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GLOBAL Relative Front Cover with Summaries FIXED INCOME RESEARCH FEBRUARY 4, 2002 GLOBAL Relative Plenty of Risks, but Staying the Value Portfolio Course with Arrival of February RELATIVE VALUE RELATIVE VALUE Global ...................... 10 No allocation adjustments recommended with the arrival of February. The U.S. recession Asia .......................... 35 that we did not know that we were in may have ended before we thought. We mark the end Technical ................. 44 of the major central bank easing cycle, contemplate current capital market risks, ponder the continued outperformance of U.S. financial assets, provide our views on coping with ECONOMICS heightened geopolitical risks, sketch the January performance of our major indices, and Global ...................... 45 suggest a Rams victory in the Super Bowl. U.S. .......................... 47 ECONOMICS POLITICAL We believe that China will probably succeed in completing the transition to a market ANALYSIS economy, albeit not without some temporary setbacks. U.S. macroeconomic data are U.S. .......................... 56 improving steadily. There is a strong case for the Fed remaining on hold for a long time. CURRENCIES 58 POLITICAL ANALYSIS The presence of several international policy leaders at the World Economic Forum INTEREST RATE underscores the difficulty in and the necessity of formulating international commerce rules. STRATEGY U.S. .......................... 61 CURRENCIES Europe ..................... 74 Investors may be tempted to look for FX carry opportunities. We recommend looking CREDIT beyond the past few years’ mainstays. Rather, the best value probably lies in a diversified STRATEGY basket of out-of-favor currencies. U.S. .......................... 81 Europe ..................... 89 INTEREST RATE STRATEGY Sovereign ................. 95 Interest rate carry trades, particularly in the 2- to 5-year sector, continue to look good. Even though we don’t see volatility reaching its historical lows, it will decline further from SECURITIZED current elevated levels. Spreads still have another 10 bp to decline in the belly of the curve. STRATEGY We favor agencies over LIBOR. MBS ......................... 99 ABS ........................ 109 CREDIT STRATEGY CMBS.................... 114 A compilation of the safest, liquid US$ names is highlighted for those seeking shelter. In addition, we compare spread volatilities in dollars and euros and offer selected trade ideas in the European telecom sector. We also discuss recent developments influencing the basis between cash and default spreads in Europe.We lower our weighting in Mexico and Bulgaria to underweight and increase our overweights in Brazil, Ecuador, and Russia. SECURITIZED STRATEGY We recommend retaining a core overweight to mortgages. In non-agencies, credit performance shows signs of weakness, but California loans continue to outperform those from other states. In ABS, we summarize the S&P ratings action on EAST and analyze the value in Providian subordinates. In CMBS, we develop a framework to project long-term delinquencies and losses. CONTRIBUTORS TO THIS EDITION RELATIVE VALUE Europe Global Tarek Nassar ................................ 44-207-260-1483 Jack Malvey .................................... 201-524-4729 Fred Goodwin ............................... 44-207-260-1219 Lars Pedersen ................................ 