Amid the flow of bearish economic news, the fixed-income markets deteriorated last week. In effect, a major re-evaluation of the bond markets occurred. With the economy much stronger than anticipated, with a sizable demand for credit and with inflation at a high level, market observeers apparently decided the economic diseases that had built up over the past 10 to 15 years can not be cured overnight.
The lower bond prices pushed all sectors of the fixed-income markets to their highest levels in 1978 and, in the case of Treasuries, to their highest levels ever.
The steep losses sustained were the result of unsold bond syndicates breaking up and their bonds being sold at much lower prices. In the corporate area, the Ford Motor credit issues are good examples fo drastic price cuts, while in the municipals area, the price cutting of the triple-A State of Califonias ran anywhere from 15 to 20 one-hundredths in the short maturities and 25 one-hundredths in the longer bonds.
In the looking at the yield curves of the graph of the two triple-A issues that came to market 7 months apart, several interesting facts can be noted.
First, the level of the two curves has changed. We see that the recent California issue is 125 basis points (a basis point is one one-hundreth of a percentage point, of 0.01 percent) igher thatn the Wisconsin in one year, 35 basis points higher in 15 years and 50 basis points higher in 25 years.
Although the levels on these Californias are the highest for such a credit in 1978, they are still away from the 1974 highs when one-year triple-As came at a 5.90 and 25 years hit 6.50 percent. However, with the sizable price reductions on the Californias this week (the one-year brok to a 5.45 while the 25 year bork to a 6.00 percent level), historic highs are close at hand.
Next, the graph shows that the yield curve has flattened. The investor could have sold the one-year Wisconsin and bought the 25-year maturity and picked up 170 basis points of yield. But if the same extension were made on the California, only 95 additional basis points could be obtained. What this means is that there is no big reward for extending and, that on a relative basis, the shorter bonds are cheaper that the longer maturities. Further, in the first seven maturities on the California issue, the return is the same. There is no reward at all for extending, and your very short bonds (one, two or three years) are cheaper than the other maturities even though they offer the same return. The flatness of the curve here is due to bank buying because they purchase almost exclusively out to 10 years.
The only case that can be made for the individual investors buying the longer maturities now is when the longer returns get close to the historic high levels. Then you know you purchased good value regardless of where the market goes.
The only spillover from the Cleveland situation was last week's sale of $105 million of Columbus, Ohio, notes. Because of the Ohio name, marketability was a problem. However, the 6.50 percent return on these top-rated notes of a double-A-rated city represented good value to any purchaser.
As we approach 1979, the municipal market should stabilize, but do not be surprised if we go through the 1974-1975 highs in January of February. A prudent investor should begin gradually adding top quality general obligation names about the levels of the recent California break.
The housing calendar is building so patience should be exercised here. Other revenues should be purchased as the returns get close ot the previous highs. The highest level for the Bond Buyer Index is 7.67 percent.