Mutual Daily Mutterings
Quote of the day…
“Don’t wrestle with pigs. You both get dirty and the pig likes it” – Mark Twain
“Living in a bubble…”
“GRAPHIC content warnings, and some cuss words…”
- Overview – US stocks were taken behind the woodshed last night, trousers down, six of the best with a gnarly old four-by-two. Chicken or the egg, bond yields went parabolic, hitting new 12-month highs. Why? After a day of levity and frolicking in the garden of the Fed’s assurances that the tapering-gun was not only holstered, but locked away in the gun cupboard, the reality-hangover kicked in and markets called bull@#$% – although no specific catalyst that I can put my finger on for this moment of clarity. In ten words or less, stocks belted, yields higher, credit wider. On the data side, US jobless claims were better than expected. The weight of money is positioned for the fact the Fed can’t ignore rising inflationary risk too much longer and will have to take the punch bowl away and wind the party up sooner than originally factor in. In English? The market is punting that monetary tightening, or tapering, in some shape or form will be triggered by surging growth and the inflationary pressures that come with it. In this environment, yields go up, and at present, the pandemic has been largely priced out. While such a move typically signals a stronger growth outlook, in this instance fuelled by fiscal stimulus, vaccine deployment and return to post-pandemic ‘normalcy’, there is an inflection point where higher yields, and higher borrowing costs, become an earnings headwind. This is more an issue through this cycle than others because of the sheer scale of outstanding debt. For some context, some comments from Chris Cole (from Artemis Capital, not the professional skate boarder), ”a normalisation of rates to pre-2008 levels (i.e. US 10s at 3.5% – 4.0%) would cause US Corporate Profits to collapse by 50% due to increased interest payments alone.” And for something really out there and left field, if rates return to 1970’s peaks (c.6.0%), when inflation was last a real, real problem, that would result in the total elimination of all US corporate profits.
- Offshore Stocks – not pretty, but at the same time also probably due. I have mentioned in the recent past that given the macro headwinds ahead relative to prevailing valuations, pull-backs will become more common, and here we are. However, full disclosure, I wasn’t necessarily expecting a massive steepening of the curve to be the catalyst (an action which has its own catalysts). Somewhat ironically, markets were all bulled up on the prospects of a ‘V-shaped’ recovery, with stocks priced to perfection. But then, ooh, the ‘V’ is now expected to be bigger than we originally anticipated, which will bring with it aggressive and rapid inflationary pressures…which in turn equals tapering, tightening, yadda, yadda, yadda…or at least that’s what markets are collectively pricing. On the night, Tech (-3.5%) particularly took a beating, as did Discretionary (-3.5%), and Telcos (-2.6%). On the day, only 8% of stocks were able to close ahead…so, yes, 92% sporting bloodied snozzes, with the S&P 500 and NASDAQ looking to close at their intra-day lows, or there abouts. VIX spiked, up almost 850 ppts to 29.8%. Despite the move, the S&P 500 is still well above its 50D moving average. Talking heads… “it’s all about interest rates….and tech has been a relative outperformer. As it led on the way up, it will likely lead on the way down too.”
- Local Stocks – with the overnight leads facing the market, yesterday was, well yesterday and somewhat likely irrelevant. For completeness however, it was a solid day with 59% of stocks up, lead by the two most important sectors for the ASX 200, Materials (+1.4% and ~40% of index gains) and Financials (+0.8% and ~33% of index gains). Only Staples (-0.3%) and Industrials (-0.7%) failed to fire on the day. That’s all history. With such soft offshore leads it’ll be a touch day in the trenches for local stock. Futures are down -1.4%, while e-mini’s are -2.5%.
- Offshore Credit – somewhat surprised that supply ticked along, I would have thought the spike in yields might have spooked a couple of issuers. Either way, $5bn priced in US IG, with WTD volume at $33.5bn, a smidge short of the mid-point of initial expectations ($30 – $40bn). A more subdued day in EUR IG, just €2.7bn priced across two issuers. All tranches reasonably well supported. Reflecting the broader risk off tone, secondary spreads drifted wider, but nothing meaningful (yet), A little more action in synthetics with the CDX +4.5 bps and MAIN +2.1 bps wider.
- Local Credit (Primary) – as a sign of how quickly markets can turn, Newcastle Permanent priced a $225m 5yr FRN yesterday at the “tight end of the range +63 bps”. That’s an optimistic take, they printed demand, so minimal price tension. From NPBS side of things, they came to market a week too late and it probably cost them 3 – 5 bps. Historically NPBS has printed deals around the $200m – 225m range and it was a struggle to get there in the end. The deal launched at +65 bps, expensive to their curve (+70 bps by my numbers), and with some window dressing it was able to print ‘tight’ to guidance, good for the DCM peeps egos, but buyers will see it for what it was, a sign that near term technicals have softened a touch. With all bids almost fully allocated, not surprisingly there was little flow post the break.
