on the relatively successful auctions of $81 billion in 3s, 10s, and 30-year Treasury debt. The results of the auctions demonstrated the still prevalent risk aversion in the markets and highlighted the strong foreign demand for U.S. debt in the 3-year and 10-year auctions. In the corporate bond market, “new issuance” was the soup du jour. With earnings season in the rear-view mirror, corporations issued over $27 billion of new debt according to Informa Global Markets data. This past week’s new issuance now brings the year-to-date total of new corporate debt to nearly $1.2 trillion. Of that figure, nearly 80% has been issued in investment grade names.

Corporate Sector Spotlight – Retailers

When examining the corporate markets during the past two years, few sectors have experienced a bumpier road than retailers. It is a sector whose fortune is directly tied to that of the overall economy and because of that, has endured significant volatility. While the worst of the crisis certainly seems to have passed, the challenges facing the U.S. household are the single greatest issue facing retailers. One need look no further than the most recent FOMC statement for confirmation: “Household spending appears to be expanding but remains constrained by ongoing job losses, sluggish income growth, lower housing wealth, and tight credit.” Given the dramatic fall off of household spending due to the broader economy, the retail group has fragmented. Moody’s recently released its U.S. Retail Outlook – an annual report providing Moody’s position on the credit issues surrounding a particular industry. This outlook provides some insight on Moody’s opinion with regards to the stability of various segments of the retail sector. The table below highlights the breakdown among the segments.

As one moves down the relative stability column, it becomes apparent that this is a reflection of the discretionary spending habits among the consumer, with more discretionary purchases being at the lowest level. Lastly, the graph below shows the yields on BBB, 5-year corporate debt from sectors including: Banking (Red), Finance (White), Retail (Green), Utilities (Orange), and Industrials (Yellow). The graph exhibits the market’s perception by the yields at which retail paper is trading. While above utilities and industrials, retailers remain well below banking and financial names. (Higher yields indicate a market perception of greater risk.)

With an understanding of the retail landscape, we can now turn our attention to the trading activity we have seen in the sector. During the previous year, corporate spreads across the curve have tightened as credit conditions have improved. The retail sector is no exception to this trend. The chart below, using Bloomberg data, illustrates the move in 5-year nominal retail spreads during the past 13 years among double-A (white line), single-A (orange line) and triple-B (yellow line). Focusing on the previous year, one can see the tightening among triple-B retailers of over 350 basis points. Like-wise, single A and double A has tightened approximately 300 and 200 basis points during that period. While double-A retail spreads have now tightened in line with their longer-term average, A and especially triple-B spreads still remain above their averages. These still wide spreads provide the opportunity for further tightening in line with longer term averages as profitability increases among firms in the retail sector.

On the subject of profitability, the past few weeks have provided an excellent opportunity to see how various companies in the retail sector have performed and, perhaps more importantly, have provided some guidance on the direction of the sector. When searching for the pulse of the retail market, the search always begins at the top with Wal-Mart. Given Wal-Mart’s focus on price-cutting and savings for customers, few retailers have had better success during the past year. While Wal-Mart showed rising profits, it did temper expectations when it forecasted 4^th quarter sales for U.S. stores open at least one year to be unchanged. In addition, Wal-Mart Treasurer Charles Holley confirmed the notion of a more frugal consumer mentality when he stated: “The shopper has reset how he is spending money and that has affected retail in general.” Many firms have echoed this docile view on the spending habits of their customers, while also attributing profitability to improvement in inventory management. For example, Nordstrom’s and Kohl’s both reported increased profits this past week, but mentioned the rebound was in part due to inventory control. Going forward, it is likely to see retailers post stronger than expected increases in year-over-year sales. However, keep in mind that last year’s plummet in sales provides a low hurdle for companies to surpass.

As we move forward and peer into the crystal ball, the outlook for retailers will likely be lockstep with that of the consumer. While retailers providing consumer staples, such as drugstores and discount retailers, continue to reap the benefits of decreased consumer spending habits, specialty retailers will likely continue to struggle. On the positive side, many of these retailers have been able to trim excess inventory and position themselves for improved profitability heading into next year. However, with unemployment at 10.2%, the 800-pound gorilla will likely keep many consumers in a frugal mindset. In addition, the trend of consumer balance sheet rebalancing will likely continue, as witnessed in the total consumer credit number, which has decreased eight months in a row. The evidence in the shift comes straight from the consumer as the latest Deloitte survey stated: “25% of consumers polled said they have permanently altered their shopping patterns in view of the asset and credit collapse this cycle.” As we move into the crucial holiday shopping season with tempered expectations, the “wonderful” component of this time of year will likely be modest improvements for many retailers.