201-524-4539 Ciaran O’Hagan ............................ 44-207-260-1262 Olivera Radakovic .......................... 201-524-2910 Joseph Di Censo ............................ 201-793-4135 CREDIT STRATEGY Asia Global Susumu Kato ............................... 81-3-5571-7201 Mark Howard ...................... [email protected] Technical Ivan Gruhl ................................. [email protected] Roman Dutkewych ......................... 201-793-6395 Joanie Genirs .......................... [email protected] Michael Klyarfeld .............. [email protected] Debbie Goldfarb .................. [email protected] Arthur Tetyevsky ................. [email protected] ECONOMICS Europe Global David Munves ................................ 44-207-260-2787 John Llewellyn ........................... 44-207-260-2272 Estefania Meana ............................ 44-207-260-2495 Paul Sheard ................................. 81-3-5571-7180 Robert McAdie ............................... 44-207-260-3036 U.S. Reto Bachmann ............................. 44-207-260-2766 Ethan Harris ................................... 201-524-2291 Puneet Sharma .............................. 44-207-260-3036 Stephen Slifer ....................... [email protected] Sovereign Marco Santamaria ............................. 212-521-1986 POLITICAL ANALYSIS U.S. SECURITIZED STRATEGY Kim Wallace .................................... 202-452-4785 Andy Sparks ....................................... 201-524-2914 Mark L. Melcher .............................. 202-452-4700 Neil Barve .......................................... 201-524-4000 Nancy Bradish Myers ..................... 202.452.4737 Steve Bergantino ............................... 212-773-0890 Arthur Chu ......................................... 201-524-4539 CURRENCIES Marianna Fassinotti ............ [email protected] Jim McCormick ............................... 201-524-2852 Brian Hargrave .................................. 201-524-2314 Russell Jones ............................ 44-207-260-1296 David Heike ....................................... 201-524-2314 Michael Koss ..................................... 201-524-5208 INTEREST RATE STRATEGY Srinivas Modukuri .............................. 201-524-4539 U.S. Jeff Mudrick ....................................... 201-524-2431 Jeffrey D. Biby ................................ 201-524-2914 David Rashty ......................... [email protected] Doug Johnston ............................... 201-524-4539 Vikas Reddy ......................... [email protected] Shashank Agrawal ......................... 201-524-4539 Stefano Risa ...................................... 201-524-2220 Mukul Chadda ................................ 201-524-5414 Jeff Ryu ............................................. 201-524-4539 Judy Goldfarb ................................. 201-524-5383 Vered Samari .................................... 212-526-8311 Priya Misra ...................................... 201-524-5383 Vaidyanathan Venkateswaran ....... 