Mutual Daily Mutterings
Quote of the day…
“My horse’s jockey was hitting the horse. The horse turns around and says “Why are you hitting me, there is nobody behind us!””.…Henny Youngman
Chart du jour…AU rates vs CPI
- Stocks inched higher again on earnings optimism, mainly margin stability and the fact that despite supply chain disruptions and rising commodity prices, many companies have been able to pass through rising costs to consumers. Despite momentum indicators flashing overbought, the S&P 500 closed at yet another record high, up +107% from the depths of last year’s March sell-off, and up +24% YTD. Oil retreated, and metals were down across the board on concerns about a slowing Chinese economy.
- Two-thirds of the S&P 500 have now reported with aggregate sales growth of +18.5% vs the prior corresponding period (pcp) and aggregate earnings up +40.1% on the pcp. Growth has been broad based with 87% of companies reporting sales growth and 81% reporting earnings growth. This is up on prior averages. Only Discretionary (-5.1%) and Utilities (-0.7%) have failed to report earnings growth, while all sectors have reported top line growth. Against estimates, aggregate sales have beaten by +2.4% and earnings by +10.1%.
- Talking heads….“while the upside for equities might be slowing versus what we had seen over the course of the last 18 months, the reality is still that there’s a solid base for risk assets to continue to perform well.” But, then there are sobering comments like this “the risk is equities are forced to price in the increasingly unfavourable policy environment,” a view I have empathy for.
- Treasury yields rallied, with the offshore narrative pointing to the RBA’s ‘dovish statement’ yesterday. I didn’t think the RBA has that much pull in US treasuries, but there you go. Two-year yields fell -6 bps, while ten-year yields drifted a basis point lower. All this ahead of tonight’s FOMC meeting, which is expected to see a tabling of actual tapering action, likely US$15bn per month (US$10bn treasuries and US$5bn of RMBS). As to when the first rate hike will come, timing is dividing economists and strategist between next year or early 2023. Futures based pricing are indicating two 25 bps hikes by the end of 2022.
- Offshore Stocks – modest gains across US stocks with the DOW, S&P 500 and NASDAQ all up over +0.3%. Within the S&P 500 winners pipped losers, but it wasn’t a slam dunk (57% vs 43%), while sector wise only two sectors failed to get out the gate. Energy (-1.0%) and Discretionary (-0.6%) being the two recalcitrant sectors. Top of the pops was Materials (+1.1%), followed by REITS (+0.9%) and Tech (+0.8%). With reporting season in the final straight (67% reported), and the Fed expected to start tapering, tailwinds will begin to dissipate and investors may again begin to question elevated valuations. Technically also, the S&P 500 is sporting RSI’s of 70.8, a momentum indicator that suggests anything above 70.0 is overbought (and under 30.0 is oversold).
- Local stocks – a modest down day for the ASX 200, although most of the pain came from two sectors, Materials (-2.1%), and Financials (-1.3%). Energy (-1.1%) also had a tough day on the tools. All up, two stocks fell for everyone that advanced. More sectors gained ground than didn’t, just, with REITS (+1.3%) top of the pops, followed by Staples (+0.6%) and Discretionary (-0.4%). The RBA policy statement at 2:30pm, which was still on the dovish side of the spectrum, gave markets a bit of an adrenalin rush (+0.4%), but most of that surge was given back by day’s end. With two of the three reporting majors in the tin, bank stock prices have taken a sizeable hit with WBC taken to the cleaners yesterday to the tune of -2.7%, which takes their market losses post ANZ reporting (Monday) to -11.8%. ANZ has fared a little better, down -1.0% yesterday and -2.7% since reporting last week. Futures signalling a strong open.