Chart of the Week: US Credit Card Rates vs Retail Sales

This week’s chart of the week ties in the tightening credit environment facing the consumer along with retail sales. The white line on the chart below, graphed against the right axis, shows the standard variable rate on U.S. credit cards, courtesy of Bankrate.com. While bottoming in September of last year, banks have been on a rate hike of great proportions, raising the rate nearly 50% in 14 months. Meanwhile, retails sales – the green line, graphed against the left axis – have fallen 26.5% since the onset of the recession. As the chart shows, the challenges facing many discretionary-type retailers will likely continue as the U.S. consumer faces increasing cost of credit. With consumers already feeling the pinch from fallen home values and rising unemployment, the ability to simply leverage up and put the new Christmas gift on the credit card is a very unlikely option this holiday season.

The author of this material is a Trader in the Fixed Income Department of Raymond James & Associates (RJA), and is not an Analyst. Any opinions expressed may differ from opinions expressed by other departments of RJA, including our Equity Research Department, and are subject to change without notice. The data and information contained herein was obtained from sources considered to be reliable, but RJA does not guarantee its accuracy and/or completeness. Neither the information nor any opinions expressed constitute a solicitation for the purchase or sale of any security referred to herein. This material may include analysis of sectors, securities and/or derivatives that RJA may have positions, long or short, held proprietarily. RJA or its affiliates may execute transactions which may not be consistent with the report’s conclusions. RJA may also have performed investment banking services for the issuers of such securities. Investors should discuss the risks inherent in bonds with their Raymond James Financial Advisor. Risks include, but are not limited to, changes in interest rates, liquidity, credit quality, volatility, and duration. Past performance is no assurance of future results.

Extended Period
By Mike Petersen
November 9, 2009

Last week, the Federal Reserve indicated that the target rate will remain near zero for an “extended period.” The Fed’s comments touched on “low rates of resource utilization, subdued inflation trends, and stable inflation expectations” as points which played into the decision to keep rates at low levels. The unemployment rate touched a 26-year high, reaching 10.2%. More telling of the challenges that lie ahead for the labor market is the broader measure of unemployment known as the U-6 from the Bureau of Labor Statistics. Reaching a record 17.5%, this includes total unemployed plus all marginally attached workers, plus total employed part-time for economic reasons as a percent of the civilian labor force. This means that almost one out of five individuals is either under or unemployed. Many feel that until we see a down tick in the lagging indicator which is unemployment, the Fed will remain subdued in its rhetoric and rate actions.

Record levels of Treasury supply greet us this week with the issuance of 3, 10, and 30 year notes. The government will sell $40 billion of 3-year notes on Nov. 9, $25 billion of 10-year notes on Nov. 10, and $16 billion of 30-year bonds on Nov. 12. The spread between 2-year and 10-year notes reached its widest point since July, measuring at 2.66%. A steep yield curve is typically indicative of an economy that is on the upswing. Investors in this case require higher rates on longer maturities under the assumption that the Fed will begin to raise rates to temper inflation or moderate growth. Treasuries have seen increased volatility recently as there appears a growing tug-of-war between the Bulls and Bears.

Spreads in the credit markets did very little this week as we are on the downhill side of earnings season. Issuance has been brisk, which has helped meet demand, but participants hoped that the Fed statement would push fence sitters into the markets. We are in an attractive environment to raise capital for most companies, so we should continue to see solid flows of new paper. Merger and acquisitions have lead much of the activity recently - another positive sign that we seem to be in the early stages of economic recovery. The overall feel of the credit markets is that many investors are either content holding onto position that have performed well this year or they are actively protecting gains as we approach year end. Spreads have moved tremendously off the lows in March and, with many feeling the post stimulus economy may experience a new set of challenges, spreads may be in for some softening.

Flows have slowed a bit versus the last few weeks. Much of the activity is still found in the front end, but there continues to be value in stepping out slightly on the curve. With two major holidays coming in the next two months, we could be in for a quiet finish to the year. The last opportunity for any significant pick up could come from portfolios which are sitting on cash and may be pushed to put it to work prior to year end. Other than that, there is very little ahead to drive a significant pick up in flows.

This week we have a light calendar on the economic front. Tuesday we’ll learn Consumer Confidence numbers. Thursday, initial and continuing jobless claims will be reported. Then closing the week on Friday will be Import Price Index and University of Michigan Confidence numbers. The real story of the week will be the Treasury supply and how much in new credit issuance will enter the markets.

Chart of the Week
Historical spread between 2-year and 10-year Treasuries. In a basic sense, a steepening yield curve (greater spread) means the economy is on the upswing. Conversely, a flattening yield curve (smaller spread) is indicative of a slowing economy. As you can see in this chart since the beginning of 2009 we have seen a gradual steepening of the curve.

