Mutual Daily Mutterings
Quote of the day…
“I know that there are people who do not love their fellow man, and I hate people like that!” – Tommy Lehrer
“One down, eleven more to go…”
- Overview – I last published my ‘Morning Mutterings’ on December 18, some 45 days ago. Time flies when you’re stuck at home. In that time a few things have changed, Trump faded into the background and Biden stepped up to the big-boy chair, brandishing a fat cheque book, and he’s not afraid to use it. He’s tabled a $1.9 trillion offering, but it may need to be scaled back in order to get through the Senate (i.e. down to $600bn). Either way, some delays possible. Vaccine deployment continues, but it’s slow going (plus EU export controls) and there are new more virulent strains of the virus emerging, placing doubts around long term effectiveness of vaccination programs. And, infection rates remain elevated and risk of further lockdowns persists (i.e. Western Australia). The death toll has reached over 2.2 million globally and the total infected has exceeded 100 million. The US is number one on the charts in both of these figures, a little over a quarter of global numbers. Nevertheless, an abundance of monetary support, expectations of additional fiscal support (US) and potentially misplaced confidence that tomorrow will be a better day is keeping markets buoyant. Stock valuations are stretched in the face of still uncertain fundamentals and there is a degree of nervousness around whether hedge funds will need to sell additional assets to cover losses triggered by the retail driven buying of pariah stocks. Bond yields have risen on tapering / inflation expectations, while credit spreads are mixed, but generally range bound.
- Offshore Stocks – offshore markets have changed little since I last published, in a straight-line sense (but tumbled on Friday). The DOW is down -0.7%, the S&P 500 is up just +0.1% and European stocks are down -2.0% on average. Volatility has risen with the VIX back in the 30% range, up over +50% since mid-December. Much of the recent narrative has focused on the short squeeze / short gamma pain trade involving a horde of retail punters (i.e. Reddit users), who have aggressively gone long a range of pariah stocks, i.e. those heavily shorted by hedge funds. Consequently, stocks with less than stellar fundamentals have outperformed and hedge funds have been forced to cover their shorts, exacerbating the volatility.
The poster child of this trade being GameShop (GME), a brick’s and mortar computer game retailer. In 2018 the business generated net income of $520m, after which it steadily declined to loss territory – it has leverage of 30x and interest cover of 1x. Despite the terrible fundamentals, retail investors have backed the truck up and gone long. YTD the stock is up 1,700%, or 8,000% over the last 12 months with a market cap of $22.7bn. The SEC is investigating for market manipulation offences, but I’m not sure what they can actually prove. Something to keep an eye on, but for mine, there has to be some form of blow-back on this trade. In the end, fundamentals win.
- Local Stocks – the ASX 200 is up a touch over +1.0% since I last published, but generally the index has been very much range bound, between 6600 – 6800 give or take and closed on Friday at 6607, a fraction below its 50D moving average of 6663. The index remains -13% below historical highs. Depending on your view of fundamentals, or the outlook thereof, valuations are frothy. LTM PE’s are at 43.5x (punchy), while forward PE’s are at 20.0x, down from pandemic highs of around 22.6x. Forward EPS expectations have firmed since their pandemic lows, but remain -14% bellow pre-pandemic levels. ASX 200 volatility has risen a touch over the past month and a half, +4.0%. Are valuations justified at these levels? Not given fundamentals, no. But, its not all about fundamentals. As was the case for much of 2020, technicals remain the dominant driver and will remain so for as long as investors remain confident on a) vaccine deployment, b) a return to normal economic behaviours, and c) stimulus, either fiscal or monetary will remain forthcoming in times of stress. Offshore leads were weak, with DOW and S&P 500 down -1.9% – 2.0%, with ASX 200 futures down -0.5%.
- Offshore Credit – given US reporting season (Q4’20) supply has been subdued, but will likely come back to life through February. The deals that did come have nonetheless been well supported. In secondary markets spreads on average in US IG markets are -1 – 5 bps tighter across corporates and financials since I last commented, while US HY is largely unchanged. In Europe, a modest widening (+2 bps) in secondary spreads, largely in the corporate space, while financials are largely unchanged. In EU HY spreads are +11bps wider. Synthetic spreads are +3 – 4bps wider since mid-December. One benefit from the above social media coordinated assault on hedge fund short positions has been a lot of companies that under normal circumstances may have been staring down the barrel of deteriorating credit fundamentals, have been able to sell stock at inflated prices and consequently shore up their liquidity positions.
- Local Credit – the main event since late last year was Westpac hitting local markets for a $1.25bn tier 2 deal, a 10-NC-5 that came with guidance of +165 bps and priced at +155 bps, broadly in line with our expectations at the time. The paper is pricing around +152 bps in secondary. Senior paper has done very little of late – three-year paper is at around TFF levels, so its not going anywhere and five-year paper is pricing off that at +24 – 25 bps. Moribund. Some chunky maturities over the next month or so, which will see cash recycled back into markets, placing tightening pressure on spreads – most likely to be reflected in tier 2 paper rather than senior.
- Bonds – US treasury curves have steepened over the last month and a half on monetary policy tapering expectations, and a mix of higher inflationary pressure. UST 10-years closed on Friday at 1.07%, +15 bps YTD. On a straight-line basis (i.e. between then and now) the UST 2-year treasuries are largely unchanged. It’s a similar story in ACGB’s, steeper with 10’s +16 bps to 1.13%, while the 3’s have traded within a couple of basis points of the RBA’s target (0.10%). It’s doubtful the bear steepening trend will persist given the ongoing commitment to accommodative policies from central banks globally, especially the Fed and obviously the RBA locally. Nevertheless, there is risk to further steepening as supply ramps up to meet fiscal needs and deficit funding. The RBA meets tomorrow. I’m not expecting any changes to current stances.
- Macro – some sound-bytes from the sell-side “in US economic data, personal income rose +0.6% in December (survey: +0.1%). Spending fell 0.2% (survey: 0.4%). The core measure of prices was up +1.5% on the year (survey: +1.3%). The employment cost index rose +0.7% in the December quarter (survey: +0.5%); Pending home sales fell -0.3% in December (survey: -0.1%). Consumer sentiment fell from 80.7 to 79.0 in January (survey: 79.2)”…(source: CBA)
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Scott Rundell, Chief Investment Officer
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