Mutual Daily Mutterings
Quote of the day…
“Someone asked me, if I were stranded on a desert island what book would I bring… ‘How to Build a Boat.’”.…Steven Wright
Chart du jour… US margin debt retreats a touch
- US labour data indicated a return to prior positive trends with a larger-than-expected payrolls gain, suggesting greater progress filling millions of vacancies as the effects of the pandemic, specifically the delta variant, faded. Nonfarm payrolls increased +531K after large upward revisions to the prior two months, while the unemployment rate fell to 4.6%. The labour-force participation rate was unchanged and average hourly earnings came in line with estimates, rising the most since February. Stocks closed higher on the day and the week, and bond yields fell on the day and week. Credit spreads edged higher in US markets and locally. Oil rebounded after a few down days.
- Talking heads… “the strong jobs report is a welcome sign that the delta wave-driven slowdown was indeed transitory. This bodes well for the expansion, which is set to continue in the coming months, driving earnings and economically sensitive sectors higher”….and…”investors are looking for a modestly growing economy as the Fed starts pulling back the reins, and the October jobs report seems to fit that bill.”
- Fed speak….Kansas City Fed President Esther George noted that bottlenecks contributing to high inflation will persist well into 2022 amid broadening price pressures, suggesting officials should not wait too long to respond.
- Adding to the positive mo-jo, the long-awaited infrastructure package from President Biden has been approved by Congress. From Bloomberg…”Joe Biden gets a real infrastructure week. The president hailed the House passage late Friday of the $550 billion bill to fund new roads and bridges, expanded broadband, clean water, power grid upgrades, and pollution cleanup. He said he’d sign it “soon.” Celebrations may be brief, as Democrats face more internal divisions over the bigger $1.75 trillion social spending package. Progressives aren’t happy Nancy Pelosi agreed to delay a vote on it until the CBO releases a cost estimate. Some moderates pledged to back the package if the analysis shows it’s deficit neutral”.
- US inflation data out this week, which will be watched closely.
- Offshore Stocks – modest gains on the back of better-than-expected US labour data. Within the S&P 500, 65% of stocks rose and only one sector, Healthcare (-1.0%), failed to get a shot off. Energy (+1.4%) clawed back some lost ground as oil prices bounced. Industrials (+1.0%) and Utilities (+0.9%) rounded out the top three. Over the week, Discretionary (+5.0%) led strongly, followed by Tech (+3.3%), and Materials (+3.2%). Financials (+0.6%) and Healthcare (+0.7%). Valuations remain a concern for me, frothy by historical averages and pricing in a Goldilocks outcome for the year or two ahead. Having said that, and I repeat the same below for local markets, I’m not expecting a meaningful correction any time soon – all other things being equal. Longer term however, so into 2022, I’m very cautious.
- Local stocks – modest gains to end the week, with the ASX 200 up +0.4% on the day and +1.8% on the week. Best performers on the week were Telcos (+4.6%), REITS (+4.3%) and Healthcare (+3.9%). Only one sector failed to get out of the gate, Energy (-1.9%) with oil down -1.9% on the week. My views on valuations haven’t changed. Economies are reopening and consumer and business spending patterns are likely to return to ‘normal’, which will provide some support, however there remains downside risks that are being largely ignored by markets. The ASX 200 is sporting forward PE’s of 18.7x, up 1.4x over the past 30 days despite a near -4.0% drop in forecast earnings over the same period. Add to this the fact that bond markets have aggressively adjusted their pricing of inflation risk (higher) and the timing of RBA hiking rates (sooner) and valuations look frothy again. I’m not signalling a pull-back per se, there’s plenty of support for stocks at the moment, with sentiment buoyed by economic re-openings etc, rather I think the market’s capacity to absorb a shock or modestly negative news is very thin. Futures are pointing to a modestly positive open.
- Offshore Credit – US IG bond supply is set to remain strong and steady this week, with estimates calling for about US$25bn of new issuance after macro concerns around inflation and rate hikes eased. US credit markets reacted favourably to the Fed’s announcement that it will begin tapering asset purchases this month with no rush to raise interest rates. Borrowing costs remain dirt cheap for top-rated issuers, who are likely to take advantage and tap the market heavily in the weeks ahead of the Thanksgiving holiday. The 10-year Treasury yield sank below 1.5% on Friday for the first time in a month, potentially setting up an issuance window for opportunistic borrowers this week. Supply is expected to be front-loaded with the US bond market closed Thursday in observance of Veterans Day.
