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Mutual Daily Mutterings

 

Quote of the day…

“The economy depends on the economists as much as the weather depends on meteorologists” – unknown

 

 

Dashboard

 

 

“The Kraken…


Source: www.hedgeye.com

 

 

“A different kind of pandemic…”


Source: www.theweek.com

 

 

Overview…”don’t buy the dip”

  • Moves: risk off… stocks , bond yields , curve , credit spreads , volatility and oil ….
  • Public holiday here yesterday in most states, with markets closed, so today we have two offshore trading sessions to factor in…both very rough sessions with US CPI coming out Friday last week higher than expected (+8.6% YoY vs +8.3% YoY cons.).  Chinese official have also walked back some of their planned lifting of COVID restrictions as cases flared up again.  Supply chain issues remain a problem.  For the past two offshore trading session, bonds have been belted from pillar to post with yields at decade highs, and the 2s10s curve has inverted…just.  Stocks have been smoked, formally entering a bear market, down over 22% peak-to-trough. Credit (CDS) sold off in line with stocks and volatility in general.  Oil advanced despite growth concerns.
  • It’s all about the Fed this week.  Markets are now asking the question, does the central bank need to drive the economy into a recession in order to supress inflation?  And the answer at this stage seems to be a resounding YES.  The FOMC meets later this week with markets now punting on +175 bps of rate hikes between now and September, which suggests two +50 bp hikes and a +75 bp hike, or +100 bps and +75 bps.  Should either of these scenarios play out, it’ll be the most aggressive Fed since 1994…and for old school bond people, you’ll know how significant that is.  Ahead of the FOMC, Fed members are in black out mode, so no comments on the data.
  • Talking heads…”it’s going to get a little uglier.  It’s going to be very hard for stocks to rally when the Fed continues to put hawkish pressure. There’s no way they can slam on the brakes with inflation without slamming on the brakes economically speaking. It’s funny we still have recession deniers.”  Pundits are now pegging recession probabilities at 50% and above.
  • Fed speak (kind of)…”as the Fed attempts to boost its credibility on inflation, it could reach for a more drastic increase if it’s compelled to demonstrate a “Volcker moment,”said Steven Englander, global head of Group-of-10 currency research at Standard Chartered Bank. He was referring to Fed Chair Paul Volcker, who crushed inflation with a series of historic rate increases, starting in 1979. With that possibility, Englander predicts there’s a 10% chance of a 100-basis-point increase Wednesday — with his baseline still a half-percentage point increase.” (Bloomberg).
  • Former Treasury Secretary Summers on Sunday said a recession was likely in the US within the next two years, while a recent CFO survey by CNBC found all CFOs expecting a recession, while 68% expected one to occur during the first half of 2023. Morgan Stanley’s CEO just on the wires is tipping a 50% chance of a recession, up from his prior estimate of 30%.” (NAB)

 

 

The Long Story….

  • Offshore Stocks – the S&P 500 puked again last night, down 3.0%, and down -22.0% YTD, technical a bear market, however many pundits fear the market has further to fall, a view I have empathy for.  Softening consumer demand and aggressive tightening by the Fed can and will take its toll on corporate earning’s profiles, which in turn should put downward pressure on PE’s.  Forward PE’s on the S&P 500 are at 16.4x, well down on levels at the  beginning of the year (22.8x), but in the context of earning’s headwinds, still a little on the frothy side.  Post financial crisis lows have been around 11.4x in 2011, which came off the back of the European sovereign crisis.  Technicals are approaching ‘oversold’ territory (chart below), which in recent past has shaken loose some dip buyers, however this time around you have to question the likelihood of any saviours here given such an uncertain outlook.  Some soothing words from the Fed might help, but they’re losing credibility at a rapid rate of knots, so not sure what they could really say that would help the cause.
  • “The last bulwark in stocks is in danger of shattering, if the mood of chief executive officers is any indication. A survey of sentiment among corporate stewards by the Conference Board showed that CEO confidence declined sharply in the second quarter of the year for the fourth straight time. Similar scepticism in the past has always coincided with a recession in profits.” (Bloomberg).

