Mutual Daily Mutterings
Quote of the day…
“I prefer quality over flash — that’s why I refuse to write my signature in cursive”.…Ron Swanson
Chart du jour…global spread changes
“The Pride Before The Fall…”
Overview…”eyes forward class…”
- Friday’s headline was a childish “a pinch and a punch” for the first day of the month…and didn’t we cop a punch in local markets, not a jab either, a good ol’fashion uppercut. Offshore markets on the other hand ducked and weaved, escaping any real damage and in fact enjoyed a lovely sprinkling of fairy dust. US markets (stocks) started the quarter on positive ground, although there are still some potential boogey men in the closet over coming weeks, including US earnings season, energy concerns, and potentially stalling China growth. Europe closed on the soft side. Bonds rallied with yields dropping a few basis points, and flattening a touch. In other markets, oil and commodities closed the week up, while credit was a tad wider.
- October is an interesting month for markets. Some of the most significant sell-offs in history have kicked off under the sign of Scorpio, including the grand-daddy of them all, the crash of 1929, which kicked off toward the end of October all the way through to November with more than 40% of the value of the S&P 500 wiped out, in turn sparking the Great Depression. Then came the grandson of sell-offs, the October 1987 crash, which saw the S&P 500 plunge -23.2%. Other notable October falls include the onset of the global financial crisis (-16.9%), the European crisis in 2013 (-6.9%), and the tail end of the pandemic last year (-2.8%). Will history repeat itself? Doubt it, too much liquidity in the system to prevent anything more than your average mid-cycle pull-back.
- Treasuries rallied a touch last week, a reprieve from recent widening pressures – driven mainly by inflationary pressures and the Fed’s recent tapering announcement. Where to from here…talking heads “at current yields, the bond market is placing a pretty explicit trust in policy makers to adequately deal with a supply shock (and persistent price pressures). To date, that policy response has largely been to pretend that said shock doesn’t exist, or won’t for very much longer. You’ve got to wonder how much longer investors will be willing to extend the benefit of the doubt. If the Treasury market actually starts to trade the inflation theme again, then things could get a bit ugly”.
- Offshore Stocks – a sold rally in US markets, while European markets stumbled a touch. Across the S&P 500, 79% of stocks gained ground and all but one sector (Healthcare, -0.04%) closed in positive territory. Energy (+3.5%) led the charge, strong out of the gates on the first day of the fourth quarter, followed by Telcos (+1.8%) and Materials (+1.6%). October sees the start of Q3 reporting for offshore markets. Focusing on the S&P 500, forward EPS expectations are running at $203 per share, largely unchanged in the last month despite some large industrial players forewarning of rising costs pressures. Heading into Q3 reporting season last year forward EPS expectations were running at $131 per share, while pre-pandemic levels were $164 per share. Consequently, forward PE’s are running hot, 21.4x vs pre-pandemic levels of 19.5x (of 18.1x as at Q3 2019). The five-year average leading into the pandemic was 19.1x. At $203 per share and at PE’s of 19.1x, that implies a ‘fair value’ level of 3870 for the index, or -11.0% below current levels. First major cab of the reporting rank is JPM on October 13.
- Local stocks – the local market copped a whack over the nose with a rolled-up newspaper, the weekend edition. The ASX 200 fell -2.0% with all sectors hammered and the worst of the worst being Financials (-2.8%), followed by Discretionary (-2.3%) and REITS (-2.3%). The best of the worst was Utilities, down just -0.05%, while no sector did any better than being down less than -1.0%. Forward EPS are sitting at $413 per share, down almost -2.0% over the past month. This time last year, forward EPS levels were running at $276 per share and pre-pandemic (Q3 2019) forward EPS were at $389 per share. Forward PE’s are running at 17.4x, well down from peak-pandemic levels of 22.6x, reflecting improved EPS outlook. Against pre-pandemic averages of 16.1x (2014 – 2019), and assuming forward EPS expectation efficacy, the market is around 7.3% overvalued. Nevertheless, the index looks to be starting the week on a positive footing with futures up +0.7%.
- Offshore Credit – US bank syndicate desks are predicting US$90bn – US$100bn of US IG primary issuance this month, with as much as US$20bn of that lining up this week. This is more than the US$80bn that priced in 2020 and significantly more robust than the US$68bn that came in 2019. A survey of prospective issuers indicates that rising rates are top of mind after the 10-year Treasury yield crossed above 1.50% last week. The belief that borrowing costs could continue to rise is likely to spur more issuance. Talking heads “the jump in interest rates created new urgency for issuers to lock in rates before they increase further, potentially pulling issuance forward from plans for coming years.” Having said that, the first half of October tends to be slower for supply due to earnings-related issuance blackouts. Secondary spreads on the week drifted wider, with US +1 – 4 bps wider across investment grade indices, while European IG indices were flat to a basis point wider.
- Local Credit – modest drift wider across major bank senior paper into financial year end for three of the four majors, while tier 2 was relatively unchanged. Given the volatility prevalent across stocks, and yield trends, it will be interesting to see how trading book risk appetite opens up now that traders have a clean slate. I’m still of the opinion that major bank senior spread will continue to drift wider into 2022 as issuance profiles ‘normalise’. Having said that, I’m not anticipating an onslaught of issuance – strengthening credit growth notwithstanding. Here and now, the banks are awash with deposit funding, but as NSW and Victoria open up and the prospect of further lockdowns ease (remains to be seen), pend up spending (household savings) will be released and banks again will be reliant on wholesale funding again. And, of course there is the TFF refinancing requirement.
(Source: Bloomberg, Mutual Limited)
- Bonds & Rates – another day of not much movement in bond yields in local markets ahead of this week’s RBA policy meeting. With NSW and Victoria set to start coming out of lockdown in October, or planned to at least, political shenanigans aside, and the international borders set for a slow and incremental reopening from early December, the outlook for the Australian economy ‘should’ begin to improve. The RBA may also be cognizant of reopening price pressures that have beset most other developed nations. On Friday night the treasuries rallied a touch despite the firmer risk tone. While over the past month or so, US treasury (and ACGB’s) yields have risen sharply, modelling suggests yields should be another +75 – 85 bps higher than they currently are given inflationary expectations. As we all know, the differential between reality and models is largely a function of unprecedented central bank buying. The Fed’s balance sheet is now sitting at US$8.5 trillion, twice as large as at the height of the GFC, and ten-times larger than pre-GFC levels. With the tapering process imminent, yields ‘should’ trend higher over the coming 12 months. Predicting the path yields take to reach these higher levels is where the real smarts are.
- The week ahead – borrowing some ink from NAB’s morning note…”the focus offshore this week is the nonfarm payrolls report on Friday night, with several high frequency indicators suggesting downside risks to the consensus of 470k jobs (one indicator even points to a negative print). Should payrolls disappoint, it might cast doubt around whether the Fed makes a taper announcement in November. Expect more headlines around Evergrande, with Bloomberg reporting that the company has guaranteed a USD bond that matures today, with any non-payment potentially leading to a cross default on Evergrande’s debt obligations. Unlike Evergrande’s USD coupons, which have a 30-day grace period before an event of default is deeded to have occurred, there is no grace period for late payment on this maturity except for 5 days for administrative issues.” Closer to home, we have the RBA meeting tomorrow, which should be a non-event. Outside of that, it’s a slow week on the local data front
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Scott Rundell, Chief Investment Officer
T: +61 3 8681 1907