Mutual Daily Mutterings
Quote of the day…
“Social media made y’all way too comfortable with disrespecting people and not getting punched in the face for it” – Mike Tyson
“No @#&$ Sherlock…!”
Overview…”cheaper, but still not ‘cheap’”
- Moves: risk off… stocks ↓, bond yields ↑, curve ↓, credit spreads ↑, volatility ↑ and oil ↓….
- No respite in risk markets overnight, although the flow of bloodletting was staunched somewhat, with the S&P 500 up intra-day. By day’s end the index had dropped half a percent on lingering concerns around inflation and the Fed’s immediate term response. Predictions of a 2023 recession are coming thick and fast. With the FOMC tonight caution was the primary sentiment with markets now pricing in a +75 bp hike vs a +50 bp hike just a week ago. Oil came off after OPEC released forecasts of future demand materially lower than previous as the global economy is expected to slow.
- The treasury rout continued, making it the worst sell-off since 1994, which hitherto has been a date of infamy amongst crusty old bond traders and portfolio managers alike. For some context, amid an aggressive hiking cycle (from 3.00% to 6.00%), US 10-year yields rose +180 bps (to 7.50%) in the first six-months of the year, peaking at +231 bps (8.03%). Year to date now 10-year yields have risen +196 bps (to 3.47%), so the rate of change is larger vs 1994, but so far, the destination (yield) is more than half of what it was in 1994. For the record, CPI back then was +2.75% YoY, and trending lower.
- Talking heads…”the volatility today is a testament to the uncertainty going into the FOMC meeting as well as concerns about the impact such an aggressive ramp of tightening could have the economy. The 75-basis-point possibility was a far-flung risk this time last week, so market participants are having to quickly revisit Fed, economy and market forecasts.”
- A Bank of America monthly fund manager survey indicates that fears of stagflation are at the highest since the financial crisis in 2008, while at the same time optimism around global growth rates has sunk to a record low. Global profit expectations have also fallen to levels last seen around the financial crisis. Analysis by BoA strategist points to the fact that prior troughs in earnings occurred during other major Wall Street crisis, specifically Lehman Brothers going kaput and the bursting of the dot-com bubble.
- All eyes on the FOMC tonight, I’d suggest 80% chance of a +75 bp rate hike, with more likely, but also might throw a small outlier into the multi and say there is a 10% chance of a +100 bp hike, and 10% chance of a +50 bp hike. Unfortunately the latter presents a lot of risk to the Fed’s credibility, so if they’re attuned to how far behind the curve they are, they can’t realistically consider the smaller hike….can they?
The Long Story….
- Offshore Stocks – some 65% of the S&P 500 fell overnight, which saw the broader index down -0.4% by days end – was up +0.8% at its peak intra-day, but sentiment waned as the day wore on. Two sectors gained ground, Tech (+0.6%) and Energy (+0.1%), while worst of the worst was Utilities (-2.6%), Staples (-1.3%), and Healthcare (-1.1%). Forward PE’s are optically suggesting the S&P 500 has cheapened, at 16.3x vs 19.9x 5Y average, which it has, but it’s not cheap. Forward EPS underpinning these multiples are stale and don’t reflect earnings headwinds – adjustments over coming months are likely as analysts digest reporting season commentary.
- Talking heads…”this is one of those environments where it is getting rougher. In our index, we’re seeing some nascent, but I would argue, not fully-throated signs of oversold conditions. So, it’s flashing like this weird and somewhat inconvenient weak buy signal — as opposed to like some sort of really strong oversold capitulation, high-conviction buy signal.” With this in mind I think any new allocations to stocks will sit in cash for the time being. Patience is required as it’s better to miss the bottom and buy when markets are ascending than to try and pick the exact bottom. A slightly more optimistic take… “Fed rate hikes and global central bank tightening will bring about slower growth. The question is how fast growth needs to slow to generate a policy-friendly inflation trend. Slower growth that doesn’t trigger a sharp recession, should lead to both lower 10-year yields and a lower equity risk premium. Under that backdrop, there is a good amount of upside to equities.“
- US stocks are now in their fourth bear market in the past twenty years – chart below. With the exception of COVID, which was a true exogenous shock caused by real world problems, other bear markets have stemmed from financial engineering gone wrong). The COVID bear elicited extraordinary fiscal and monetary response, which in turn, turned the market frown upside down and stocks rallied aggressively. In each prior bear market however, support was more monetary policy in nature (and arguably the root of our current problems) and we can see the recovery took materially longer. Given the prevailing headwinds and uncertainty, and limited chance of further Fed support, or meaningful fiscal stimulus, the recovery this time around will likely resemble the dotcom bust and the 2008 financial crisis…slow.
