Last week was a solid week for U.S. equity markets as the Dow, Nasdaq, and S&P 500 rallied 2.3 percent, 3.9 percent, and 3.1 percent respectively. As we stated, Friday’s rally was fairly predictable in light of technical trends and the build up to the employment report. As the employment report came in better than anticipated, equities finished with a flurry on Friday. Recall also that tomorrow marks one year (March 9, 2009) that the U.S. equity markets bottomed out and it felt like the world was at the precipice of collapse. One year later, the Dow, Nasdaq, and S&P 500 have gained 61.4 percent, 83.4 percent, and 68.3 percent respectively, marking a remarkable recovery in equity values and restoring some much need wealth along the way. While the market would be hard pressed to continue at this pace, the short-term trend is to the upside. Futures are indicating a slightly stronger opening today on favorable news surrounding Greece and Dubai. Specifically, it appears that Greece’s budget issues will be contained and Dubai is moving closer to restructuring its debt. As a result, Credit Default Swap spreads have declined across the globe. All in all, it looks like it could be another solid week for equities.
On the economic front, the calendar is relatively light this week. However, solid data could buttress the markets and help propel the rally further. The calendar is as follows:
Monday March 8: No data
Tuesday March 9: NFIB Small Business Optimism, IBD/TIPP Economic Optimism, ABC Consumer Confidence
Wednesday March 10: MBA Mortgage Applications, Bloomberg Global Confidence, Wholesale Inventories. Monthly Budget Statement
Thursday March 11: Trade Balance, Initial Jobless Claims, Continuing Claims
Friday March 12: Advance Retail Sales, University of Michigan Confidence, Business Inventories
On the treasury front, yields move markedly higher on Friday across the curve as the flight to quality trade abated. The higher yield trend is continuing again this morning, with prices off slightly across the curve. A better risk outlook across the globe, given the aforementioned news on Greece and Dubai, could put further pressure on treasury yields in the short term as investors add more risk to portfolios, coupled with $74 billion in new issue treasury auctions this week. Last Wednesday we mentioned that the ten-year treasury yield was nearing the 200 day moving average yield of 3.55%, representing a key resistance level. Recall that we also mentioned the previous three times this occurred over the past four months, yields bounced higher over the following weeks, which is precisely what occurred this time as well.
In the fixed income markets, spreads continue to tighten across sectors as risk appetite continues. Interestingly, despite the significant treasury sell off on Friday, mortgage backed security (mbs) prices ended the day only off a few ticks as the spread versus treasuries tightened considerably. This is in large part due to the abundance of cash on the sidelines, exacerbated by acceleration in prepayment speeds resulting from FNMA and FHLMC’s decision to purchase 120-day delinquent loans. Friday marked the day that the new pay down factors on FNMA and FHLMC pools became available for the prepayment activity in February. Recall also that FHLMC’s implementation was a one time transaction in February while FNMA’s will take place over a few months beginning in March. Not surprisingly, FHLMC prepayment speeds spiked tremendously depending on security type, vintage, coupon, etc resulting in extremely high one month speeds, in some cases pushing 100% CPR, which is precisely what we expected. One can expect this same phenomenon to occur in FNMA pools over the coming months. One cannot also rule out that FNMA and FHLMC might announce other similar programs over coming months in order to assist the administration in modifying more loans, creating additional prepayment risk. Consider selling higher coupon and ARM paper at premiums rather than getting prepayments at par. We’ve had a number of clients successfully implement this strategy over the past few weeks.