Barclays strategists say time may be nearing to ease auto underweights

By Ronda Fears

Nashville, March 14 - As spreads widened over the past month, Barclays Capital Markets strategists are less negative on the European credit markets, but still recommend defensive positions.

That said, Barclays credit strategists Jim Reid and Gary Jenkins said in a report Friday it could be approaching the time to ease underweight positions in retail, industrials and autos due to spread widening. They are aggressively overweight in telecom, and bullish on tobacco.

"As we write this, the equity markets are in freefall (but as we go to print they are flying through the stratosphere), government bond yields are close to 40- to 50-year lows, geopolitical risk is heightened, credit fundamentals remain negative, event risk is slowly increasing again, and the global economy remains mixed to weak," the analysts said in the report.

"Some of the short-term volatility could reverse very quickly, so we do not want to be too 'gloom and doom.' However, our view remains similar, if slightly less negative: stay defensive and underweight in the cyclical sectors and overweight in the more defensive ones."

Generally, they see a reduction in the number of underweights in retail - mainly due to Ahold falling out of the index - industrials and autos.

"For industrials and autos we remain underweight but have reduced this after significant spread widening in certain names," the analysts said.

They added more names to the overweightings in the telecom and tobacco sectors this month, noting that the telecom sector remains the one with the most overweights.

"Our view remains that weak fundamentals will be in constant battle with the strong demand-led technicals throughout 2003. It is fair to say that we are slightly less negative than last month as spreads have widened, and this is reflected in our individual name picks," the analysts said.

"However from a top-down and bottom-up perspective we are still defensive, whilst acknowledging an easing in geopolitical tension could lead to a short-term rally. The weighting tables still show a general preference for names in the sterling market over those in the euro market."

There is no obvious sign of any improvement in Euro credit quality in terms of rating agency activity, the analysts noted, and they are still concerned about corporate earnings on an absolute level as well as regarding the quality of earnings.

"In Europe we have seen three of the 10 biggest corporate losses in history reported so far in March 2003, and although valuations look more attractive now in Europe, the equity culture is so damaged that it is difficult to see who is going to aggressively step in to buy the market," the analysts said.

The equity/credit relationship has re-established itself in the weaker sectors but telecoms continue to de-couple, they observe.

"We still believe that equities are going to be a strong influence on lower-rated spreads over the next few months. We do not think there will be sustainable widespread decoupling between credit and equities outside the telecom sector," the analysts said.

"Our view has been that de-coupling is justified in the telecom sector, as external support changed its outlook last year. However, the prospect of decoupling is premature for other lower-rated sectors."

After de-coupling at the end of last year, Ford is back trading more in line with its equity price movement, they noted.

"Given how far spreads have widened in autos, we are more nervous of our underweight on the sector than in recent times, and if you have been underweight against an index then it may be the time to scale in some of the bets," Reid and Jenkins said.

"Having said that, we are going to wait for March's U.S. auto sales before changing our underweight recommendation. The potential downside remains significant even if we are being too pessimistic in the short-term with spreads this wide."

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