Mutual Daily Mutterings
Quote of the day…
”Why waste your money looking up your family tree? Just go into politics and your opponent will do it for you…” – Mark Twain
Overview…”COVID still impacting markets in some shape or form…”
- Moves: risk on … stocks ↑, bond yields ↓, curve ↑, credit spreads ↔, volatility ↑ and oil ↓….
- Despite a modest bounce overnight (dip-buyers apparently), offshore markets are considerably lower since the Australian market, bonds and stocks, last traded (Friday). When local markets open this morning, they’ll adjust for the net effect of Friday’s moves and the action last night. On that basis, the S&P 500 is down a smidge over 2.0%, so a meaningful headwind for local sentiment. Offshore yields are flattish since Friday, but rallied overnight as markets grow increasingly concerned around the COVID situation in China and what it means for growth – remembering that China accounts for ~12% of global trade. Curves bull steepened.
- “Oil prices have cratered, falling by more than 4% in New York, as concerns over demand increase. China, the world’s biggest crude importer, is heading for the largest oil-demand shock since the early days of the pandemic as the nation’s bid to tame a worsening virus outbreak encompasses large swaths of the economy.” (Bloomberg). Energy stocks took it in the neck as a consequence (-3.3% in the S&P 500).
- A bit of a red-letter day overnight. Bloomberg is reporting that negative yields have ‘vanished’ from the corporate bond market. Bloomberg is reporting that every bond in one of their indices that tracks global IG bonds is yielding 0% or more as of Friday’s close. This compares to US$1.5 trillion worth of bonds with sub-zero yields as of August last year (most in Europe).
- Talking heads…”the rebound shows that stocks weren’t ready to test year-to-date lows…last week’s selloff was an overreaction to Powell’s comments.” A glass-half-full view of the world, for what it’s worth. A more balanced view here…“this week may easily be a fork in the road of equities…we have nearly a third of the S&P 500 and half of the Dow Jones set to report quarterly results. Bottom-up drivers will either confirm or reject what the challenging macro backdrop has given us over the last three weeks.”
- And, I have some empathy with this view “it’s not that the current news flow is bad. The problem is that the range of potential economic outcomes is too wide to predict future corporate earnings with any certainty.”
The Long Story….
- Offshore Stocks – European markets comfortably in the red overnight, down -1.5% – 2.2% and down -3.0% – 4.0% month to date. US markets started similarly in the red, with the S&P 500 down -1.6% in the first few hours of trading, but then dip buyers emerged, and the index closed +0.6% higher. The DOW advanced +0.7% and the NASDAQ +1.3%. Within the S&P 500 58% of stocks advanced, while at the sector level it was seven sectors higher, and four lower. On the downside, Energy (-3.3%) was the worst of the worst as oil retreated on China demand concerns. Utilities (-0.7%), REITS (-0.5%) and Materials (-0.3%) were also lower on the day. In the roped off VIP section, Telcos (+1.5%), Tech (+1.4%) and Discretionary (+0.8%) were partying with the good stuff.
- “While the run of losses shows Fed hawkishness starting to bite, the damage remains but a flesh wound when considered next to most measures of valuation — a sign that could signal more losses to come. At 22.0x earnings and almost 3.0x sales, the S&P 500 is still valued at about 60% more than U.S. gross domestic product, higher than any time before the pandemic.” (Bloomberg)
- Local Stocks – the ASX 200 last traded heavy, on Friday, down -1.6% with almost 80% of the index retreating and only one sector, Healthcare (+0.5%) gaining any ground. Materials (-3.3%), did the bulk of the damage, ably assisted by Financials (-1.7%). In a straight-line sense, Tech (-2.5%) and Energy (-2.5%), also weighed on the index’s broader performance. Despite the rebound in US markets and prima-facie positive lead, I expect markets will open weaker. Futures are down -0.3%.
- ASX 200 Relative Strength Indicators…
- Offshore credit – “a key measure of corporate credit risk climbed to the highest level since June 2020 as China’s worsening COVID outbreak compounded fears sparked by faster Federal Reserve tightening. Preliminary estimates from high-grade syndicate desks project sales slowing to around $25 billion for the week.” (Bloomberg). The measure references the CDX, which hit 81 bps overnight, +1.5 bps at one stage, however as sentiment turned in stocks, so it turned in synthetics. In the end the CDX closed -2.7 bps lower at 77 bps. The MAIN (EU) was less fortunate, +2.4 bps to 84.5 bps. In cash, issuance has slowed as reporting season progresses. Some heavy hitters reporting this week, Citi and Goldman Sachs, which once done, will likely see issuance resume.
