Mutual Daily Mutterings
Quote of the day…
“Christmas is a time when kids tell Santa what they want and adults pay for it. Deficits are when adults tell the government what they want and their kids pay for it” – Richard Lamm
Chart du jour… bonds vs stocks…
“And we have what to show for it…?”
Overview…”profit taking or change in risk appetite?…”
- As of late last-week, the omicron variant and the prospects of a tapering and hiking Fed were nothing but a thang. Stocks rallied, bonds rallied…wait, what? Scroll forward to today and apparently the omicron variant might be a concern after-all, and heck, the prospect of less generous monetary policy settings in the face of pandemic uncertainty and elevated valuations just might be a concern. So, last night we saw a broad-based sell-off across US and EU stocks. With no discernible catalyst on the day, the narrative is reaching for the “year end profit taking” go to card (returns are +20% – 25% across core indices), or possibly “a cyclical change in risk appetite”. Both make sense fundamentally, but come tomorrow these themes could be lining the bottom of a bird cage somewhere. Bond yields continue to rally also, suggesting rising growth concerns, among other things.
- Talking heads…”the Fed’s pivot to a more aggressive tapering schedule poses a larger risk for asset prices than most investors believe. Good news, supply is improving, but will it arrive at the wrong time?” And…”we do not expect the Fed to slam on the brakes to choke off liquidity, but rather look for it to “pump the brakes” as lightly as it can as it takes the mechanisms of emergency stimulus off gradually,” and lastly “as long as the Fed doesn’t provide a materially hawkish surprise this Wednesday (something that’s possible, but unlikely), stocks can rally into year-end on momentum, even if valuations are again stretched.”
- Inflation watch…according to a survey conducted by the Fed of New York, inflation expectations among US consumers rose to a new high of 6.0% for the coming year. The study indicated that Americans foresee faster price increases for items like housing (rent) and foodstuff, which take up a big chunk of household spending and can’t easily be substituted.
- The FOMC meeting kicks off tomorrow with consensus expecting the Fed will accelerate its tapering plans and signal rate hikes in 2022 this week. More than half of surveyed economists predict the Fed’s quarterly forecasts will show two hikes next year from current levels near zero. “It’s going to be the biggest hawkish shift in the history of the dot plot.” Elsewhere, the BOE follows and then the ECB on Thursday and the BOJ on Friday.
The Long Story….
- Offshore Stocks – down from the get-go in US stocks, although the trend into the close appeared to be on the improve, but then softened again in the dying minutes. The S&P 500 closed down -0.9% with 64% of stocks in the red. Tech took it in the neck, with the NASDAQ down -1.4%, while the DOW was down -0.9%. European markets were also softer, with the spreading omicron variant and new restrictions weighing on sentiment. “The ghost of the tech bubble could soon come back to haunt investors as hefty valuations may be threatened by the likely tightening of monetary policy. The S&P 500’s long-term price-to-earnings ratio — which compares the current price with the 10-year average real earnings per share — has reached 37, a level last seen in 2000.” (Bloomberg).
- Local Stocks – modest gains in the ASX 200 yesterday (+0.4%), but the index stayed well within recent trading ranges, with advancing stocks only just outnumbering retreating stocks, 55:45. Energy (+1.7%), REITS (+1.7%) and Materials (+1.6%) dominated the leader board, with the latter contributing the vast majority of gains. Financials (-0.3%) were the main drag on tone, ably supported by Healthcare (-0.3%) and Discretionary (-0.1%). YTD the ASX 200 is up +12.0%, well behind its US peers (+17% – 25%) and EU peers (+12% – 25%), but well ahead of regional peers that have ranged from losses of -12.0% (Hang Seng) to gains of +4.4% (Nikkei). Weak offshore leads have futures in the red, -0.4%.
- Local Credit – winding down into year end with flows on the lighter sider as traders and portfolio managers interests switch from punting bonds to seeing how far they can stretch the entertainment budget for year end lunches. I once heard a story about a PM who told his sales representative that he didn’t want an end of year lunch, rather the sales person should meet him at Bunnings, where he proceeded to point out the new tool box he wanted instead. Compliance was brought into it and said PM got the boot. Back to credit, no change in major bank senior spreads, while tier 2 paper continues to grind a tad tighter, -1 bps to unchanged on the day. Buying was seen coming out of Asian private banks and some modest local buying. Technicals softening into year end, so spreads likely to remain range bound.
- Bonds & Rates – bonds rallied with a bull flattener on the day, which is counter-intuitive given growing prospect of a tightening Fed. The theme persisted overnight with a meaningful -6 bps drop in 10-year yields despite the Fed expected to formally kick off its tapering agenda and flag likely rate hikes next year. The fall likely reflecting concerns around growth outlook in an environment where monetary policy settings are less accommodative than that have been, especially amidst historic outstanding debt levels. While US 10-year treasuries have traded in a fairly wide 1.17% – 1.70% range over the past quarter, currently 1.42%, 2-year yields have been trending higher directionally, up from 0.21% at the beginning of the quarter to 0.64% current (and 0.69% peak). Consequently, the slope has flattened from 130 bps to 77 bps since the end of September. Similar, the ACGB curve has flattened, in from 120 bps to 70 bps as markets price rate hikes in the front end, and growth concerns out the back end…which to me signals a short’ish hiking cycle this time around, coz rising debt costs amidst a mountain of debt will create growth headwinds.
- This snippet from the wires highlights the risk to fixed rate bonds over the coming year or so… …”traders are losing more money than they have in 40 years and things are unlikely to change any time soon. Bonds have already lost about -2.0% outright over the past year, but with CPI surging 6.8% investors are even deeper in the hole. Moreover, markets are projecting that 10-year yields will hold below the inflation rate for the next decade, meaning any investment income will be more than wiped out by the rising cost of living.” While the comment refers to US treasuries, the themes are equally applicable to ACGB’s. Now, while AU CPI and US CPI are not necessarily correlated (nothing meaningful), there is a very strong correlation between treasuries and ACGB’s (>90%).
- Offshore Macro – a quiet session in terms of macro news. Focus now turns to the FOMC tomorrow, and the ECB and BOJ later in the week.
Local Macro – NAB Business Conditions and Confidence out today, the only data of note.
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Scott Rundell, Chief Investment Officer
T: +61 3 8681 1907