 

  • S&P 500 relative strength indicators


Source: Bloomberg

 

  • Local Stocks – Friday’s close in the local market is largely irrelevant given what happened in the US on Friday night, and again last night as markets continue to digest what the Fed will do as the inflation genie is well and truly out of the bottle and shaking its blue backside at the Fed with disdain.  Nonetheless, we had a soft end to the week with the ASX 200 down -1.3% on Friday and down -4.2% month to date.  All bar two sectors fell on the week, those being Energy (+5.0%) and Utilities (+0.5%).  Elsewhere it was all red, with Financials (-9.0%) worst of the worst, followed by REITS (-7.6%) and Tech (-4.8%).  Futures are pricing in a grim day, down -2.7%…which would probably be a good day to be honest, I would have thought something at least around -3.0% as the likely end result…probably will be in the end.,
  • Optically, the ASX 200 is back around its long run trend (1990 – now) at 6931, give or take, so the recent sell off has just taken some pandemic driven froth off the top.  Not that being at the long run trend level would halt any slide.  Today’s expected decline notwithstanding, further meaningful downside is still plausible and let’s be honest, very much probable.  I have 6300 – 6500 as my next target level, likely in the next 2 – 3 months if central banks behave as required.  So, that suggests another -10.0% down side (give or take) from here.  Caveat, I’m a credit / bond guy, so take that with a grain of salt.

 

  • ASX 200 relative strength indicators…


Source: Bloomberg, Mutual Limited

 

  • Offshore credit – given the poo-storm across risk markets, any issuers considering coming to markets overnight wisely stepped away and put the cue back in the rack.  Nevertheless, forecast IG issuance for the week is US$25bn – US$30bn, which is the standard forecast these days.  In synthetics, CDX closed +7 bps higher, while MAIN was +6 bps higher.  Senior Financials were +9 bps and Subordinated Financials +18 bps higher.  Cash spreads were wider, with US IG +3 – 5 bps, while EU IG was +10 – 11 bps wider.  High yield spreads under pressure also, +34 – 54 bps wider across EU HY and US HY.

 

  • Cash spreads proving somewhat resilient to volatility elsewhere…12 month view


Source: Bloomberg, Mutual Limited

 

  • Local Credit – traders…”a quiet end to the week as we await a seminal US CPI reading. Domestic spreads showing some resilience here, though we would comment that secondary market price dispersion remains elevated as sell side dealers refrain from providing bid side liquidity which in turn drags independent mids wider forcing the brave few who do still provide liquidity to take an instant mark to market hit. Pleasingly, we are seeing ongoing reengagement from a number of domestic accounts with the secondary markets and we expect this to continue as the primary pipelines remains light.”  Pleasing comment, but key point is sentiment and ergo liquidity is fragile at present.
  • And on banks…”mid curve buying from one prominent domestic account was the highlight of the day, joined late on by another. Have we seen the near term wides in senior spreads..? We are inclined to think we have. The curve still looks too flat to us and whilst we do not expect further domestic supply from the majors, we do think that ADI issuance from offshore banks may preclude further flattening. As for the front end, it remains heavy with street inventory abundant though we are starting to ‘feel’ things thing a bit: dealers aren’t as aggressive on the offer as in weeks past. The issue is that there are a number of lines on the curve that have been heavily sold by domestic bank balance sheets and have now taken up residence on dealer’s trading books precluding any curve steepening.”  I’m still confident spreads have peaked for now, and expect spreads to consolidate around current levels.  Risk to this view is a return to primary from one of the majors, in size at least.
  • May-27 maturing major bank senior paper is quoted at +96 bps, which is -4 bps on the week, whereas indicative curve is at +104 bps.  As such I’d say any new deal would likely come around the +105 – 110 bps area.  If anyone is to come, it’ll be ANZ as they’ve been absent for a while.  Having said that, they have been clear in signalling they’ll issue as required, rather than issuing ahead of time.  Three-year major bank senior is at +81 bps, which is -3 bps on the week and the curve is at +79 bps.  Offshore volatility shouldn’t push spreads wider in isolation, although I suspect liquidity conditions might seize up a bit, at least until we have some clarity around what the Fed will do.
  • A quick note on my previous comments on tier 2, specifically CBA’s Apr-27 callable.  It appears Bloomberg has a gremlin in the system and callable paper is defaulting to YTM once they go sub-par.  So, that +210 bps I quoted on CBA’s line last week, is really +226 bps.