- Local Credit (Secondary) – traders…”a modicum of comfort can be taken from emerging buying in the longer end of the fixed rate curve by offshore real money accounts. Otherwise, ongoing selling seen across the FRN curve by both domestic and offshore accounts. We closed the curve 1-2 bps wider with the expectation that we see further steepening and an underperformance of the FRN curve versus FXD. The circuit breaker most likely being the combination of un-refinanced AUD maturities (next benchmark maturity 7th April) and the increased deployment of latent TFF cash. Regionals not immune though spreads are holding in for now”. Me now, sentiment has soured in A$ credit as risk sentiment whipsaws between optimism around the Fed keeping to its word of accommodative for longer and pessimism that growth and inflation will explode such that the Fed will be forced to taper sooner than what markets had priced. Time will tell, but it’s also a conundrum facing the RBA and local markets. Major bank senior spreads are a couple of basis points wider, with the Jan-25’s now +28 bps (vs lows of +24 bps) and the three-year part of the curve is around +22 bps (vs +18 bps lows). In tier 2, we called the tights almost to the minute earlier in the week with the 2026 callable cohort hitting the +124 – 126 bps area. The same selection of notes are now in the +133 – 137 bps range, or +5 bps on the day according to trader’s runs. The street is suffering a little indigestion, tip of the cap for taking the stock in even though it probably had a sour taste. Spreads will remain soggy until the street has cleared the decks somewhat…would suggest also that no deal is imminently in the pipeline given the softer backdrop. What’s the move in rates done for credit returns? Month to date the fixed rate credit index (AusBond) is -0.67%, where in the FRN space, which is our sandbox, the index is up 0.01%.
- Bonds & Rates – treasuries first…the 10-year ‘real’ yield — which strips out inflation and is seen as a pure read on growth prospects — climbed as much as +11.5 bps to -0.68% overnight (was -1.10% earlier in the calendar year), surpassing its post-election peak. The rate on the nominal 10-year hit 1.61%, +23 bps on the day and the highest in the past 12 months, with demand for a 7-year auction ‘cratering’. The increase forced a crucial group of investors such as holders of mortgage securities to sell Treasuries, which in turn led to further increases in yields. Further, from Bloomberg…”in a tell-tale warning sign for some strategists, the 5-year Treasury yield soared convincingly above 0.75% on Thursday, a crucial level that was expected to exacerbate selling, as traders pulled forward bets on when the Federal Reserve will start lifting policy rates.” As I type the spike in yields has morphed into a butter knife, but a particularly sharp one, sharp enough to draw blood, +16 bps to 1.53%. Locally yesterday the steepening trade re-asserted itself with vigour with the local 10’s up +12 bps to 1.74%, well and truly above pre-pandemic levels, and back to levels last seen in Q2’19. With the 3’s anchored within 2 – 3 bps of 0.10%, the 3s10s curve has hit +161 bps, levels not seen in well over 5 years. Momentum has the floor, get in the way at your own peril.
Macro – spent too much time rabbiting on above, going to borrower some words from Alice (Aka ‘Coops’)…. “US 4Q GDP was revised to +4.1% from +4.0% (est. +4.2%), with a minor pullback in personal consumption to +2.4% from +2.5%, while the core PCE remained at 1.4%. January durable goods orders were firmer than expected, the headline measure up 3.2%m/m (est. +1.1%m/m, prior revised to +1.2%m/m from +0.5%m/m), with ex-transport up 1.4%m/m (est. +0.7%m/m. prior revised to +1.7% from +1.1%m/m). Weekly initial jobless claims came in at 730k (est. 825k), with continuing claims close to expectations at 4.42m (est. 4.46m). January pending home sales fell 2.8%m/m, the annual pace still a solid +8.2%y/y with NAR Chief Economist Yun continuing to cite insufficient stock to meet demand. However, he does expect inventory to rise in coming months. US Feb. Kansas Fed manufacturing survey surprised on the headline lifting to 24 (est. 15 from prior 17). Employees rose to 21 from 13, but new orders slipped to 16 from 25 and other gains related to prices rising”.
Click here to find the full PDF from our Chief Investment Officer’s daily market update.
Scott Rundell, Chief Investment Officer
T: +61 3 8681 1907