Mutual Daily Mutterings
Quote of the day…
“Never miss an opportunity to shut up”– Mark Twain
Chart du jour…Crude vs 10-year yields…
Overview…”Storm in a petri-dish …?”
- Buy the dip is alive and well as investors re-assess Omicron risk, comfort seemingly taken from the early indications, that while the new variant spreads more readily than prior variants, prevailing vaccines are seen to be effective in protecting against severe illness. That’s what is evident on the surface anyway…looking under the hood there is evidence the rally is on shaky ground. Specifically, the most actively traded S&P 500 options are puts betting on a drop to 4400 by year end, or -5.6% from last night’s close.
- Talking heads…”investors are evidently making an assumption today that omicron may not be as bad as had been feared on Friday, and that vaccines may still prove effective…it will take some time — possibly a couple of weeks at least — to understand this variant better. So, what might happen going forward is that we will see elevated levels of volatility.”
- Bond yields rose, but only a fraction of Friday’s moves with US 2-year yields still 13 bps below pre-Thanksgiving peaks (-1.5 bps last night), and 10-year yields are -14 bps below pre-holiday peaks, and +5 bps higher overnight. Yield picked up post President Biden cautioning Americans against panicking over the new variant. It’s likely that until more is known about Omicron, markets will range trade, sell the rally, buy the dips.
- Oil remains on a nitro-fuelled ride. Crude is up +0.3% after earlier rallying as much as +6.0% intra-day (vs Friday’s -11.0%) as markets weigh omicron risks vs OPEC+’s potential response. Most market analysts concede that Friday’s move was a baby with the bathwater moment, way overdone…”the deflation of a bubble that overstated market tightness.” Other street peeps are signalling higher prices, with some (JPM) seeing Brent hitting $125 in 2022 and $150 the year after due to a lack of spare capacity. Brent closed a smidge under $73 last night, so if accurate that’s a meaningful inflationary headwind.
- Some COVID statistics…so far there have been 262 million cases, or around 3.4% of the world’s population. Deaths have hit 5.2 million, or 0.1% of the world’s population. A fraction of the deaths caused by the Black Death or Bubonic Plague (200 million dead, ~40% of Europe’s population) in the 14th Century, and also well below Smallpox (56 million), which holds second place on the list of global nasties. Spanish Flu is third (40 million). COVID is sitting at the 8th largest pandemic in recorded history…and still counting
The Long Story….
- Offshore Stocks – a solid dip-buying party was had by all, led by Europe initially – although the strength of the rally did wane toward their market close. US markets opened cautiously higher and then accelerated as the day wore on as the narrative focused on comments that the new COVID variant, while easier to catch, it’s symptoms were proving mild milder, and as such unlikely to trigger any meaningful or widespread lockdowns. In the end the NASDAQ dominated all, up almost +2.0% on the day followed by the S&P 500, while the DOW tagged along for the ride. In fact, the NASDAQ is trading at a higher level than it close at the day before Thanksgiving, completely discounting the Omicron variant risk. Within the S&P 500, a broad rally with three stocks up for every one down, and no sector was left behind, all sporting summery shades of green. Tech (+2.7%) dominated, followed by Discretionary (+1.8%) and Utilities (+1.7%). Industrials (+0.4%), Healthcare (+0.6%) and Financials (+0.6%) were bottom of the daily foodchain.
- Local Stocks – a modest retreat in the local index as Omicron uncertainty continued to weigh on sentiment. The ASX 200 dipped below its 200D moving average, although with the bounce in offshore markets overnight it should regain some lost ground. More stocks fell than rose yesterday, 60:40 and most sectors were in the red. Only Materials (+0.7%) and Tech (+0.6%) were able to gain ground, while at the other end of the performance tables, REITS (-1.4%), Energy (-1.4%) and Industrials (-1.2%) were the worst performers. As we close in on month end, the ASX 200 is down -1.2%, which much of the damage done by two sectors, Financials (-8.0%) and Energy (-8.4%). On the Financials front, banks are down -10.2% month to date. WBC is the worst culprit by a long way, down -18.5% month to date, with an RSI of just 19.4 (‘oversold’)…..and trading at a 25% discount to consensus 12 month price target – for the record, their credit spreads have fared much better. Futures are up +0.6%.
- Offshore Credit – Bloomberg…”corporate bonds are still headed for difficult months, even if the variant proves milder than initially feared. U.S. investment-grade bond spreads’ recent widening has reflected risks tied to rate hikes and inflation. Those are headwinds that would remain if markets reverse their early reactions to omicron. Spreads on U.S. high-grade bonds have widened to levels last seen in March amid expectations that earlier rate hikes and less accommodative Fed policy will hurt the securities. As cases began rising again in Europe this month, spreads continued to widen. They did so again on Friday as part of the broader response to omicron. That signals traders considered the rise in credit risk to outweigh a possible return to dovishness by the Fed in response to the virus. Spreads could narrow this week if gauges of credit risk continue to ease on more optimism surrounding omicron. Traders may also see high-grade bonds’ cheapening this month as a chance to sell Treasuries and buy corporates, particularly as investors elsewhere dial back expectations for rate hikes. That said, if omicron symptoms are indeed mild, the corporate-bond market will find itself in a situation similar to the one that sent spreads wider this month. Traders will then have to decide whether negatives tied to future rate hikes and rising inflation outweigh potentially better news on the virus.”