- As per above comments, the volume of bonds in negative yield territory has dried up. The Bloomberg global corporate bond index is now yielding about 3.7%, its highest since March 2020, jumping from 1.3% at the end of 2020. Also, the US IG cost of funds almost doubled this year as government bonds slumped. The yield to worst on the benchmark Bloomberg high-grade index closed at 4.25% on Friday, not far from the post-global financial crisis peak struck in March 2020.
- Offshore Credit Spreads…Historical
Source: Bloomberg, Mutual Limited
- Local Credit – traders…”a more constructive end to the week in the lead up to the ANZAC day break, the market given a respite from recent sell flows which have dominated price action across the last month.” While liquidity has been problematic lately as investors sit on their hands, and the street seems reluctant to take on risk, spreads have trended sideways. Relative to offshore trends, local credit has remained resilient. Offshore spread volatility has been 2x – 3x higher than local spreads, with standard deviation in spreads of 22 – 26 bps for US IG and 17 – 21 bps for EU IG, compared to 8 – 10 bps for local credit. We expect these relativities to persist over the immediate term all other things remaining equal.
- A$ spreads vs offshore peers…
Source: Bloomberg, Mutual Limited
- Bonds & Rates – another rout in bonds on Friday (locally), which the last time local markets traded given yesterday’s public holiday. The BBSW 3M is also on the rampage, up to 0.46% vs 0.07% at the beginning of the year as markets accelerate rate hike expectations. “With the May and June RBA meetings now widely seen as the two most likely months for the first move, the BBSW rates face a form of “roll up”, as the meetings approach” (CBA). Treasuries overnight witnessed a solid rally in what seems to be pegged as a flight to quality – reflecting China COVID concerns. With China stubbornly hitching its wagon to a zero-tolerance COVID approach, and associated lockdown situations (makes Chairman Dan’s lockdown look like a holiday camp), there is renewed concerns global supply chains will be more chaotic than they already are and in turn a headwind for growth. Rough and dirty, ↓ growth = ↓ yields (more so longer end), all other things being equal. The other schoolyard bully, Russia, and their empirical wants and desires are adding to the geopolitical @#$% show that investors are having to digest.
- I think long end yields have gone too far, a view I’ve been expressing for a few weeks now, although acknowledging that momentum would likely see yields overshoot. Anything north of 3.0% in ACGB 10-year looks overdone for me. If we assume consensus peak cash rate this cycle is 1.50%, and factor in an average 10-year vs cash rate spread of ~90 bps, then we have a 10-year rate of 2.40%. Adding perhaps +50 bps for margin of error, this gets us to 2.90%. All very simplistic and very much licking the finger to test the direction of wind, but 10-year around 2.90% – 3.00% seems more plausible and defendable given know risks, than say 3.10% – 3.20%. Consensus estimates have ACGB 10-year at 2.91% – 2.96% through Q2 – Q4.
- ACGB 10-Year yield vs 12 Month moving average…
- ACGB 3-Year yield vs 12 Month moving average…
- Market implied RBA cash rate trajectory…
- Macro –
- the main event for local markets this week is tomorrow’s CPI print. Bloomberg is reporting consensus (core) at +1.7% QoQ and +4.6% YoY, or trimmed of +1.2% QoQ and +3.4% YoY. Credit growth data also out later this week, with another strong print expected, +0.6% MoM and +8.0% YoY. Some street colour on CPI expectations ….“we expect core trimmed mean inflation to be 1.2% QoQ and 3.4% YoY. While that is broadly in line with consensus, it is well above the 0.8% QoQ implied by the RBA’s February SoMP forecasts. The latest RBA Board Minutes indicate the RBA is braced for a core inflation print above 3% and this was one of the reasons for the RBA pivoting to bringing forward the likely first rate hike. The RBA has explicitly stated it wants to see “both inflation and the evolution of labour costs” before contemplating lifting rates, seemingly pencilling in June given WPI is on 18 May and GDP is on 1 June. Though the bar appears high, a stellar core CPI print still has the potential to bring forward the first-rate hike to May. We think a core trimmed mean print of around 1.5% QoQ that is sufficiently broad-based would be enough to see the RBA feel compelled to move in May. A broad-based 1.5% QoQ trimmed mean print would see annual inflation at 3.7% QoQ, necessitating a substantial revision to the RBA’s inflation forecasts and a quicker and perhaps steeper tightening cycle.” (NAB)
- CPI vs BBSW 3M….
Source: Bloomberg, Mutual Limited
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Scott Rundell, Chief Investment Officer
T: +61 3 8681 1907