Mutual Daily Mutterings
Quote of the day…
“I don’t make jokes. I just watch the government and report the facts”.…Will Rogers
Chart du jour…global default rates (S&P)…
- A modest rally across stocks offshore overnight, following another tough day in the trenches for local markets. While the DOW, S&P 500 and European counterparts eked out some modest gains, the NASDAQ dropped the ball and retreated a touch. Bond yields rallied a smidge as the Fed and fellow central banks voiced continued support of the transitory inflation narrative – Powell blamed price pressures largely on pandemic-related bottlenecks, and while on him, he declined to comment on whether he’d like another term as chair of the Fed. Meanwhile, markets remain alert to the potential for market disruption should US politicians fail to raise the government’s debt-ceiling in time to avoid a default on US obligations.
- Talking heads “jitters surrounding elevated levels of inflation and slowing growth are likely to remain for some time…and the US debt-ceiling discussions could be in focus amid a quiet economic calendar.” I’ll nail my opinion to the mast early on this one – while the debt ceiling situation is concerning at face value, I can’t imagine in any known universe, parallel or otherwise, where the US would deliberately default on its obligations. While US politicians have proven themselves to be a whacky bunch of petty and small-minded knuckleheads over and over again, deliberately defaulting on treasuries is just a step too far, even for them. Nevertheless, the risk – as remote as I think it is – will weigh on sentiment…until it’s replaced by a new narrative.
- Speaking of investor sentiment…according to a survey of clients conducted by Citigroup in the US, a majority of investors harbor fears of persistently high inflation, with a 20% pullback in stocks seen as more likely than a 20% rally. Though most expected modest gains next year in the S&P 500, price pressures and a policy reversal by the Fed are big risks, according to the survey of more than 90 pension, mutual and hedge funds this month. Note, no real mention of the debt ceiling as a material concern – although I haven’t seen the full survey, just snippets.
- S&P published some updated global default rates (Chart du jour), which continue to fall as financial conditions remain accommodative…can you say zombie companies kiddies?
- Offshore Stocks – a modestly positive rally across most key indices globally with the only real driver, as far as I can see, being some cooing noises from central banks around inflationary pressures. The scale of the rally suggests there is a degree of scepticism amongst market participants, so I put the daily moves down to just the usual trading noise. Within the S&P 500 some 58% of stocks advanced, as did seven of eleven sectors. Utilities (+1.3%) led from the front, followed by Staples (+0.9%) and Healthcare (+0.8%). Bringing up the rear, we had Materials (-0.4%), Telcos (-0.2%) and Tech (-0.1%). Despite the Fed and its central peers espousing cautious optimism around the path of inflation, rising price pressures and supply chain disruptions are coinciding with downward revisions to S&P 500’s upcoming Q3 earnings estimates. Some examples: FedEx and Nike are among companies that recently cut their earnings outlooks, citing inflationary headwinds. With guidance on inflation and supply chains in the upcoming reporting season tied up with lofty valuations, risk remains that companies will more likely be punished for downgrades than rewarded for upgrades. All other things being equal, more muted outlooks will weigh on the path of stocks.
- Local stocks – yet another tough day across the battlements with the ASX 200 dropping another -1.1%, now down-5.7% since its August peak. Over three-quarters of ASX 200 stocks retreated and only two sectors were able to make ground – Utilities (+0.2%) and Staples (+0.1%). King of the cellar-dwellers was Tech (-2.4%), followed by Healthcare (-1.9%) and Energy (-1.8%). Modest leads from offshore overnight has futures up a touch (+0.3%).
Offshore Credit – five borrowers priced US$4.6bn in US IG bond market overnight, pushing the weekly total to more than US$22bn and past weekly projections calling for US$20bn. Stepping away from primary markets, S&P published some default stats recently (Chart du jour). Accommodative financing and the global economic recovery helped increase positive rating actions through August 2021, most of which have been changed from negative outlook/CreditWatch to stable as credit metrics stabilize across the speculative-grade rating spectrum. Although the ‘B- and below’ population remains at a high, the negative bias for issuers rated ‘B-‘ and below has fallen to a record low of 27%, pointing to a robust stabilization of the rated universe, and decreased default risk in the near-term.
- Local Credit – traders…”local secondary credit continues largely unabated by the broader weakness in risk. Flow remains mostly light into FYE, aside from the corporate sector which saw better client buying and dealers tidying positions in the street”. A little bit of movement in the major bank senior curve with some selling noted in the Jan-25’s and 3-year part of the curve, resulting in half a basis point widening. Tier 2 remains firm and continues to “trade constructively”, although no movement on the spread front yesterday. With ANZ, NAB, and WBC at year end by COB today, and the relative cost of issuing locally vs offshore currently skewed (in favour of offshore issuance), the likelihood of any A$ issuance over coming weeks is modest. November is more likely than October, although I note NAB has $1.75bn maturing on October 21 and WBC has $1.5bn maturing on October 25. Each of the majors are swimming in cash, so they’ll be under no pressure to issue in order to refinance these lines. Having said that, Murphy’s Law suggests a new deal will be announced as soon as this note hits in boxes.
