Mutual Daily Mutterings
Quote of the day…
”Nuclear power is one hell of a way to boil water”…Albert Einstein
“The ol’ finger in the barrel strategy…”
Overview…”no end in sight…”
- Moves: modest risk on … stocks ↑, bond yields ↔, credit spreads ↓, volatility ↓ and oil ↑….
- Stocks ended the week on a firmer footing, taking weekly gains to +5.0% – 6.0% across US and EU markets. Bond yields were mixed with a modest bear flattening in US (2’s ↑ 10’s ↓). GILTS on the other hand put in a solid rally, -7 bps in the 10’s. Sentiment in credit markets firmed up, with spreads tighter across the board on Friday and the week. Oil drifted higher as more companies, including three of the world’s largest oilfield contractors, stepped back from Russia.
- Gauges of volatility in currencies, bonds and stocks eased over the latter half of the week as investors took comfort from news that China didn’t want to see the invasion of Ukraine, while the US warned them against supporting Russia. China, through its envoys, pledged to do everything to de-escalate the war, stating that its relationship was “not part of the problem”…certainly not part of the solution either.
- The Fed got back in the game, hiking rates 25 bps, the first of seven signalled hikes over coming months – six more to go, likely one per meeting according to the dot-plots. Fed speak…”Fed Waller noting that he favours front-loading rate hikes and is open to +50 bps moves; Fed Barkin saying he was ‘very open’ to a +50 bps move if inflation doesn’t moderate; Fed Bullard suggesting the Funds rate could be above 3.0% by year end while Fed Kashkari (a known dove) who now sees another six +25 bps hikes as the base case for this year.”(NAB)
- The Russian invasion of Ukraine entered its fourth week with little meaningful progress on Russia’s plans for domination, or the faux peace talks for that matter. The list of reported Russian war crimes continued to grow over the weekend with further “indiscriminate shelling of urban areas”. Russia also unleashed its prized hypersonic missiles (called ‘Kinzhal’ or ‘dagger’) in a bid to tip the scales in their favour…hypersonic missiles fly at 10x the speed of sound, so somewhat hard to detect and stop.
- Talking heads…”Russian operations have changed… a strategy of attrition that will involve into the reckless and indiscriminate use of firepower. This will result in increased civilian casualties, destruction of Ukrainian infrastructure and intensify the humanitarian crisis.”
The Long Story….
- The war impact so far….
Source: Bloomberg, Mutual Limited
Source: Bloomberg, Mutual Limited
Source: Bloomberg, Mutual Limited
- Offshore Stocks – modest gains across European markets, and same with US markets. With the Fed kicking off its hike cycle, most known risks are out of the box and before us. To set markets spiralling again we’ll need to see a material escalation in the Russia vs Ukraine conflict (i.e. nuclear) or policy error from the Fed, ECB etc. Conversely, if Putin has a personality transplant and becomes a good guy, calling the troops home, then we’ll have a good news bounce. For now, I suspect we’ll range trade. On Friday, in US markets, apart from a very modest hiccup in early trading, it was one way directionally. Around 70% of the S&P 500 rallied, while only Utilities (-0.9%) failed to get out of bed. Discretionary (+2.2%), Tech (+2.2%) and Telcos (+1.4%) led from the front.
- Local Stocks – more modest gains on Friday for the ASX 200 (+0.6%), taking weekly gains to +3.5%. Friday’s gains were underpinned largely by Materials (+1.3%), representing around half of the day’s gains. Line honours went to Energy (+2.2%), followed by Tech (+1.6%) and then Materials third. Only three sectors fluffed around without any gains, Discretionary (-0.8%), Staples (-0.4%), and Telco’s (+0.2%). Forward PE’s are at 16.3x, around pre-pandemic averages, 16.1x, but given headwinds and growth uncertainties, still to rich for my blood.
- Offshore credit – a reasonably busy week of issuance with Wall Street analysts predicting thirty-yards to be price din the IG space. Investment-grade supply has already reached US$158bn month to date, exceeding initial forecasts of US$135bn for all of March. There’s now a good chance supply could exceed US$200bon. Earlier in the month, a desire to lock in funding given the economic uncertainty — between Fed policy tightening and war in Ukraine — drove heavy bond sales. Now, lower risk premiums may encourage opportunistic issuers.
- Local Credit – traders…”an end to another chastening week in local credit markets, though evidence to suggest that the broad-based re-calibration of the past few weeks is almost complete.” Per comments above, offshore credit spreads seemed to have ceased widening and turning the corner now that the Fed is in play, and realistically the situation in Ukraine is becoming a grind, and tragically will become background noise for markets…unless Putin does something completely insane. In the local banks…”light flows as investors process the moves of recent weeks.” As for where we go from here, I still think there is some widening pressure. Any new major bank primary deal, in senior, has to come north of +100 bps (vs +90 bps for the Feb-27’s on Friday), at least in guidance. Which is quite boggling when you consider that we saw seven-yards of major bank 5-year senior paper print just two months ago around +70 – 75 bps. Regional bank spreads marched wider also, +25bps on the back of the A$ Bendigo Bank deal and then the USD$ Macquarie Bank deal. Major bank senior was largely unchanged on the day, but a couple basis points wider on the week. In tier 2, the drift wider had some legs still, +2 bps on the day and +6 – 9 bps wider on the week. The NAB Nov-26 is now at +180 bps, and with implied 5-year senior at +100bps, the next tier 2 deal will likely come with a 2-handle.
