Mutual Daily Mutterings
Quote of the day…
“Spilling whiskey is the adult equivalent of letting go of a balloon”.…random
Chart du jour: global debt vs global wealth
“Dear Leader Indeed…”
Overview…”a good start, but will it last…”
- US reporting season is front and centre and for the time being plastering over some of the broader issues markets have been dealing with, namely inflation expectations and market implications. For now, earnings season is the new shiny-pretty-play-toy keeping the market gold-fish all frothed up with bullish vigour…until the next shiny-pretty bauble of narrative-of-the-month comes along.
- Last night brought the fifth straight session of gains for the S&P 500, with the index within a bee’s bum hair of new record highs. The index closed at 4519 vs its record high 4536 just over a month ago. Talking heads…”another week of upbeat results could be the boost that bulls are after to recapture those record levels.” And this…”this earnings season could be highly important for investors, as inflation, labour, supply, and currency risks settle in…we will be particularly attuned to companies’ guidance on the path ahead and whether higher costs could reduce corporate margins.” The latter point will be telling, and it’ll take a few weeks for a more substantial tone to emerge, once a more balance pool of companies have reported.
- The near record highs is stocks is somewhat hard to fathom given the messages bond markets are sending, and obviously the rising spectre of inflation and potential accelerated rate hike cycles. For the time being, it would seem the Fed and RBA are the only two central banks resolutely standing by their ‘transitory’ inflation calls, and stocks are drinking the Kool-Aid.
- Bond yields continue to rise globally with US 10’s up another +4 bps, while the 2’s bucked recent trends and dropped, producing a bouncing baby bear steepener. On the Fed, some speakers out and about, with the general theme that tapering should kick off next month, but that rate hikes are “still some time off.” A favourable view on the Fed’s actions is this…” “they’re probably going to be very careful and cautious on rate hikes because of the fact that they just don’t have enough information on the inflation front…we didn’t see the market fully price in three hikes by the end of 2023. And now you’re going to see a little bit of adjustment based on what the Fed’s saying.”
- Offshore Stocks – generally a positive session from the get-go, with the NASDAQ leading most, up +0.7%, followed closely by the S&P 500 (+0.6%) and DOW (+0.6%). European markets up modestly also, everyone’s a winner! Within the S&P 500 almost three-quarters of stocks closed higher and only Discretionary (-0.3%) stumbled. Healthcare (+1.3%) was top of the pops, followed by Utilities (+1.3%) and Energy (+1.1%). US reporting season passed 10% reported (S&P 500) with aggregate sales up +12.4% on the pcp and earnings up +34.7% on the pcp. So far, between 83% and 85% of companies have reported growth in sales and earnings, which is higher than recent (past 5 years) average (~65% – 75%). Against expectations, aggregate sales have beaten to the tune of +2.1%, while earnings have beaten by +13.0%. Only Discretionary has recorded any meaningful misses with earnings -8.9% shy of expectations.
- An outtake on US reporting season, highlighting the impact inflation can have on earnings…Proctor & Gamble, a global consumer products behemoth dropped -1.2% (troughed at -2.0% intra-day) in an otherwise up day. The group’s quarterly results reflected a sizeable quarterly margin miss, impacted by rising commodities, transportation and packaging costs. The company also guided that they saw meaningful EPS headwinds from continued commodity and freight cost issues well into 2022. This is not a small company, this is a company with scale benefits and buying power, a company that realistically should be able to pass through these costs. What does it mean for smaller firms, without such buying power and competitive strengths? Nothing good I’m thinking. An RBC check of 23 S&P 500 companies that had reported from Oct. 4 through Oct. 15 showed inflation was a key topic among supply-chain issues, second only to labour concerns. The key risk, and this is probably what the Fed is worried about is if inflation becomes entrenched in consumer expectations, then it becomes self-fulfilling. Accordingly, they keep calling it ‘transitory’. Only time will tell whether its worked, or they’re just peeing in the wind.
- Local stocks – very modest losses on the day, rounding errors perhaps, certainly no thematic change of note. Uppers vs downers were roughly even at the stock level, while at the sector level there was more red than green, 6 vs 5. Tech (+1.6%) dominated the winner’s circle, sharing the limelight with REITS (+1.0%) and Healthcare (+0.8%). Meanwhile, Materials (-1.4%), Energy (-0.7%) and Telcos (-0.5%) were left to muck out the stables. Solid leads provides’ for confidence for the day ahead, futures are up +0.6%.