- Local Credit – traders comments…”a relatively tame end to the week despite the overnight moves in rates…generic credit recovering some poise (despite underperforming offshore markets) with spreads closing the week better bid.” And, on financials…”closing the curve unchanged. An awkward peace now exists with buyers unwilling to add in secondary and issuers disinclined to tap local primary markets. This standoff isn’t playing well in secondary markets with flows light and the curve inclined to drift wider. As mentioned, we do not expect A$ senior issuance this side of Christmas, however, we think a well-received offshore deal may help refocus the attention of domestic investors. Optically the long end of the curve looks a bit flat and we have some sympathy for the view that spreads have a little further to go, however, we think the widening trend (~20 bps in 8 weeks) is almost done.” No arguments there, definitely agree with the no supply before Christmas. On the week major bank senior spreads are +2 – 3 bps wider with the Aug-26 closing at +60 bps and the Jan-25’s at +47 bps. In the tier 2 space, “better buying with a number of domestic accounts active. Near term spread direction likely to be set by A$ issuance (or lack thereof) that may transpire this week. Supply is expected but the quantum of which will be manageable.” The 2026 callable lines are +2 – 3 bps wider at +136 – 140 bps, while the 2025’s are +1 – 2 bps wider at +127 – 131 bps and the 2024’s are at +99 bops (+2 bps on the week).
- Bonds & Rates – what a week in local bonds! Yields did what we expected them to do on Friday given offshore leads, easing back a touch. We’ll get a more meaningful rally today with a sizeable move lower on Friday night in US treasuries following positive labour data (see below) – which is slightly contrary to what I would have expected. Greater jobs growth than forecast theoretically nudges the Fed closer to normalising monetary policy, i.e. rate hikes, but markets thought otherwise. Perhaps, while jobs were added, average hourly earnings fell. Over the week US treasury yields were 10 bps lower. ACGB’s were somewhat more-frisky with three-year-yields falling 30 bps to 0.93% and ten-year yields falling -28 bps to 1.81%, clawing back a smidge of recent increases. Ten-year yields are still +73 bps up since the beginning of August, and a similar move has occurred in three-year yields. Markets are still pricing in 3 – 4 rate hikes by the end of 2022, down from 4 – 5 rate hikes a week earlier (chart below). The RBA central case remains no rate hikes until 2024, but in their latest SOMP they did acknowledge a scenario where the cash rate is hiked in 2023. They categorically ruled out a 2022 rate hike. For what it’s worth, US markets are pricing in two rate hikes by the end of next year. And if the RBA is correct, where inflation is bigger problem offshore than onshore, then perhaps local markets have priced in too much inflation risk and we have a pull back in coming weeks.
- As a side note, a snippet from one of the local news papers was sent my way over the weekend, it was titled “Investors losing money in safe haven funds”. Apart from the shoddy journalism and usual sensationalist clap trap that one finds in newspapers these days, it was blatantly wrong and misleading. The article quoted an economist of note who works for a shrinking funds management business. The gist of the article and specifically the quotes from said economist was that bond funds have lost money over the past 12 months and will likely do the same over the year ahead. Yes, FIXED RATE bond funds have generated negative returns. However, despite the extensive experience of said economist in Australian financial markets, the existence of Floating Rate Notes was ignored. Accordingly, the strategy of choice per this article is cash and / or dividends. Argh! Have we not progressed from that old trope of just cash and stocks! FRN’s are a viable solution in a rising interest rate environment. I’ve charted (below) monthly (October) and annual returns for the main Bloomberg AusBond indices, most of which are fixed rate, but with one FRN, against our own three funds, all of which are purely FRN based. Feel free to call and discuss.
- Local Macro – borrowing some ink from NAB…”a big week domestically with employment figures for October on Thursday. The key message from leading indicators is that we should expect a sharp rebound in the labour market in coming weeks and NAB sees aggregate employment back to pre-lockdown levels by the end of the year. The timing of that showing up in measured employment though is less clear. We look for the start of the rebound to have occurred in October in NSW and pencil in +80k for employment and for the unemployment rate to be unchanged at 4.6% (consensus +50k, 4.8%). Also out during the week are the NAB Business Survey on Tuesday and W-MI Consumer Confidence. The price components of the NAB Business Survey will continue to be watched”
- Offshore Macro – US payrolls on Friday surprised to the upside in outright jobs added, +531K vs +450K expected, and +194K in the prior month. The unemployment rate printed at 4.6% vs 4.7% expected and 4.8% in September. Average Hourly Earnings growth eased, rising +0.4% MoM vs +0.6% MoM in September, while annual data grew +4.9%, in-line with expectations and up vs +4.6% YoY in September. The participation rate missed to the downside, 61.6% vs 61.07% expected, but flat MoM. For the week ahead…stealing some commentary from CBA…”US CPI data later in the week will be the first test of whether markets believe the FOMC’s latest guidance. We expect both headline and core CPI accelerated in October (Thursday). Importantly, another acceleration in the monthly annualised trimmed CPI will reinforce our view that the FOMC is behind the curve. Broad underlying inflation suggests that inflation will remain persistently above the Fed’s 2%/yr target. As a result, the longer the FOMC waits to tighten monetary policy, the greater the risk the FOMC tightens more to bring inflation back under control later”.
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Scott Rundell, Chief Investment Officer
T: +61 3 8681 1907