- S&P 500 history of bears…
- Local Stocks – local markets digested a couple of day’s of offshore changes given the long weekend. Net effect was a -3.6% drop in the ASX 200, with 92.5% of stocks losing ground and not surprisingly every sector was in the red. Energy (-4.9%), Tech (-4.5%) and Materials (-4.4%) occupied the podium of mediocrity, while Financials (-3.7%) deserved a dishonourable mention at fourth worst. Utilities (-1.8%) probably did better than most in that only 67% of stocks in the sector retreated, with Healthcare (-2.6%) next best with 79% retreating. Forward PE’s are down to 13.5x, cheaper, but probably not cheap in the context of earnings headwinds and stale EPS forecasts in the system, i.e. forward EPS numbers remain at all-time highs despite inflation concerns and tightening financial conditions…cray cray!
- ASX 200 relative strength indicators…
Source: Bloomberg, Mutual Limited
- Offshore credit – the main focus last night was the fact that CDX index cracked the tonne and raised the bat, 100 bps intra-day, closing just shy at 99 bps (+0.5 bps CoD). MAIN was +3 bps higher at 108 bps, while Senior Financials were +2.5 bps at 122 bps and Subordinated Financials closed at 233 bps (+5 bps CoD). Cash spreads are drifting again, with European IG underperforming US IG. Given FOMC meeting and broad market uncertainty, primary markets were quiet.
- Offshore cash spreads drifting wider on broader risk off tone …12-month view
Source: Bloomberg, Mutual Limited
- Local Credit – I was generally right in my expectations around local risk sentiment, i.e. one of resilience and caution, but wrong in that I expected less movement in spreads. Traders are noting no panic selling and in fact pockets of strength, in that select parts of the market are happily soaking up what selling there was. Liquidity remains “opaque with bid offer spreads elevated.” The major bank senior curve steepened a touch with recently issued 5-year paper quoted at +101 bps (+4 bps CoD), still inside issuance levels (+105 bps) and 3-year paper quoted at +84 bps (+3 bps CoD). Importantly for my ego, spreads remain below levels where I call the ‘peak’ in credit spreads.
- Tier 2 held up well, wider by +3 – 5 bps, but resilient in the face of deteriorating risk sentiment. CBA’s Apr-27 call is at +229 bps (+3 bps CoD), while the 2026 calls are at +215 – 223 bps (+3 – 4 bps CoD) and the 2025 calls are at +202 – 203 bps (unchanged). Given continued caution in broader markets we might see further drift in spreads over coming days, especially if the FOMC produces anything fruity for markets to digest, what’s the risk they break out the ‘Big Bertha’ and hike by +100 bps? Importantly for now, we’re not seeing elevated selling, which signals to me that there has been no meaningful spike in fund redemptions. (Note: Big Bertha was a golf club back in the day, can’t remember the brand, but we sold it at Rebel Sport when I worked there during my uni days. I just checked, it was a Callaway, and they still exist…)
- Returns for fixed only credit managers are looking catastrophic. The Bloomberg AusBond Credit (FXD) index lost over 100 bps yesterday and is down -2.33% month to date, and -8.63% year to date. So far, it has been the third worst month since the index’s inception, and is more than 2x worse than the worst month during the financial crisis (-1.03%, Feb-08). Over in Mutual Limited’s sand-box, things a looking much calmer. The Bloomberg AusBond Credit (FRN) index is down -0.01% month to date and -0.41% year to date. Three-month bank bills peaked yesterday at 1.71%, but are now quoted at 1.61%, still +35 bps month to date. With regard to the pain and suffering felt within the fixed rate universe, specifically fixed credit, the index is down -8.63% year to date as per above, with underlying yields up +151 bps year to date (to 4.75%). In the floating rate space, bank bills are up +154 bps, yet the index is down only -0.41%. And, that’s the impact of duration. In a rising inflation and interest environment, floating rate notes trump fixed rate bonds. Just saying…
- I’m somewhat comfortable with local bank’s abilities to withstand the challenging times ahead. Key amongst my ‘likes’ of the local banking system is the strength of regulatory oversight provided by APRA. To this end, a couple of announcements yesterday added to this. In the interest of time, I have lifted some brief Citi commentary: “APRA finalised its APS 220 standard, relating to Credit Risk Management. Essentially this codifies APRA’s ability to set limits on particular types of high-risk lending at particular banks if it deems too much risk is being generated at a system level. Under the revised standard, banks must be operationally prepared to implement certain macroprudential policy measures, if needed. More specifically, banks will need to have systems in place to limit growth in higher risk residential mortgage lending, such as loans at high debt-to-income multiples or high loan-to-valuation ratios. The standard also clarifies that there will be very limited carve outs to proposed lending limits, for example construction loans (given their role in contributing to housing supply). In addition, Buy Now Pay Later (BNPL) and HECS-related debt will also not be carved out of debt-to-income calculations. Note that the finalised standard contemplates potential further macroprudential measures at the bank-level, rather than a system-wide level.”
