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THE SOVEREIGN ADVISOR
Prepared by
Sovereign Management Investment Counsel
With the Producer Price Index having fallen for 6 consecutive months, interest rates have declined to the lowest level since December 1996. The bond market has had a difficult time breaking above the 118-00 level which was last seen during the week of February 16, 1996. The market has failed to trade above 117-00 on two occasions which makes the technical picture look weak. This is in line with our bearish long- term outlook for interest rates. At this point it appears unlikely that the bond market will continue higher as commodity prices have resumed their upward course and the economy regains its strength (the unemployment rate has fallen to 4.8% a 28-year low).
The Fed Chairman Greenspan is now in a very difficult spot in regard to future Fed policy. If the economy accelerates too much and inflation reignites he will be forced to raise interest rates which would be a negative for both stocks and bonds. If the economy slows too much we run the risk of recession and deflation which would be positive for bonds but a negative for stocks. The economy needs to stay the course to maintain a favorable environment for equity investors.
Monetary Indicators: Bullish–Chairman Greenspan has officially thrown in the towel on this market as he acknowledged that investors are reacting to a positive economic environment. Since this lessens the near-term possibility of an interest rate increase our monetary indicators have upticked to a bullish mode.
Bond Indicators: Neutral–Market momentum has slowed as resistance has been reached at the 117-00 level on the long bond. We expect the market to temporarily move sideways until the direction of the economy can be determined. We still have a negative long-term outlook on the bond market.
Inflation Indicators: Neutral–Since late June/early July commodity prices have trended higher. The price of crude oil is up +9½%, the Goldman Sachs commodity Index +8½%, and the CRB index +5.7%. These markets were due for a rebound. We must now see if these gains can be extended and if so what effect they will have on the bond market.
Portfolio Strategy
If bonds break below the uptrend line we will be forced to sell our position and increase our cash allocation. The bond market will be hard pressed to break above the 118-00 level and subsequently above the all-time highs of 122-10. In order to do so the economy would have to slow considerably and/or deflation would have to occur. We do not see the economy slowing (indeed we see continued strengthening) or deflation. If we do have deflation we will decrease our equity exposure accordingly.
Model Portfolio: Balanced remains at 70% stocks; 8% bonds; and 22% cash. Equity remains at 78% stocks and 22% cash.
August 4, 1997Donald L. Sazdanoff
Sovereign Asset Management
2628 Trotters Way, Columbus, Ohio
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