Mutual Daily Mutterings
Quote of the day…
“English? Who needs that? I’m never going to England”.…Homer Simpson
Chart du jour…US break evens..
Overview…”kicking the can”
- An up session in offshore markets overnight. Risk appetite received a boost from some progress being made in the US debt-ceiling talks with the can kicked down the road through to December. While not a lasting solution, the goldfish like minds of the collective market hive mind was clapping joyfully like a one-year-old child shown a shiny new bauble. European markets were running hard early on news that Uncle Putin would be bringing some Russian gas to the party, easing some of their energy concerns this winter. US markets jumped enthusiastically early, fuelled by buoyant European leads, and boosted by debt ceiling headlines, however gains were pared back a tad later in the session on news that China plans to tighten its supervision over technology companies.
- Bonds have been more mixed, with the US curve continuing to bear steepen – where the long end rises faster than the front end – with 10 year yields up +5 bp to 1.57%, with the 10-year break evens increasing +2.5 bps to 2.47%. Higher oil prices were likely a key driver in these moves. In Europe, however, sovereign yields were mostly a touch lower and BEIs softened as gas prices eased.
- Debt ceiling specifics…. Senate leaders reached a deal to raise the US debt ceiling until December 3, forestalling the imminent threat of default. The agreement lifts the borrowing cap by US$480bn. While the compromise averts an immediate crisis, the partisan battle will ramp back up just as Congress deals with a funding deadline and as Democrats try to muscle through their infrastructure and tax-and-spending plans. Just another day in US politics really.
- Markets and investor sentiment have been buffeted over the past month by an array of worries, some temporary and fixable, some more entrench with no obvious solution. Specifically, an energy crisis, elevated inflation, reduced stimulus, slower growth, and uncertainty around the US government’s ability to fund itself. Of these headwinds, and as per prior comments, the latter is the most likely to resolve itself within a relatively determinable time frame – give or take. But it’s only a temporary solution. Nevertheless, it’ll move to the backburner for a few months at least. Then markets will again hone in on inflation and growth concerns, both of which have widely variant views and expectations. Time will tell which views are the right ones.
- Offshore Stocks – a positive session across the board on easing headwinds…for now. The S&P 500 hit intra-day gains of +1.5%, but then the Chinese tech headlines hit, talking some wind out of the sails. By day’s end the index was up +0.8% with just over three-quarters of stocks advancing and all but one sector, Utilities (-0.5%), gaining ground. Discretionary (+1.5%), Materials (+1.4%) and Healthcare (+1.3%) led the gains. I’m still concerned about valuations relative to remaining risks. Having said that, what are the risks of a meaningful sell off over the near term (i.e. this quarter)? In a word, I’d say modest. While policy support is easing – tapering – the Fed is still growing its balance sheet, and there is no expectation they will actively sell-down assets once buying ends. Accordingly, liquidity in the system will remain elevated.
- I’ve dusted off some old school measures to determine whether the broader market is over-valued or not (charted below). The chart to the left details the capitalisation of US stocks (the Wilshire 5000), as a % of US GDP through time. This is a popular measure touted by Warren Buffett with the guide being when the ratio is between 71% and 93%, the market is ‘fairly valued’. Any measure above or below this range indicates degrees of over and under valuation. Anything above 135% is considered ‘significantly overvalued’. The current ratio is 200%, an all-time record high, so by this measure valuations are frothy, volcanic even.
- The chart on the right helps explain why Buffett’s ratio is so high, and by extension provides clues to potential sources of downside risk. The dotted red line depicts the Fed’s balance sheet, which is sitting at US$8.5 trillion and as you can see has tracked the market nicely since the GFC. So, it’s fair to assume that as the Fed begins tapering its asset buying programs, growth momentum in markets should ease, and as the Fed ceases it’s asset buying programs – likely mid-2022, markets will have less upside support, all other things being equal. At some stage markets will need to stand on their own two feet….of the Fed remains an entrenched and structural element of the market…maybe?
- Local stocks – a modest rally in local stocks with the market up from the get go. Just under three-quarters of the ASX 200 advance, while only one sector, Energy (-0.8%) retreated. Tech (2-.3%) gained most in a straight-line sense, while Financials (+1.0%) had the most influence on the broader index. Healthcare (+1.0%) also had a good day. Futures are up around +0.46% this morning.
- Offshore Credit – a more stable macro backdrop was enough to coax eight borrowers out of bed and hit the primary market overnight. Almost US$8bn priced, taking weekly volumes well past the US$20bn syndicate desks projected for the week. On the outlook for US credit, talking heads….”high-grade funds saw the biggest outflows since April 2020 in the week ending Oct. 6, according to the latest data, shedding US$2.5bn. The yield on the Bloomberg US corporate bond index, which has a maturity of just over 12 years, has risen to 2.14%, but that’s still less than breakeven inflation (~2.4%). The yield on 10-year TIPS plus the spread to Treasuries of corporate bonds adds up to less than zero. On the other hand, corporate America is getting low-cost funding, which has to be good news for shareholders at least”. The US market is largely fixed rate, with less FRN representation, which offer better inflation insulation characteristics.
- Local Credit – traders…”secondary spreads close broadly unchanged with flows very light. Local rates markets remain volatile and it would seem credit investors are opting to stay on the sidelines”. Major bank senior and tier 2 lines closed unchanged, while Bloomberg is quoting BEN’s new tier 2 line at +147 bps vs launch spread of +148 bps, although one trader had it marked at +146 bps, but advised they had not been asked to bid on any volume. The deal seems to have dragged the curve lower with the Nov-25 call a basis point tighter.
- Bonds & Rates – modest flattening of the local yield curve yesterday…some insight from CBA “yesterday’s price action was interesting, with the Australian front end continuing to be under sharp selling pressure, while the long end took its cue from the relief rally offshore”. Offshore leads this morning will be in the opposite direction with a +2 – 4 bps rise in 10-year yields being my guess for the day. Looking at bond markets differently, some comments in CBA’s Daily Wrap yesterday were interesting, relating to APRA’s recent macro-prudential policy announcement and what it might mean for interest rates…“only 8% of CBA home loan borrowers use the maximum borrowing limit, which means the serviceability changes are less potent. But if we assume this is step one in a process of increased macro prudential control, the risk of a potential delay of rate hikes (relative to market pricing) is a realistic one.”
- Macro – the main event over the next 24 hours is US non-farm payrolls. Consensus expectation is for +450K jobs added vs +243K last month and the unemployment rate to drop to 5.1% from 5.2% last month. Average weekly earnings growth is forecast to moderate vs last month, +0.4% MoM vs +0.6% MoM, yet advance a touch over the year, from +4.3% YoY to +4.6% YoY.
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Scott Rundell, Chief Investment Officer
T: +61 3 8681 1907