Mutual Daily Mutterings
Quote of the day…
“Tell people an invisible man in the sky created all things, they believe you. Tell them what you’ve painted is wet, they have to touch it to believe.”…George Carlin
Chart du jour…global credit spread changes
Source: Bloomberg, Mutual Limited
Overview…”see, nothing to worry about”
- It was a volatile holiday-shortened week as everything from oil to bonds to stocks swung. On Thursday the narrative pointed it’s gnarly finger at the Delta COVID variant for being the primary trouble maker, yet on Friday the sun came up, market liquidity was still abundant, and greed remains one of the seven deadly sins, actually no, it’s not. Regardless, risk assets were back on the good foot. Nothing fundamentally changed from a day-to-day sense, nothing obvious at least. The oil situation remained unresolved. The OPEC+ relationship in serious need of an intervention and counselling. Nevertheless, oil gained, as did commodities broadly, and core US stock indices ended the week at record highs. And, European markets aren’t too far behind.
- While many central banks are on the cusp of taking the punch bowl away (tightening), China has elected to top theirs up again, cutting its RRR by 0.5 ppt for most banks. The quantum of this is not immaterial, unleashing about A$200bn equivalent of long-term liquidity into the economy. The move hints that China’s economic recovery may be slowing quicker than they expected, necessitating more liquidity injections.
- This week will be all about economic data, coupled with several US Treasury auctions that are likely to give at least the bond market some direction. Here’s what’s on the dance card: Tonight, Treasury Secretary Yellen addresses global tax policies in Brussels, and the Fed runs a three-year and 10-year Treasury auction. Tomorrow, US CPI data and bank reporting season (Q2) in the US kicks off (JPM and Goldman Sachs first), while locally we have NAB Business Conditions. On Wednesday we have WBC Consumer Confidence data. On Thursday, US initial jobless claims, Empire State manufacturing and industrial production, as well as local labour data. And, lastly on Friday Eurozone CPI, US retail sales and University of Michigan consumer sentiment
- Offshore Stocks – a strong recovery from Thursday’s brief doldrums, with the DOW, S&P 500 and NASDAQ notching up new all-time highs and clocking in modest gains for the week. A touch over 90% of stocks in the S&P 500 gained on Friday with all sectors sporting a summery shade of green. The old guard led from the front, Financials (+2.9%), Energy (+2.0%), and Materials (2.0%) driving the bulk of gains, while the relative underperformers were Utilities (+0.2%), Healthcare (+0.4%), and Staples (+0.6%). RSI’s are approaching the high-60’s, 67.6 to be precise, and traded volumes were a smidge below recent averages, which was expected given the holiday shortened weekend and the usual summer lull. YTD the S&P 500 is up +16.3%, which is broadly in line with the growth in forward EPS estimates, +17.0%. Despite the strong EPS growth expectations, traditional valuation measures are still frothy, with forward PE’s at 22.9x vs a 5-year average of 19.4x. E-mini’s rose in after-market trading.
- Local stocks – a tough day in the trenches as the local market dealt with the blow back from offshore weakness, the ASX 200 down -0.9% on the day, and unlike offshore markets on Friday, almost every stock was left on the bus, almost 80% of the ASX 200 closing in the red. Only one sector was able to get some runs on the board, Energy (+0.1%), with the next best performer being Utilities (-0.03%), and then Staples (-0.6%). Wallowing in their own self-misery, Tech (-2.8%), Discretionary (-1.6%) and Industrials (-1.2%) soiled themselves on the day. Nevertheless, strong offshore leads from Friday have futures this morning at +1.1%, indicating a strong open. RSI’s are middling, around 50, half way between overbought and oversold, while volumes were a smidge above recent averages.
- Offshore Credit – while offshore stocks forgot their troubles and rebounded on Friday to notch up some weekly gains, offshore credit failed to find the love so quickly, with spreads drifting wider – but they did recovery a touch on Friday. US IG closed the week +3 – 4 bps wider, while high yield was +13 bps wider. EU IG outperformed on a relative basis, spreads unchanged to -2 bps tighter, and in high yield containing widening to just +4 bps. A steep drop in underlying yields (treasuries) in recent weeks has caused investors to closely look at spreads, which are very tight versus historical averages. With benchmark rates falling, the total interest investors can earn on new issuance has waned, which could lead to investors demanding higher spreads in primary….’could’, but nothing too obvious yet.