201-524-5383 Portfolio Recommendations Global Fixed-Income Asset Allocation GLOBAL AGGREGATE * February 1, 2002 Year-to-Date Total Return (%) % Over (+) or Amt. Out. # of OAD Local 100% Hedged into % of Recommended Under (-) ($ billion) Issues (years) Currency U.S. Yen Euro Sterling Index Portfolio (%) Diff. Weight U.S. Aggregate 6,041 3,123 4.53 0.80 0.80 0.66 0.95 1.01 46.6 47.4 0.8 2 Eurodollar (ex-U.S. Agg) 240 378 3.54 0.70 0.70 0.56 0.83 0.90 1.8 1.9 0.0 2 144A (ex-U.S. Agg) 78 153 6.02 1.02 1.02 0.88 1.16 1.22 0.6 0.6 0.0 2 Canadian Government 153 46 5.84 0.05 0.03 -0.13 0.14 0.21 1.2 1.2 0.0 3 Pan-Euro Aggregate 4,001 2,435 5.21 0.70 0.56 0.42 0.70 0.76 30.8 32.3 1.4 5 Asian-Pacific Aggregate 2,411 1,336 5.24 5.24 -0.47 -0.64 -0.37 -0.30 18.6 16.3 -2.3 -12 Euroyen 49 83 4.61 -0.59 -0.42 -0.59 -0.32 -0.25 0.4 0.3 0.0 -11 Global Aggregate Index 12,973 7,554 4.88 - 0.47 0.33 0.60 0.67 100.0 100.0 * Based on $300 million liquidity criterion. Note: regional aggregate indices have lower liquidity criterion (usually $150 million) under current rules. GLOBAL AGGREGATE INDEX* BY CURRENCY OF ISSUER a Market Value Number of OAD Recommended % Over (+) or ($ billion) Issues (years) % of Index Portfolio (%) Under (-) Weight Currency: U.S. Dollar 6,690 3,654 4.51 48.8 50.5 4 Euro 3,566 1,994 4.91 26.0 26.7 3 Other Europe 147 43 4.08 1.1 1.1 1 Sterling 530 398 7.56 3.9 3.9 2 Yen 2,454 1,266 5.33 17.9 15.7 -12 Other Asia 152 153 3.58 1.1 1.0 -7 Canadian Dollar 173 46 5.84 1.3 1.3 1 *Based on $300 million liquidity criterion. Note: regional aggregate indices have lower liquidity criterion (usually $150 million) under current rules. ASIAN-PACIFIC AGGREGATE a % Over (+)/ Market Val. Number of OAD YTD Return Recommended Under (-) (yen billion) Issues (years) (yen) % of Index Portfolio (%) Difference Weight Asian-Pacific Aggregate 341,585 1,327 5.21 -0.64 100.0 100.0 Country of Issuer: Japan 317,351 1,116 5.33 -0.68 92.9 97.3 4.4 5 South Korea 10,402 93 2.96 0.26 3.0 0.0 -3.0 NA Non Asian-Pacific 3,826 61 4.33 -0.49 1.1 0.0 -1.1 NA Australia 5,521 26 3.83 -0.44 1.6 1.7 0.0 2 Malaysia 90 2 2.31 0.01 0.0 0.0 0.0 -13 Singapore 2,585 17 4.45 0.25 0.8 0.8 0.0 -1 New Zealand 1,164 6 4.12 0.70 0.3 0.3 0.0 -12 Thailand 647 6 5.82 -0.07 0.2 0.0 -0.2 NA a Index returns as of January 31, 2002. Lehman Brothers 1 February 4, 2002 U.S. Fixed-Income Asset Allocation U.S. AGGREGATE CORE PORTFOLIO SUMMARY RECOMMENDATION Option-Adjusted Duration Spread Duration February 1, 2002 98% 119% Percent of Market Value by Duration Range Contribution to % Over(+)/ % Over(+)/ 0-2 2-4 4-7 7-9 9+ Total Under(-) OAD Spread Duration Under(-) Sector Index Rec Index Rec Index Rec Index Rec Index Rec Index Rec Weight Index Rec Diff Index Rec Diff Weight Treasury 5.37 4.65 4.97 1.05 3.90 4.57 1.09 1.20 6.69 0.50 22.01 11.96 -46 1.28 0.48 -0.80 0.00 0.00 0.00 - Agency 3.50 2.85 3.72 4.07 2.64 3.58 0.72 2.13 1.32 0.00 11.91 12.62 6 0.51 0.53 0.02 0.50 0.53 0.02 5 Mtg. Pass-throughs 4.61 1.95 24.70 25.16 5.62 8.84 0.00 0.00 0.00 0.00 34.93 35.95 3 1.10 1.25 0.14 1.26 1.36 0.10 8 CMBS 0.05 0.00 0.38 0.44 1.62 1.86 0.06 0.00 0.00 0.00 2.10 2.30 9 0.10 0.12 0.01 0.10 0.12 0.01 10 ABS 0.52 2.33 0.78 1.99 0.34 0.53 0.06 0.00 0.00 0.00 1.70 4.85 186 0.05 0.10 0.05 0.05 0.10 0.05 100 Credit 2.98 3.17 8.15 9.17 9.56 10.25 2.30 3.20 4.35 6.53 27.35 32.32 18 1.48 1.96 0.48 1.47 1.93 0.46 31 Total 17.03 14.94 42.69 41.88 23.68 29.63 4.24 6.52 12.36 7.03100.00 100.00 4.53 4.43 -0.10 3.39 4.03 0.64 19 % Over (+)/ Under(-) Weight -12 -2 25 54 -43 Recommended Portfolio by Duration Range Portfolio Allocation by Asset Class % Relative to Index % Relative to Index 60 54 50 186 30 25 25 18 9 6 3 0 0 -2 -25 -12 -30 -50 -46 -43 -60 -75 0-2 2-4 4-7 7-9 >9 Treasury Agency Mtg.
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