Mutual Daily Mutterings
Quote of the day…
“I told him, ‘Son, what is it with you. Is it ignorance or apathy?’ He said, Barass, I don’t know and I don’t care.”.…Ron Barassi
Chart du jour…..credit spreads
Source: Bloomberg, Mutual Limited
Overview…”see-saw Margery Daw.…”
- Not quite a dead cat bounce following Monday night’s rout, more a dead cat splat. Last night saw markets see-saw through the trading session, fading from meaningful gains in the overnight futures markets (+1.5% – 2.0%) to some modest losses across US markets. European markets were a little more buoyant. Yields inched a smidge higher, but there wasn’t much in it. Oil rose, while commodities eased back a touch. Gold was a smidge firmer, and credit reasonably resolute.
- Fear of a potential default by China Evergrande Group continues to weigh on sentiment, but for now markets seem to have come to the conclusion any default would be a manageable problem – and not a Lehman type moment, with the fallout contained within the Chinese economy. While probably true, China represents around 20% – 25% of the global economy these days, so there will be some ripple effects.
- More broadly, investors will be seeking hints on whether the Chinese government will step in to save the day, as they have tended to do in the past with systemically significant companies. Focus in this regard will be on the PBOC, which restarts open-market operations today (China has been on hols this week). It is believed that a large net injection may signal plans to reduce systemic stress from a possible default. However, if it withdraws funds, that could mean officials are prepared to tolerate higher market volatility as Evergrande moves toward default.
- As for the company of the moment, Evergrande, the group missed interest payments due Monday to at least two of its largest bank creditors. According to “people in the know,” lenders were expecting the development, and it’s unclear if they’ll formally declare default. A proposed a loan-extension plan might be on the cards, which is likely holding any formal default call at bay. The next big deadline is tomorrow, when two bond coupons are due.
- Tonight’s FOMC meeting will also be on market’s minds. While a formal tapering announcement isn’t the base case, it can’t be completely discounted.
- Offshore Stocks – a wishy-washy day across US markets. The DOW and S&P 500 closed a touch lower, while the NASDAQ closed a smidge higher, and Europe was stronger. The expected retail dip buyers emerged to stem Monday’s blood-letting, but conviction waned as the day wore on. At its best, the S&P 500 advanced +0.9% intra-day, at its worst it was down -0.3%, with the lead between gains and losses changing multiple times. Around two thirds of stocks retreated, and only three sectors advanced. Namely Energy (+0.4%), Healthcare (+0.1%), and Discretionary (+0.1%). Dragging markets lower were Industrials (-0.7%), Telcos (-0.3%) and Utilities (-0.2%). The Fed outcome (tonight) and the Evergrande situation remain the main near-term influences for market trajectory from here. If the Fed sits on its hands for another month, that’s one less tactical headwind. However, the Evergrande situation is probably carrying more weight because consensus expect the Fed to do nothing. If the Fed surprises and pulls the taper trigger, duck and cover people, duck and cover! As for Evergrande, per some comments under “offshore credit” below, while tomorrow is an important date for impact value, these things can drag on in China, so it will potentially fade as a market driver before long.
- Local stocks – with some pretty whiffy offshore leads, the local market opened in the red yesterday, albeit only just. As the day wore on the tone firmed up, with offshore futures also turning the corner, and the ASX 200 advanced on the day, closing with some modest gains. Some two-thirds of stocks closed higher, and only one sector, Financials (-0.4%) failed to get out the gate. Leading the charge at the front was Energy (+1.5%), followed by Tech (+1.3%) and Discretionary (+1.1%). Futures are down a smidge, -0.2%, so likely a soft’ish open.
- Offshore Credit – a snippet here on Bloomberg that offers some potential insight to how Evergrande might play out. “China Evergrande is following a very different pattern to the US bankruptcy-triggers-contagion template. In China, walking-dead companies default on interest payments for many months and are repeatedly given time to repay. I spent three decades as a reporter and editor covering Chinese credit collapses, and I’ve seen the Evergrande movie before. It’s long, drawn-out and there is no surprise ending”….and…”companies are either slowly strangled to death by Chinese creditors or are guided into a streamlined rebirth with founders disappearing for chats with regulators over tea. Bondholders lose most of their money, but state banks survive another day. It may not encourage economic dynamism but it avoids scenes like the protesters in Evergrande offices evolving into wider discontent”
- Local Credit – traders…”a whippy day that saw the local credit market open on the back foot but recover modestly throughout the day. Hard to get an accurate sense of where curves should sit, but would not suggest anything was too adversely impacted. Flows were light, not uncommon in these conditions. We expect this volatility to persist as we await further headlines on Evergrande and the US Fed on Wednesday night. Little incentive to add material risk at this time.” The major bank senior curve drifted a basis point wider with the Aug-26’s at +45 bps and the Jan-25’s at +32 bps. As market technicals normalise over the coming year, it’s safe to expect 5-year major bank spreads will drift back toward 60 – 70 bps, which is still under their post GFC average (+80 – 90 bps), but the technicals have changed quite a bit. Similarly, a basis point move wider across the tier 2 space, with the 2026 callable cohort at +125 – 131 bps and the 2025 callable cohort at +118 – 121 bps. Again, flows were reported as light.
- Bonds & Rates – local bonds did as I expected in the end yesterday, with 10-year ACGB yields -3 bps or so lower on the day, although in early trading they were down as much as -7 bps. As the day wore on offshore stock futures looked to price in a decent rally, which took some of the wind out of the bond rally’s sails. Not a lot of movement from offshore overnight, US treasury (10-year) yields were a smidge higher at 1.32% (+1 bps), while the 2-years were largely unchanged. Markets will be focused on what China does around market liquidity, signalling its intent to either nullify any Evergrande related volatility, or let it rip.
- Offshore Macro – the Fed meets tonight and I suspect we won’t see anything on tapering, explicitly at least. I read this comment yesterday and have some empathy for the views given recent market ructions and apparent causes…”while the Fed statement is unlikely to make any explicit mention of the China saga, it is likely to persuade the less-certain members of the policy committee to sit on the fence on the taper time line and possibly cause them to be more circumspect about the growth outlook that may have an impact on the summary of economic projections. Given the massive implications of an adverse outcome surrounding Evergrande, and what that means for China’s growth and in turn the global economy, it’s only natural that there will be some recency bias at work — even if only subconsciously”.
- Local Macro – the RBA minutes came out yesterday, which were pretty much a non-event from a market’s perspective. Yesterday the OECD some comments on the economic outlook for Australia, with growth through 2021 forecast to fall from +5.1% YoY to +4.0% on account of lockdown – the biggest decline among the world’s 20 largest economies. Not a surprise, and not all that insightful.
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Scott Rundell, Chief Investment Officer
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