- Local Credit – traders reporting a relatively quiet day with the focus on the RBA policy meeting, and possibly the Melbourne Cup. After living in Sydney for 17 years, I know that despite Cup Day not being a public holiday in NSW, it didn’t stop dealing rooms from downing tools for the afternoon – at best operating with a skeleton crew. Either way, a quiet day. In major bank senior paper, some very modest driftage wider for anything with more than a year to run to maturity. The NAB Aug-26 line is quoted on Bloomberg at +59 bps and the implied curve for 5-year primary at +60 – 65 bps. I’ve been saying for a month or so now that +60 – 70 bps is my expected range for 5-year major bank senior, which I think is still likely by year end, all other things being equal. Major bank Tier 2 paper has also drifted wider, with the longest dated 2026 call (NAB’s Nov-26) now pricing at +142 bps, while the other 2026 calls are at +139 bps.
- Bonds & Rates – the RBA held its November policy meeting yesterday. The board decided to scrap its Apr-24 0.10% ACGB yield target, while leaving the cash rate unchanged, both of which were expected. On the decision to abandoned its YCC settings…”the decision to discontinue the yield target reflects the improvement in the economy and the earlier-than-expected progress towards the inflation target. Given that other market interest rates have moved in response to the increased likelihood of higher inflation and lower unemployment, the effectiveness of the yield target in holding down the general structure of interest rates in Australia has diminished.” In response to the statement, three-year yields fell -7 bps to 0.960%, while ten-year yields were largely unchanged at 1.905%.
- As for the first rate hike…”the Board will not increase the cash rate until actual inflation is sustainably within the 2.0% – 3.0% target range. This will require the labour market to be tight enough to generate wages growth that is materially higher than it is currently. This is likely to take some time. The Board is prepared to be patient, with the central forecast being for underlying inflation to be no higher than +2.5% at the end of 2023 and for only a gradual increase in wages growth.” In subsequent Q&A, this snippet from ANZ…”Lowe made it clear that the end of the yield target did not necessarily mean interest rates were going to go up before 2024. He also emphasised that the RBA wanted to see inflation at 2.5% before rates were raised. And he also pushed back against market pricing of 2022 rate increases as not consistent with the RBA’s “reaction function.” Market pricing of rate hike expectations charted below.
- Local Macro – from the RBA November meeting statement yesterday…”the central forecast is for GDP growth of +3.0% over 2021 and +5.5% and +2.5% over the following two years. One important source of uncertainty continues to be the possibility of a further setback on the health front”. Employment….”the unemployment rate to trend lower over the next couple of years, reaching 4.25% at the end of 2022 and 4.0% at the end of 2023.” Inflation….”has picked up, but in underlying terms is still low, at +2.1%. The headline CPI inflation rate is +3.0% and is being affected by higher petrol prices, higher prices for newly constructed homes and the disruptions in global supply chains. A further, but only gradual, pick-up in underlying inflation is expected. The central forecast is for underlying inflation of around +2.25% over 2021 and 2022 (+50 bps vs prior guidance) and 2.5% over 2023 (+25 bps vs prior guidance). Wages growth is expected to pick up gradually as the labour market tightens, with the Wage Price Index forecast to increase by +2.5% over 2022 and +3.0% over 2023. The main uncertainties relate to the persistence of the current disruptions to global supply chains and the behaviour of wages at the lowest unemployment rate in decades”.
- Offshore Macro – fair to say the main event over the remainder of the week will be the FOMC meeting with a tapering announcement expected. Consensus seems to be that the Fed will tighten the monetary faucet a smidge, reducing its monthly asset buying from US$120bn to US$105bn, and reduced a further US$15bn per month thereafter, ending in June 2022. This tapering ‘should’, in theory, see bond yields rise. It adds supply to the market and affirms that inflation among other things, has risen enough for the Fed to start withdrawing stimulus. But, the formal tapering announcement is very much expected and as such is probably already priced in. History also suggests that increased supply (of treasuries) doesn’t necessarily cause yields to rise, rather in many instances they fall. Case in point is in 2014, when the Fed was last required to taper its bond buying activities. Yields actually trended lower – “perhaps anticipating a coming rate hike and slower inflation, as the 2s10s curve flattened”. Some strategist are suggesting something similar this time around also.
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Scott Rundell, Chief Investment Officer
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