The author of this material is a Trader in the Fixed Income Department of Raymond James & Associates (RJA), and is not an Analyst. Any opinions expressed may differ from opinions expressed by other departments of RJA, including our Equity Research Department, and are subject to change without notice. The data and information contained herein was obtained from sources considered to be reliable, but RJA does not guarantee its accuracy and/or completeness. Neither the information nor any opinions expressed constitute a solicitation for the purchase or sale of any security referred to herein. This material may include analysis of sectors, securities and/or derivatives that RJA may have positions, long or short, held proprietarily. RJA or its affiliates may execute transactions which may not be consistent with the report’s conclusions. RJA may also have performed investment banking services for the issuers of such securities. Investors should discuss the risks inherent in bonds with their Raymond James Financial Advisor. Risks include, but are not limited to, changes in interest rates, liquidity, credit quality, volatility, and duration. Past performance is no assurance of future results.

Bond Market Commentary
By Brian Cebuhar
November 2, 2009

From the Corporate Bond Desk, a quick look back at last week's markets shows a fair bit of volatility. The trading of U.S. Treasuries experienced a wild week with the yield on the 30 year Treasury trading at a high of approximately 4.375% and a low of 4.22%. In terms of principal, that is nearly a 2.75 point swing in value from high to low, with Treasuries finishing the week stronger than the open, i.e. higher in price and lower in yield. The Dow Jones followed suit to a degree with a nearly 250 point sell off on Friday to put the DJII down 155 points on the week. For the most part, corporate bond spreads, the risk premium at which corporate bonds trade over yields on comparable Treasury securities, were seemingly unchanged but with noticeably less volume. Issuance in the investment grade markets was relatively light, with Continental Airlines, Eastman Chemical, and GMAC (FDIC insured TLGP offer) being the three most notable issues that came to market last week.

Monday (11/02/09) is an important day for economic reports, as ISM Manufacturing, Pending Home Sales (MoM), ISM Prices Paid, Construction Spending (MoM), and Pending Home Sales all will be released at 10am EST. Manufacturing and Construction Spending will be two numbers that the market will want to see in terms of how recovery is progressing. Positive news continues to embrace our markets through another earnings season, as banks and insurance companies as a whole show profits and free operating cash flow. Much of this news and better earnings is somewhat expected due to the various regulatory changes and liquidity programs set up by the government. A real fear seen in the market is whether or not these results are sustainable in the next 6 - 18 months, especially if the government liquidity programs fall off in 2010. Nothing emphasizes this fear more than CIT Group's pending bankruptcy officially announced this weekend. CIT's inability to secure government liquidity program standing is widely considered a large catalyst into the chapter 11 filing, which is expected to be the fifth largest by assets in U.S history. In contrast, GMAC through the government liquidity program brought another $2.9 billion in 3-year FDIC-insured notes last week at an interest rate of only 1.75%, the proceeds of which are needed to bolster the company’s balance sheet. Clearly the ability to not only tap credit markets, but at such favorable interest rates is in large part keeping comparable consumer credit companies from the same fate as CIT. One take on the market is that most participants realize this fact and are treading very carefully, which is creating some degree of stagnation in secondary markets. Further evidence of these fears can be illustrated by the news reports of major banks keeping large amounts of cash on their balance sheets at this time. Citigroup, in particular, has $244 billion in cash currently and JP Morgan is reported to have more than $450 billion in liquidity (cash and liquid bonds that can be borrowed against on a short-term basis), according to Bloomberg. Relating to these topics, Greg Dodson from our Mortgage-Backed Securities desk points out that banks indeed are currently underwriting mortgages, but they are doing so under the guidelines of the Government-Sponsored Enterprises (GSE) of Freddie Mac, Fannie Mae, and Ginnie Mae. Non-GSE securitized debt is much less of this market. Banks and lending institutions are taking a much more conservative approach to the lending process, which should not surprise anyone, given the environment in which most of them are operating.

In the week ahead, the new issue calendar continues to look light in the investment grade markets. The Economic Data calendar is fairly busy throughout the week with Consumer Confidence, FOMC Rate Decision, Labor/Employment Data reports to be released. Treasuries are opening up softer this morning indicating that we may see some continued volatility in these markets again this week. Investment grade corporate bonds appear to be opening up mostly unchanged this morning, which may indicate another week much like last week ahead of us in the credit markets.

As of 11/02/09. The author of this material is a Trader in the Fixed Income Department of Raymond James & Associates (RJA), and is not an Analyst. Any opinions expressed may differ from opinions expressed by other departments of RJA, including our Equity Research Department, and are subject to change without notice. The data and information contained herein was obtained from sources considered to be reliable, but RJA does not guarantee its accuracy and/or completeness. Neither the information nor any opinions expressed constitute a solicitation for the purchase or sale of any security referred to herein. This material may include analysis of sectors, securities and/or derivatives that RJA may have positions, long or short, held proprietarily. RJA or its affiliates may execute transactions which may not be consistent with the report’s conclusions. RJA may also have performed investment banking services for the issuers of such securities. Investors should discuss the risks inherent in bonds with their Raymond James Financial Advisor. Risks include, but are not limited to, changes in interest rates, liquidity, credit quality, volatility, and duration. Past performance is no assurance of future results.