Mutual Daily Mutterings
Quote of the day…
“Are they going to stop skill tests next? Maybe endurance, strength and conditioning testing? They’ll even stop the psychological testing and just have draftees front up and say ‘listen I think I can play 200 games for you’.” Former Saints Coach Grant Thomas in response to the AFL banning skin-fold tests.…
Chart Du Jour…US CPI vs PPI (and oil)
Overview…”A pause, or a warning shot?”.
- After eight straight daily advances, a pause or pull back was always on the cards for US stocks. European markets provided the lead, closing softer. Despite the weak leads, US stocks opened higher, but it was fleeting with early gains erased as a few large algo sales ploughed through the market, and the VIX tested upside resistance and filled a gap. The VIX (a measure of volatility) rose to 18.5, the gauge’s three week high, a move that failed at the 50 DMA (rising VIX = negative for stocks). From Bloomberg “the robot sales were not big by any measure but were persistent and large enough to move the market at the same time as parts of the nation struggled with an internet outage. The move was also accompanied by a volume surge in E-mini S&Ps. Robot sales of more than 1000 names in one swath typically get more investor attention”.
- Bonds rallied on the softer risk tone with another day of sizeable swings in yields. Yields have traded in a wide range since the end of June as markets continue to digest and absorb inflation data and monetary policy signals. Treasury 10-year yields have traded as low as 1.17% and as high as 1.70%, although there is no evidence yet of a taper tantrum with yields at seven-week lows. Traders are treading cautiously trying to pick the longer-term trend, but it’s proving a challenge.
- And, if Eurodollar futures are correct, any rate hike cycle is likely to be short and slight, with just one Fed rate hike priced in beyond 2023. “The markets are already pricing in way less that the Fed forecast for rate hikes after 2023. Markets currently match the Fed dot-plot up to the end of 2023 but then turns decisively dovish. In-fact, by the end of 2025 the market is pricing in just half (around 1.25%) of the Fed’s 2.50% longer-term forecast” (Bloomberg). Not surprising to be honest, given the scale of debt globally. As things stand, the economy can’t absorb any meaningful increase in debt funding costs without any meaningful and detrimental consequences.
- US earnings season post-mortem… Q3 US earnings season has defied sceptics saying commodity inflation and supply-chain snarls would squeeze the profit-margin expansion that’s buoyed the bull run. However, according to JPM data, S&P 500 firms that have reported boosted net-profit margins to 13.5%, up from a pre-COVID level of 12%. Cost-cutting measures and rising consumer demand are partly to thank for that.
- Offshore Stocks – weak leads from European markets saw US markets trend lower from the get-go, with algos a dominant driver on the day – not surprising given strong overbought technical signals. I doubt it’s the start of anything sinister, rather just a slight breeze to blow some froth off the top. Winners vs losers were at 57% to 43% respectively, with Utilities (+0.2%), Materials (+0.2%) and Energy (+0.2%) doing their bit for the bulls. Meanwhile, Discretionary (-1.5%) took a swift, sharp kick to the soft and delicate under-carriage, largely on account of Tesla (-11.3%). This fall is further follow-on to a ‘yes’ majority response to Elon Musk’s tweet asking whether he should sell-down 10% of his holdings and pay some capital gains tax as a result. He is certainly cut from a different cloth to most other billionaires. Financials (-0.7%) were also under some selling pressure, mainly reflecting the further flattening of US yield curves, but also the report that “Fed Governor Brainard had been interviewed by President Biden for the Fed chair job – as well as incumbent Jay Powell – with Politico reporting that Biden planned to make a decision by Thanksgiving (November 25). The hot money is still on Powell being re-appointed, but in which case Brainard seems certain to get the role of supervisor of the financial system, in which respect she has in the past been critical of what she regards as a too- lenient Fed attitude toward banking supervision and regulation. From a monetary policy perspective, whether it’s a reappointed Powell or Brainard in the chair shouldn’t make a whole heap of difference – they are equally dovish in our view and both mandate-constrained, but the prospect of a tougher regulatory environment for banks (and which could still occur if Brainard gets the chair’s role) is reason for investors to be worries about what that could mean for banks” (NAB).
- Local stocks – a modest retreat for the local index yesterday with 57% of stocks down on the day and very few winners across sectors with only three gaining ground. Tech (+1.1%), Materials (+1.0%), and Healthcare (+0.5%). Countering the strength in Materials, and then some (higher index weighting), was Financials (-1.0%), followed by Energy (-1.0%) and Telcos (-1.0%). NAB reported FY’21 results yesterday morning, the last of the majors to report this year (NAB down -0.8% on the day, outperforming the other majors that all fell -1.2% – 1.6%). I’m pilfering some of Coop’s (WBC Credit Strategy) commentary here coz he knows banks better than most in A$ credit world…see below:
- NAB reported a significant lift in both statutory profit (AUD6.36bn) and cash earnings (AUD6.56bn) in FY21 driven by the absence of notable items and a provision release, following the significant build in provisions undertaken in FY20. On an underlying basis (pre-provision and ex-notables), operating earnings declined 6.8%, while 2H21 results were also down 3.6% on 1H21 which largely reflected the continued decline in markets income. Ex markets, the FY result was flat and 2H21 was 2.0% up on 1H21. NII was up 1.7% in 2H21 as traction in lending volumes saw both home and SME lending above system while CIB growth accelerated, which was offset by ongoing margin pressure, largely through home loan pricing and higher liquids. Costs came in within the management target of 0-2% growth to support a clean result. Items of note:
- Lending momentum in place… NAB has held onto the momentum it saw late in the 1H to record above system growth in both home and SME lending.