- Local Credit – traders comments…”a volatile trading session as the market trades cautiously around the evolution of the new Omicron COVID variant. Cash spreads close wider on the day, led by Tier 2 and corporates, the latter of which saw a steady stream of selling from select domestic clients.” On the majors, in senior, markets were better offered, but little flow seen. The curve closed a basis point wider, with the Aug-26 now +62 bps (+1 bps) and the Jan-25’s at +44 bps (+1 bps). In tier 2, flow was reported as light, although skewed to the selling. The 2026 callable lines are at +143 – 146 bps (+2 bps), while the 2025 callable lines are at +133 – 134 bps (+2 bps). The 2024’s are unchanged at +101 bps. Probably too soon to jump in and take advantage of wider spreads, but if the positive (or less negative) news around Omicron continues, then there is some bargains to be had. We still don’t expect to see much, if any, major bank issuance for the remainder of the year.
- With regard to the ‘offshore credit’ comments above and whether a widening in offshore spreads would filter through to A$ credit…maybe, probably, but if it does it will be a much more muted reaction because of diverging technical dynamics, as evidenced in the following chart. FRN’s are less volatility, which is obvious optically. Statistically, FRN spread standard deviation has been 17 bps since the end of 2019, vs 43 – 45 bps for US Corps & FIns, 37 bps for European Fins, and 24 bps for A$ fixed. If inflation is the true root of all concern in fixed income markets, and less so Omicron, then the natural safe haven is floating rate notes:
- Still with local credit…APRA released its final guidance and standards in relation the new capital framework that include APS110 (Capital Adequacy), APS112 (Standardised Approach to Credit Risk) and APS113 (Internal Ratings-based Approach to Credit Risk) with the new standards to be implemented on1 January 2023. I still need more time to absorb it, but I doubt, from my quick read, that the announcement will move spreads or issuance levels. Some high level outtakes from Coops aka Alice aka Brendon Cooper at WBC (he’s all over this stuff)…”the final standards remain largely in line with the original draft and while banks will now need to determine the impacts across specific businesses and products, the larger ADIs we cover are well placed from a capital perspective, operating comfortably above minimum requirements and have already begun the transition for upcoming changes (ie, Westpac’s model adjustments to mortgage RWA in FY21). The new framework continues to APRA’s aims of making the system more risk sensitive (more granular risk weights and higher mortgage RWA), flexible (the use of buffers), transparent & comparable (more closely align with international standards and require IRB banks to report under standardised approach) and proportionate (simplified requirements for less complex banks) while also providing some allowance to enhance competition (IRB capital floor of 72.5% to reduce capital differentials).” On tier 2…I nicked this also from Coop…”today’s release only addresses CET1 capital, however APRA will commence its consultation on the Resolution Framework shortly which includes the finalisation of loss absorbing capital rules. An update on ALAC requirements (which will be influenced by the lower RWA confirmed today) therefore appears imminent.”
- Bonds & Rates – despite the whopping rally in Treasuries (and others) on Friday night, not a lot happening in local markets, although that was to be expected, local bonds led the rally on Friday. Last night we had some pull back as investors re-assessed that perhaps the Omicron variant wasn’t as ominous as first thought (probably too early to tell in all fairness). Local bonds will likely tighten a little today, but I would expect too much, all other things being equal. Strategically, I still see rates rising, but with lower cyclical highs than in prior tightening cycles given the sheer volume of debt that has been raised in the past two years.
- Offshore Macro – from NAB…”data releases were generally stronger than expected but looking at intra-day price action in bond markets the impact appears to have been limited. Of note was the muted reaction in the Bund market to the stronger than expected inflation data for Germany. US new homes sales rebounded in October and are at the highest level in ten months while the Dallas Fed report showed a further jump in raw materials and wages (the report surveys 95 Texas manufacturers).”
- Local Macro – from NAB again…”on the calendar for Australia today we have Q3 Balance of Payments, Building Approvals for the month of October while RBA Deputy Governor, Guy Debelle, is giving a fireside chat at the ACI Australia Conference (this is at 1pm AEDT and can be watched live). Offshore there is China manufacturing PMI data, Eurozone CPI and Fed Powell testifies before the Senate.” Credit growth is also out, which is expect to show further acceleration in credit.
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Scott Rundell, Chief Investment Officer
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