- Global credit – S&P has commented on the path of potential default rates…”we expect that the combination of strong recovery prospects for CCC rated companies and less supportive governments and financing conditions would lead the strongest companies to be upgraded and the weakest to default,”…hmm, not the most insightful comment in hindsight, some might fail, some might not! Regardless, the crux of their comments is that zombie companies have been fed a diet of fresh meat over the pandemic, and by fresh meat I mean highly accommodative monetary and fiscal policies. A rebounding global economy and investor hunt for yield has also encouraged them. As these “key lifelines” fade, the zombies will drop (default).
- Local Credit – traders reporting real money sitting on the sidelines as outright yields bump and grind every which way. The main focus for some was Bank of Queensland mandating banks for a 5-year A$ deal. Traders thoughts….”a proactive move which may soak up some of the redemption proceeds from the forthcoming $1.5bln NAB maturity. Our view is this will land in the high 60’s assuming the deal size is commensurate with their A$600 maturity due on the 16th November. Given the regional bank’s reliance on domestic funding markets we hope this is well executed deal which resonates with the traditional real money buy base.” I sent out a note internally and landed on a likely spread area of +65 – 70 bps, so great minds think alike. For mine, the BOQ curve is at +66 bps for 5-year money, and I’ve added a few basis points for a new issue premium. Traders also reporting some switching ahead of the deal, which suggests there isn’t a whole lot of cheddar (cash) sloshing around. No meaningful movement in major bank senior or tier 2 paper.
- Bonds & Rates – see below for comments on the RBA minutes, but for the purposes of bonds and rates, the RBA reiterated its stance on inflation expectations (transitory) and first-rate hikes (2024). Nevertheless, the market is pricing in a full rate hike by August 2022 and +50 bps of hikes by the end of 2024. Soothing words around rate hike timing saw the front of the curve a little better supported – mainly the three-year’s, while the Apr-24’s, which are subject to yield curve control measures, were left to drift higher, +2 bps to 0.17% vs a TCC target of 0.10%. The RBA was absent in secondary. For mine, I think all the heavy lifting has been done with scope for further increases in yields, especially the front end, limited. On this, some thoughts from CBA…”there’s been episodes like this before, the most notable for recent memory was the selloff in February and March, which caused quite the premature extrapolation of market forecasts for bonds and swaps. Yields dropped from March onwards, hitting their lows in July/August. In terms of some reasoning, we make the clear point here that the RBA changed its reaction function to actual inflation rather than implied or expected inflation. Easy to say in hindsight after the market has made the move it has, and without doubt a move we had not expected for the front end. One thing to note is the longer end (10s and 30s) have not had the same move which goes to the heart of the view that the Australian economy, and others are more sensitive to a higher rates structure. As such we see yields falling from here across the yields structure and quite simply, too much is priced in to the front end and the market has asymmetric risk..”
- Some offshore colour…from Morgan Stanley…”Everyone is worried about tapering from the Fed, but the U.S. fiscal deficit should shrink dramatically next year….I don’t see a supply-side issue on Treasuries right now. Treasuries are the world’s risk-free asset. That’s not going away. The level of U.S. yields relative to the rest of the world is also very high, meaning the U.S. is a high-yielding alternative.”
- Local Macro – RBA minutes yesterday, which provided some clarity and insights into the central banks thinking around inflation. The key theme is, “we’re different,” i.e. in the context of inflation experiences and expectations offshore. Most recently the New Zealand CPI print, which blew the roof off, but also US inflation…also running hot. Why are we different…well mum says I’m special, but as for the RBA the starting point to this fable is Australian “patterns in wages growth differed across advanced economies. Some economies that were experiencing a pick-up in wages growth, such as the United States and the United Kingdom, were also those that had experienced relatively fast wages growth and higher inflation prior to the pandemic”; and thus “while disruptions to global supply chains were affecting the prices of some goods, the effect of this on the overall rate of inflation in Australia was limited. Wages growth and underlying inflation were expected to pick up only gradually as the economy recovers.” Wages growth (YoY) charted below vs CPI, which somewhat supports the RBA’s case. Accordingly, the RBA reiterated its expectation that inflation will remain within its 2.0% – 3.0% band on a sustainable basis, with no rate hikes until 2024. And, for this to occur, we need a tighter labour market, tight enough to driver wages materially higher. On broader issues, the minutes mentioned macro-prudential policies for financial stability purposes (i.e. rampant house price growth), over and above what has already been imposed. Further the RBA does not see a role for itself, here and now, in responding to rising house prices – which I agree with, rate hikes in order to curb housing prices is a pretty blunt tool, with meaningful collateral damage elsewhere.
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Scott Rundell, Chief Investment Officer
T: +61 3 8681 1907