We mentioned a few days ago that it would not be surprising if a bond fund was blowing as the reason behind the sharp rise in bond yields. Yesterday, Bear Stearns revealed that it is accepting bids for $3.8 billion dollars worth of mortgage securities from the Bear Stearns High-Grade Structured Credit Strategies Enhanced Leverage Fund, down 20% so far this year. The fund, which has approximately $600 million in assets, was obviously very highly leveraged and the sell off in mortgage backed securities has taken its toll.
Last month, UBS AG closed down its Dillon Read Capital Management LLC hedge fund unit as well due to large losses in the mortgage bond market.
While these two events may not be directly related to the US Treasury bond market, as we will find out shortly in an article in process, mortgage backed securities have become increasingly complex over the past few years. The creation of securities such as CDO's spread risk over the entire bond market rather than just one sector. In the article I will detail how securities such as CDO's are created and the various risks they entail.
The fact that Bear Stearns is accepting bids rather than attempt to sell these securities in private transactions shows how liquidity has dried up in various sectors of the bond market.
The US Department of Labor released the May PPI report yesterday showing a 0.9% rise in PPI for May 2007 with the core rate rising 0.2%. June CPI was up 0.7% in May as the core rate was up 0.1%.
It is expected that the June PPI and CPI reports will show a drop as gasoline prices are trending lower as the summer driving season has started.
It appears as though the sharp drop we experienced earlier in the week will be known as the summer correction. Technically, we are bouncing along the top of the trend channel which always worries me. I prefer to be somewhere in the middle to bottom remembering the old adage 'buy low, sell high.'
A number of my indicators are still bullish which means we should see further upside. As long as liquidity is increasing at a strong clip and corporations are flush with cash any significant downside is limited. If you have a stock in your portfolio and it is showing weakness pay a little more attention to it.
The end of quarter earnings games have started. What happens in the end of quarter game is Wall Street will lower earnings estimates so that companies can more easily beat the bar rather than announce that they will miss estimates. Last quarter earnings growth slowed to 6% from double digit rates the previous quarter but you can see that a number of companies who had their earnings estimate trimmed significantly in the final weeks of the quarter beat or matched estimates in the quarter. If you have access to Bloomberg where you can see the change in earnings estimates you can see this in action. The purpose of this exercise is to keep the bad news to a minimum so as not to affect the confidence level of the US citizens.
Source: Bloomberg, US Department of Labor PPI and CPI reports
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