- Bonds & Rates – yields pushed higher again on Friday our time with ACGB 10-year yields hitting new three-year highs, 2.858% (+7 bps CoD), levels now not seen since the second half of 2018. Similarly, 3-year yields rose, also around three-year highs at 1.925% (+5 bps CoD). A modest easing in 10-year US treasury yields on Friday evening will likely see local yields ease off the gas a touch today. US 2-year rose a touch as markets continue to adjust for a tightening Fed. I think given growth headwinds, because of geopolitical shenanigans and monetary policy tightening, long-end yields are running too hot and will likely pull back at some stage. Consensus has ACGB 10-year yields at 2.33% by year end, so if consensus is to be trusted, we’re looking for a 20 – 30 bps pull back in yields. At this stage, fixed rate indices continue to soil the bed with ACGB’s, Semi’s and fixed credit sporting -3.5% – 4.4% losses YTD. Floating rate credit indices are down just -0.3%, although if our expectations of the overshoot in yields proves correct, there is scope for some pull-back from the brink.
- Macro – “it was a light data calendar session. The US existing home sales report was weaker than expected, falling -7.0% in the month of February (versus market median forecast of 6% decline) with housing affordability seen as a major challenge to buyers as house prices continue to rise (lack of stock an issue) as do mortgage rates.” (NAB). For the week ahead, not much in local markets to get hot and bothered about. RBA Guvna Lowe is speaking at the Walkley Awards for Business Journalism (tomorrow), and then we have consumer confidence. Offshore, it’s a mix of German PPI, UK CPI, and Eurozone PMI. The usual array of central bank speakers will be out and about spruiking their monetary policy snake oil, including the ECB’s Lagarde.
- Over the weekend we had the South Australian state election, which I have little interest in, but the result provides some colour on the state of the electorate’s mind. Comments from the chat lines this morning…”South Australia election landslide win for the ALP – 5.6% 2 party swing with ALP projected to win 28 seats to Libs 14 and Independents 5. Leaves NSW as only major Lib state. Implications for the Federal election (Oz): “Losing two House of Representatives electorates in South Australia would make the Morrison government’s bid for re-election even harder, given the Prime Minister goes to the May poll with only 75 seats. A minimum of 76 seats is required in the 151-seat House of Representatives. The opposition goes into the next election with a notional 69 seats. Winning two South Australian seats would mean Mr Albanese would only need a net gain of another six seats from the Coalition to become prime minister.” (BAML)
- Steak Knives… some analysis on equity market premiums from Bloomberg that struck a chord…”investors’ reliance on stocks to generate outsized returns has never been greater since the US came off the gold standard, highlighting how the market slump comes at a time when money managers need equities to perform the most. The ex-ante equity risk premium on U.S. stocks is currently around 11.7%, based on year-to-date Treasury returns and an assumed required rate of return of 7.0% from stocks. The Bloomberg Treasury Index, denominated in the dollar and unhedged, has incurred a loss of 4.7% so far this year.
- The measure of this year’s equity risk premium — the incremental return that investors need to justify holding stocks rather than a risk-free asset — is the highest in data going back to 1973. The expected return of 7.0% from equities is based on convention. Foundations, for instance, are typically required to spend at least 5.0% of their asset value every year, so their targeted returns are generally around 7.0%+, to account for an assumed 2.0% inflation and several basis points of research and running costs needed to generate those returns. If anything, with inflation running around 8.0% and one-year breakevens fast approaching 6.0%, the conventional number based on historical inflation estimates may understate the reliance on equities in the context of a 60-40 portfolio.
- The S&P 500 Index has declined about 10.0% this year, while the Nasdaq 100 basket has shed a fifth of its value from the peak seen last year. Those declines have come on the back of fears that the Federal Reserve may have to raise rates as many as seven times this year, taking its benchmark to 2.0%. If those expectations come true, equities stand to lose a key pillar of support. The S&P 500 Index almost doubled in value from the end of 2018 through 2021 as the Fed funds rate slumped from 2.5% to nearly zero.
- Concerns about higher rates have concurrently weighed on Treasuries, too, with two-year yields more than doubling to around 1.8% in less than three months this year. It’s questionable whether equities will be able to regain their peaks of last year in the current economic cycle should the Fed be successful in raising rates as envisioned.
- The findings suggest that money and pension-fund managers should recalibrate their expectations on expected portfolio returns this year given the geopolitical and macroeconomic backdrop. To be sure, investors in stocks can also factor in dividend income. While the dividend yield has improved to around 1.55% on the S&P 500, the price return required this year may still be too high. A limitation of the analysis is that it also assumes that Treasury returns in the remainder of 2022 will continue to be unimpressive. All told, an ominous combination of spiralling inflation and a higher rates trajectory pose a big question mark over equity-market returns going forward. The augury may not be all good.”
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Scott Rundell, Chief Investment Officer
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