- Also from APRA, their quarterly performance stats for the banking system. Again, I’m pilfering comments from Citi in the interests of time, but the key outtake is the banks are tightening lending standards, which should moderate lending growth and therefore wholesale funding needs…”APRA data for the March quarter showed that there was a slight tightening in mortgage lending standards during the period, at least relative to the preceding quarter. Firstly, the proportion of new mortgages with borrower debt to income > 6x moderated slightly from 24% in Dec21 to 23% in Mar22. Secondly, the proportion of new mortgages being funded with LVR > 90% decreased to 7.3% in Mar22 (vs 7.9% in Dec21). Thirdly, the weighted average interest rate buffer used for servicing assessments increased to 3.1ppt (vs 2.9% in Dec21) – which is consistent with APRA’s recent requirement that banks use a minimum interest rate buffer of 3ppt when making loan assessments. Overall, it does look like the banks are tightening lending standards at the margin (as observed by the above metrics), after a number of these measures loosened throughout 2H2020-2021.”
- Bonds & Rates – a tough day in the trenches for duration managers yesterday. Bonds were taken behind the woodshed for a decent old roughing up, which every man, women, dog and anything else in between were expecting given US leads. ADGB 10-year yields closed at 3.96% (+28 bps CoD), but were up over 4.00% at one stage through the day. More carnage at the front of the curve with 3-yearf yields closing +34 bps higher at 3.46%. The Bloomberg AusBond ACGB index dropped over 1.60% yesterday, taking month to date losses to -3.20% and year to date losses to -11.52%…semi’s were equally pummelled, down -3.25% month to date and -11.43% year to date.
- There will be little respite today for local bonds. Overnight, US treasuries continued to sell off ahead of the FOMC, which commences tonight and is expected to see the Fed deliver a +75 bps hike and potential guidance of another +75 bp move at the next meeting. If the Fed wants to regain any credibility, they need to go hard, and they need to go now. They are a good six-months behind the curve. US 10-year yields rose +12 bps overnight to 3.477% and 2-year yields rose another +8 bps to 3.439%. Curve inversion has reared its ugly noggin, with 3s10s inverted, 3.59% vs 3.47%. Historically yield inversion has been a precursor to recession, which is looking more likely in the US, with many market pundits calling such 2023.
- RBA Governor Lowe was on the 7:30 Report last night, a rare interview for him outside of normal and scripted speeches. I missed it, so borrowing some commentary from ANZ…”RBA will do “what’s necessary” to get inflation down to 2-3% over time: You know its unusual times when the Governor of the RBA appears on ABC’s 7.30 program to be interviewed by Leigh Sales. Inflation was characterised as “too high” and likely to get to 7% by the end of year. He made it clear the RBA would do “what’s necessary” to get inflation back to target. When pushed what this means for policy, he said that “it’s unclear at the moment how far interest rates will need to go up to get that”, though he also said it was “reasonable” to think interest rates could reach 2.5% at some point.” Given these comments and offshore leads, local bonds will face selling pressure today.
- US treasuries…3s10s inverted
- A$ Fixed Income Markets…
- Macro – US inflation commentary from ANZ…”the US May PPI rose 0.8% m/m, up 10.8% y/y vs 10.9% y/y in April. Core measures were less dramatic, rising 0.5% m/m, but still signalling high pipeline inflationary pressures. Most of the rise in the headline index resulted from higher energy costs. Service prices rose 0.4% m/m following a 0.2% drop in April. Meanwhile, the May NFIB Small Business Optimism survey was little changed (down 0.1), but the details were mixed. Plans to hire rose to 26% vs 20% and firms reporting positions not able to fill rose to 51% vs 47%. 49% of firms reported increasing compensation and 47% of firms plan to increase it, indicating robust nominal wage growth. However, the balance expecting a better economy fell to -54%.”
Source: Bloomberg, Mutual Limited
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Scott Rundell, Chief Investment Officer
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