- Bonds & Rates – not a lot of price action yesterday in local markets, yields hardly budged, the most meaningful move being +2 bps out the back end of the curve, 15 – 30 years. Elsewhere, it was tumbleweeds. Offshore overnight, a very modest rally, very modest, just a basis point for the 2’s and 10’s, in to 0.293% and 1.525% respectively.
- Local Macro – the main data of note today is credit growth (August) with consensus at +0.5% MoM (vs +0.7% MoM in July), and +4.6% YoY (vs +4.0% YoY in July). Long run credit growth data is charted below, and as we can see credit growth trend has been positive, with strong growth across the business sector – a mix of borrowing given accommodative lending conditions (i.e. debt is cheap), but also borrowing to stay afloat through lockdown. Investor lending also showing a solid bounce. With regard to lending growth, the prospect of macro-prudential policies being implemented to curb house price growth is growing more and more likely. Treasurer Frydenberg has recently stated..” with Australia’s economy well positioned to strongly recover as restrictions ease, it is important to continually assess the appropriateness of our macro-prudential settings….we must be mindful of the balance between credit and income growth to prevent the build-up of future risks in the financial system….carefully targeted and timely adjustments are sometimes necessary…there are a range of tools available to APRA to deliver this outcome.” A likely policy tool will be caps on debt-to-income ratios. If and when implement, these measures will likely moderate credit growth.
(Source: RBA, Mutual Limited)
- Steak Knives…some good analysis (I think) by one of the talking heads I respect at Bloomberg, Cameron Crise – I thought I’d share it…with a little editing
- One of the basic truths of financial market investing is that when volatility elevates, beta trumps alpha. In other words, it is the general direction of the market, rather than one’s security selection, that is the primary determinant of portfolio returns. In practical terms this usually means that when the stock market drops significantly, there ultimately aren’t many places to hide. There are a few ways of looking at market internals to determine just how significant the beta-driven headwinds are for equity investors. The good news is that they currently appear modest … though that leaves room for a substantial deterioration in conditions.
- If you want to get a sense of the importance of market beta, look no further than Bloomberg’s world bond monitor. While the economic and policy backdrop is somewhat different across geographies, on a one-month horizon the yield of every single benchmark 10-year bond has risen. With all but Japan and China going up by at least 10 basis points, it’s clear that the recent bearish turn in fixed income has been a macro, beta phenomenon rather than one driven by specific local factors.
- While beta is always an important driver of equity market returns, its significance increases markedly during times of elevated volatility and financial distress. Indeed, a rise in index-level volatility is simply a manifestation of two phenomena — an increase in the level of volatility of each of the constituent names, and a rise in the correlation across all of those names. In truth, you could probably argue that the causality flows in the other direction — in other words, that index-level hedging causes each of the members to trade in lockstep.
- In any event, tracking the realized correlation across index members is a useful way of gauging how much equity trading is being driven by index-level considerations. Despite some of the consternation surrounding the recent equity market drop, the realized one-month correlation across S&P 500 names is below the peaks observed in March and June of this year, let alone those of last year. That’s a reasonable indication that this is all just an orthodox blip thus far.
- In a sense, the stock market is a four-dimensional object, with facets representing returns, volatility, correlation, and liquidity. As such, we also need to consider the role of liquidity in driving market price action. This column has articulated a way of measuring stock market liquidity in the past, most recently by converting my usual measure to an index. In updating the data through Tuesday, we find that liquidity has unsurprisingly ebbed recently but isn’t actually that bad relative to much of the past few years.
- Now, there is clearly a relationship between sharp declines in market liquidity and drops in the stock market, though the flow of causality is almost certainly two-way and self-reinforcing. To date, the dip in liquidity isn’t anything special, and thus offers little cause for undue concern. Indeed, over the longer sweep of time the correlation between market liquidity and drawdowns isn’t actually that great, other than an apparent frontier of maximum losses consistent with a given level of liquidity.
- Funny enough, moderately substandard liquidity isn’t necessarily that big a deal. Going back to 1996, the average liquidity reading when the SPX is at its all-time highs is 91, with a median reading of 86. Trading conditions were at those levels a little more than a week ago. The interim, of course, has changed the complexion of market trading conditions, but not that substantially.
- So, what’s the point of all of this? Well, neither correlation nor liquidity analysis suggests that market price action is in any way consistent with panic or some sort of crescendo, though in truth you could probably draw the same conclusion from the still-modest drawdown from the peak earlier this month. Those of a sunny disposition might conclude that this is all just a run-of-the-mill dip that will swiftly reverse like others this year.
- An alternative interpretation is that there is room for a significant deterioration in the tone of market trading as liquidity evaporates and correlations surge. To some extent, whether or not that happens may be down to the caprices of the bond market. In any event, when things start to get spicy it’s usually a good idea to keep tabs on each dimension of the market tesseract.
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Scott Rundell, Chief Investment Officer
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