Mutual Morning Mutterings

Quote of the day…

”If you stretched the average person’s intestines out from end to end, it would make them scream a lot” – Demetri Martin

Themes … ”Does two down days make a trend…?”

Overview – after opening with a spring in its step, markets took a minor tumble on Friday on virus headlines and weak US data.  This was the second consecutive risk-off session, which has been a reasonably rare event over the past month.  The spread of the coronavirus and the slow realisation in the US (and other countries) that the outbreak might actually have a fundamental impact on global growth sending investors into the loving arms of safe haven assets.  Data out on Friday indicated that US business activity shrank in February for the first time since 2013.  As evidenced recently by Apples earnings warning, supply chains have been disrupted and many firms are reluctant to place orders.  Leading into the weekend cases of the coronavirus in China appeared to be slowing, however the pace picked up over the weekend.  The number of reported cases outside of China is also picking up, most noticeably South Korea and Italy.

Stocks – major indices extended their Thursday losses into Friday with all bar two indices wallowing in a sea of red to close out the week.  European stocks showed a little more resilience relative to their US peers, but still down nonetheless.  Over the two-day period the S&P 500 was down -1.4%, while the ASX 200 was down just a touch, -0.1%.  YTD gains are still solid, +3.3% for the S&P 500 and +6.8% for the ASX 200 (before today’s likely losses – ASX 200 futures are down -0.75%).  Valuations are still elevated in a PE sense.  The ASX 200 is pricing around 19x vs 17x average over the past 12 months, and 15x average since 2005.  Equity yield (1/PE) and equity premiums however are less stretched.  Because bond yields are so low, the prevailing equity premium is ~420 bps vs long run average of 284 bps.

Bonds – global sovereign bonds gained a solid bid on Friday as investors headed for safety on the coronavirus headlines.  In the US 30-year long bonds set new all-time lows at 1.9032%.  US 10’s fell to 1.44% post release of the PMI data, before climbing back to 1.47% at the close, lows not seen since September last year and prior to that, June 2016.  The curve flattened a touch (-1 bps) and is now just 12 bps.  While the coronavirus outbreak remains front and centre in the headlines, we see no real scope for bonds to trade materially higher than current levels.

Credit – offshore credit spreads (cash) were sluggish with most (~70%) USD bonds sold in primary through the week trading wider in secondary.  With heavy issuance volumes and negative virus / macro headlines, credit investors have clued on to the fact the virus is something to be concerned about….at least offshore that is.  EUR spreads saw little action, generally a touch wider.  AUD spreads have to date remained resilient to virus headlines and should continue to remain so.  If history is any guide, and technicals remain supportive (and they should) local spreads can withstand up to two weeks of offshore widening before they start to move wider in sympathy. Synthetics also pushed higher, but still remain at historically tight levels.

Data & Events – strong signals that the coronavirus outbreak is having a tangible impact on macro outlook.  The IHS Markit Purchasing Managers Index, which measures composite output at factories and service providers fell on Friday, down 3.7 points to 49.6.  This is the lowest level since October 2013 when the US government shut down.  Figures below 50.0 indicate contraction and we’ve seen similar measures locally and in Japan evidencing contraction.  Further evidence of the macro impact – car sales in China fell 92% over the first half of February.  In local markets this week we have some partial GDP prints with construction work done on 26 February (-1.0% consensus), private capex on 27 February (+0.5% consensus), and the RBA’s private sector credit data for January on 28 February. No consensus up yet, but last month was a modest beat, +0.2% MoM vs +0.1% Mom consensus.  If I had to guess, I’d say a +0.2% – 0.3% MoM figure can’t be discounted if December’s positive momentum gathers pace.

So, what’s it all mean Basil? – I’ve been spruiking a cautious stance for a few weeks now.  Friday’s moves in offshore markets justify that stance and we’ll sit on it for a while yet.

This day in history – 24 February 1968: – discovery of first pulsar announced (CP1919) by Jocelyn Bell Burnell and Antony Hewish.  It would be 10 years before Nissan launched the car of the same name.

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Contact:

Scott Rundell, Chief Investment Officer

T: +61 3 8681 1907

E: Scott.Rundell@mutualltd.com.au

W: www.mutualltd.com.au

Interest Rate Futures

• 3m Bank Bills – implied yield 0.89%
• 3yr Govt Bond down 4pts– implied yield 0.64%
• 10yr Govt Bond down 6pts– implied yield 0.94%
• 20yr Govt Bond down 6pts– implied yield 1.23%

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