 

  • Major bank 5-year vs Bloomberg AusBond Credit FRN Index…


Source: Bloomberg, Mutual Limited

 

  • Bonds & Rates – never mind where we ended on Friday, it’s irrelevant…other than a starting point for today’s likely rout.  When local bond markets closed on Friday our time, US 2-year treasuries were yielding 2.81% and 10-year yields were at 3.04%.  Over Friday night and then again last night, yields have surged +56 bps and 33 bps respectively as markets price in a more aggressive rate hikes with +75 bps moves now firmly on the table (at least in the market’s collective mind).  Markets are no pricing a terminal Fed Funds rate at 4.0%, levels not seen since before the financial crisis.  In the history of the Fed Funds Rate, still a ‘modest’ level with a long run average of almost 5.0% (1971 – now) – peaks of 20.0% and lows of 0.25%…of course the post financial crisis average is ~0.75% and the volume of outstanding debt now vs the distant past is exponential!  As at the end of 2020 global outstanding debt was estimated at US$226 trillion, or 256% of global GDP, having increased more in 2020 than any other year since WWII.  Debt-to-GDP in 2009 was 215%, and ~110% in the early 1970’s when the world was last confronted with a meaningful inflation problem (source: IMF).
  • While our inflation story is not as alarming as the US, there is nonetheless a very high correlation (>90%) between US treasury yields and ACGB yields, so local bonds will be smacked over the back of the head today, with a particularly large and rancid wet fish!  I think futures are pointing to a +25 bps move in 10-years, which would take yields to around 3.90% – 3.95%, levels not seen since 2013.  Postscript, bond market just opened – 3’s are +33 bps higher at 3.45% and the 10’s are at 3.93%, +25 bps, bank bills are +7 bps to 1.61% (90D).

 

  • RBA Cash Rate vs Fed Funds Rate…


Source: Bloomberg, Mutual Limited

 

  • A$ Fixed Income Markets…


Source: Bloomberg

 

  • Macro – US CPI (core) was a shocker on Friday night our time, +8.6% YoY vs +8.3% YoY consensus, or +1.0% MoM vs +0.7% MoM consensus.  As per above comments, this sets the stage for some interesting conversations within the halls of the Federal Reserve.  Ahead of the meeting later this week, Fed members are in black out, so unable to comment on the data.  Accordingly, the statement and subsequent presser from Chairman Powell will be closely dissected.  It’s not all doom and gloom, there are glimmers of hope, at least in the data.  Below is a chart of US CPI vs dry-bulk shipping costs, which shows a reasonable degree of correlation and we can observe that shipping costs have declined – but still elevated vs historical ranges…of course, costs elsewhere have risen, so it’s still a very uncertain set of circumstances.
  • Some comments on the CPIU specifics…”headline inflation was a full three tenths higher than expected at 1.0% m/m against 0.7% expected, taking the annual rate to 8.6% y/y and its highest since 1981. The core measure was also one tenth more than expected at 0.6% m/m against 0.5% expected, with the annual rate at 6.0% y/y. Alternative core measures suggest the breadth of inflation pressures has actually picked up with the Cleveland Fed Trimmed Mean at 0.8% m/m, its highest in the history of the series which dates back to 1983. Ditto for the y/y version at 6.5% y/y. Fed officials in the lead up to the FOMC meeting on Wednesday said they would be looking at the monthly inflation prints to see whether the Fed moves back to 25bp hikes from September, after two 50bp moves in June and July. Clearly the foot will still have to be on the pedal.” (NAB)

 

  • US CPI vs the bulk dry index (shipping costs)…


Source: Bloomberg, Mutual Limited

 

  • Charts:

 

 

 


Source: Bloomberg, Mutual Limited

 

Click here to find the full PDF from our Chief Investment Officer’s daily market update.

 

 

 

 

Contact:

Scott Rundell, Chief Investment Officer

T: +61 3 8681 1907

E: Scott.Rundell@mutualltd.com.au

W: www.mutualltd.com.au

 

 

Mutual Limited Daily Update

Mutual Funds

MCTDF – Mutual Cash Fund
Gross running yield: 0.78%
MIF – Mutual Income Fund
Gross running yield: 2.07%
Yield to maturity: 1.78%
MCF – Mutual Credit Fund
Gross running yield: 3.34%
Yield to maturity: 2.99%
MHYF – Mutual High Yield Fund
Gross running yield: 6.00%
Yield to maturity: 6.02%