- …but margins are feeling the pressure: Home lending is skewed to fixed rates (58% 2H flow) and is also seeing strong pricing competition driving front book margins lower which has seen this business become the main drain on margins. As rates rise (or curves steepen), so will the hopes for NIM.
- Cost performance remains strong… As planned, NAB costs hit the 0-2% target range (albeit at the high end) and the group remains on track to record costs below AUD7.7bn from FY23. Investment spend is also on track and should generate better returns as the focus moves to customer.
- … and while notables are gone, AUSTRAC remains: NAB confirmed that remediation costs are on track to be completed in CY22, which leave AUSTRAC. No update was available, but NAB have listed this as a key priority for FY22.
- Capital well ahead of the range… NAB’s 13.0% CET1 ratio looks strong (or even its post buyback/post acquisition 12.25% pro-forma number) and the group’s payout ratio of sub-65% on a FY basis was below the group’s target range. Buybacks could continue for a while.
- … supported by the credit cycle: We saw further provision releases in 2H21 despite NAB retaining significant FLAs, with credit quality also supporting CRWA as improving risk grades and portfolio mix offset loan growth. This tail wind may wane as loan growth continues and risk grades stabilise, however NAB remain cautious on its COVID risks of retail trade, tourism, transport and CRE. Provisions remain well placed.
- Funding will return (cue Imperial March): NAB (and peers) are emerging from a period that featured the TFF, strong underlying deposit growth and subdued lending growth to now see both home and business credit growth (NAB above system), the exit of the TFF, the CLF (NAB AUD31bn) transitioning to zero, a refinancing requirement of AUD28bn and a genuine question mark over deposit trajectory (both retail and business, noting NABs NCO for liquidity was up 10% in the last 6 months) as the economy reopens. Forecasts remain difficult, however we would expect a funding task of ~AUD30-40bn, with AUD4-5bn of Tier 2 in the mix, noting this increase in supply is not out of line with historical settings.
- Local Credit – markets are fuelling my ego, doing as I said they would with the major bank curve -1 – 2 bps tighter following WBC’s little issuance jaunt to US funding markets. Trader EOD talk from yesterday…”the reception given to Westpac’s multi tranche USD deal overnight has provided the circuit breaker to ongoing spread widening on the domestic curve. Have we now seen the medium-term wides in major bank senior…? Our assumption is that we will not see any senior supply before Australia Day 2022 by which time another ~A$5.3bln will have matured. Importantly, this view seems to chime with domestic real money accounts, a number of whom were active today after a prolonged absence”. The NAB Aug-26’s closed at +58 bps, or -2 bps on the day, as did the Jan-25’s, in to +43 bps. I might be so bold as to suggest we’ll see the Aug-26’s back around +50 bps within the month, and the Jan-25’s into around +35 bps over the same time frame.
- In the tier 2 space it was a head-scratcher curtesy of Bank of Queensland (BOQ) announcing another tier 2 deal. I say another because they issued in April and its pretty rare, i.e. unheard of, for a regional bank to tap markets for tier 2 paper so close together. More than twice in one year! Crazy talk, Marge! We can only guess someone miscalculated their needs with the ME merger, or it’s just a small top deal. Either way, no clear guidance provided by respective syndicates…it certainly isn’t because of strong lending growth. BOQ’s lending book has grown ~$2.1bn between April (last tier 2 deal) and the end of September, whereas deposits have grown $2.6bn, more than covering loan growth. Either way, by my calculation the curve suggests +172 bps area, but we’ll be agitating for a little more juice given the frequency of the deal. If the pricing on their last senior deal is anything to go by, it could price at +185 bps, which is the top end of our fair value calculation. Another consideration, possibly, is they’re targeting Asian investors with BAML and UBS joint lead managers. We’ll see today, I guess. No change in major bank tier 2 spreads on the day.
- Bonds & Rates – talking heads… “we are at the point of the cycle where policy is shifting to be somewhat less accommodative…we do think financial conditions ultimately are going to tighten by the middle of next year and investors don’t seem to care. They’re hooked on the IV of very low real interest rates.” Local yields a touch wider yesterday, following prior offshore session leads. And, today we’ll likely go the other way.
- Offshore Macro – US PPI Final Demand printed at +0.6% MoM last night, in line with consensus, but accelerating on the +0.5% MoM reported in September. Ex food and energy PPI came in at +0.4% MoM, a smidge below the +0.5% MoM expected, but well up on the +0.2% MoM rise reported a month earlier. Annual data, +8.6% YoY (final) and +6.8% YoY (ex-food & energy) were in line with consensus and flat on the September annual data – but still at 10+ year highs. Talking heads…”there’s no denying that pricing pressure looms large…though there were no surprises with the PPI read, it could be viewed as somewhat of a disappointment in that inflation hasn’t eased up in the slightest.” US CPI for October is due out tonight with core expected to come in at +0.6% MoM (vs +0.4% September), or +5.39% YoY (vs +5.4% YoY September). CPI ex food and energy is expected at +0.4% MoM (vs +02% MoM in September) and +4.3% YoY (vs +4.0% YoY in September).
- Some oil talk given its impact in US inflation…”US government analysts raised their 2022 domestic crude production estimate by 1.4% to 11.9m barrels a day on expectations that this year’s doubling in oil prices will encourage drillers to step up their pace. The report will inform the Biden administration’s decision about whether to tap strategic reserves. The Energy Information Administration also predicted retail gasoline will drop below $3 a gallon, on average, by the beginning of January. Crude traders appeared to shrug off the monthly report. After a 15-minute interlude which saw little movement in oil prices, WTI jumped and is now up more than 2% on the day”
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Scott Rundell, Chief Investment Officer
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