Income Strategy August 3, 2007:            

The credit crunch appears to be gaining momentum, the problems that surfaced at Bear Sterns a couple of weeks ago have now been seen a round the world. This week an Australian hedge fund reported a substantial write down due to Collateralized Debt Obligation investments that are now clearly not going to be of any value going forward. Similar problems have been reported by pension funds in Germany and Britain.

As the problems escalate in the sub-prime sector the rest of the financial sector will be reviewing their lending criteria and that will mean more rules and requirements that will have to be met before qualifying for the loan. This change in the lending business will mean the end of the excessive borrowing that has been fueling the takeover and buy out mania over the past two years.

Long time hedge fund manager Jim Rodgers, who was one of the first to see the new commodity cycle starting to develop and who was a partner with George Soros in the phenomenally successful Quantum Fund, is now quoted as saying that the real estate and sub-prime problems have only just started, so be prepared for a lot more pain before this is over.

The US non farm payrolls did not meet expectations coming in at only 92,000 new jobs created in July verses the forecast of 127,000. The main decline was in US government jobs in the education sector, which could be reversed in the report for August. The surprise is that the decline in construction jobs was not very large at all with a decline of only 2,000.

The Federal Reserve will not likely react to the jobs report as the bulk of the decline could very easily be reversed in August. The Federal Reserve is expected to stay on hold and leave rates unchanged when they meet again next week.

The Bank of Canada may not have to increase interest rates when they meet in September due to the impact that a stronger Canadian dollar which is doing much of the work that a rate increase would achieve.

Over the next few months the spread between the yield on government issued bonds and those issued by corporations will continue to widen as investors demand a premium for risk, which has been missing in the investment equation for a couple of years now. In this type of environment hold off on moving into corporate bonds until the decline in bond prices has stabilized.