- Local Credit – from the traders “a fairly dislocated day with no discernible trend or theme. Local credit markets remain resilient with spreads in a tight range”. Traders have expressed confidence that primary market activity will resume this week and to echo their thoughts, these deals will likely be well received given we have a couple of chunky deals maturing this week. CBA has $2.5bn of A$ senior paper maturing today, and then another $1.6bn a month later. ANZ also have some upcoming maturities, A$ senior also, including $2.0bn this Friday (July 16th), and then $2.8bn a month later. So that’s $4.5bn of cash this week looking for a new home. On Friday, major bank senior closed unchanged, and with these maturities and no obvious sign of impending replacement paper, spreads could grind tighter. Traders reported in the EOD commentary on Friday that “a number of accounts have expressed a reticence to buy in the ‘longer end’ of the curve, preferring to avoid the likely landing spot for forthcoming supply. Entirely understandable and we would suggest that 2.5-3yr tenors provide the best relative value”. The Jan-25’s are stuck at +32 bps, while the 3-years are at +23 bps. What’s the bet the 3-years are sub-20 bps by month’s end? Any takers? In the tier 2 space, no movement. The 2026 calls are ranging around +124 – 127 bps, while the 2025’s are at +116 – 121 bps, and the 2024’s at +100 bps (went sub-100 bps last week briefly). The MQG 2025 calls are hovering around +136 bps, which is cheap to majors on a purely rating perspective. MQG tier 2, which is issued out of the bank, is rated BBB, just one notch lower than major bank tier 2, and pricing +15 – 20 bps wider for similar call dates. Given prevailing tight technicals, I’d suggest that’s +5 – 10 bps too high (full disclosure, we own MQG tier 2 across our funds and mandates).
- Global spreads, Jan-2020 to now…
- Bonds & Rates – local bonds steepened on Friday, with the long end rising despite the reasonably strong risk-off tone. Based on Friday’s close, US treasuries and ACGB’s are within a hair of parity in the 10’s vs a +11 bps average spread over the past 12 months. For some longer-term context, over the past 5 years, ACGB’s have spent an equal amount of time trading at a premium or discount in a yield sense to US treasuries (10 years), while post the GFC ACGB’s have averaged a spread to treasuries of +84 bps, but traded inside treasuries for much of 2018 and 2019. US treasuries on Friday sold off aggressively as risk rebounded, with the 10’s +7 bps to 1.36% and the 2’s +2 bps to 0.21%. The ACGB 10’s will likely move into the 1.40% – 1.45% range today, possibly higher. The yield of ACGB 10’s has fallen around -55 bps since the end of February as the reflation trade fades and markets have come around to the RBA’s way of thinking on inflation, i.e. it’s transitory. I have empathy for the transitory argument, i.e. I tend to agree. Nevertheless, I suspect yields have hit their tactical lows and will likely trend higher from here, for no other reason than normalisation of yields as the post pandemic recovery continues.
- Offshore Macro – nicked this from NAB this morning…”early in the US day, but not market moving, The Fed published its Monetary Policy Report to Congress, ahead of testimonies by Fed chair Powell on Wednesday (House) and Thursday (Senate). It notes that although the unemployment rate has moved down sharply from its pandemic high, broad measures of labour conditions continue to point to substantial slack in the labour market. It talks at length about maximum employment and the inability to measure it directly (remember the Fed’s assessment of this having been achieved is a stated pre-requisite for starting to lift rates). On inflation, the report re-iterates the view that the recent inflation surge will prove transitory, noting that “inflation has increased notably this spring as a surge in demand has run up against production bottlenecks and hiring difficulties. As these extraordinary circumstances pass, supply and demand should move closer to balance, and inflation is widely expected to move down.”
- Local Macro – a range of measures out this week, tabled below. From a policy perspective, the labour data has most potential to move markets on a miss or a beat. Consensus is expecting a modest +20K of jobs added, but with the unemployment rate to drop to 5.0% (from 5.1% last). This would place unemployment back at 2019 levels, where it printed 5.0% – 5.2% through the year. At its worst last year, unemployment peaked at 7.44%, levels not seen since the late 1990’s, and a good 150 bps above GFC levels. Consumer Confidence and Business Confidence measures also released, with the Victorian and NSW lockdowns no doubt weighing on sentiment to some degree.
Click here to find the full PDF from our Chief Investment Officer’s daily market update.
Scott Rundell, Chief Investment Officer
T: +61 3 8681 1907