Mutual Morning Mutterings

Quote of the day…

“Why don’t you knock it off with them negative waves? Why don’t you dig how beautiful it is out here?  Why don’t you say something righteous and hopeful for a change” – Donald Sutherland as Oddball, “Kelly’s Heroes”, 1970 (trailer).

Themes … ”tug-o-war…”

Overview – push me, shove you, markets jittery and on edge overnight, a real tussle between technicals and fundamentals as the virus narrative in the US seems to be developing a sense of urgency.  The US FDA has warned “we’re on the cusp” of global pandemic.  It’s not a question of ‘if’ the virus makes landfall in scale in the US, but ‘when’.  Yesterday (last night) was the first day where the number of coronavirus cases reported outside of China exceeded the number of cases reported in China.  Countries most affected included South Korea with 1,000 cases and Italy has 400.  To make matters worse for Japan and its weakening growth outlook, the Olympics, scheduled for later this year in Tokyo, are now at risk of being cancelled, or at best delayed.  The WHO has noted the peak of the virus in China seems to have been between 23 Jan and 2 Feb.  With the virus spreading elsewhere, China has now implemented travel bans on visitors from some countries to prevent re-infection.

Stocks – European stocks pared losses overnight, but it wasn’t all one way with a roller coaster of a session.  Coronavirus fears dominated the narrative, but after four days of losses US markets opened on a firmer footing, which gave the Europeans some cheer and they closed with their noses marginally ahead.  Despite the promising start, an arm wrestle between technicals and fundamentals ensured in US markets and an enthralling struggle ensued.  Sounds all bit dramatic!  US stocks oscillated between being in the red and being in the green about 5 or 6 times in the last hour of trading.  In the end key indices closed in the red – except the NASDAQ.  E-minis are marginally in the red also.  Momentum indicators are now pointing to equities being oversold.  The S&P 500 RSI is 28 and the ASX 200 is flashing 28 also (below 30 indicates oversold), while MACD indicators are still signalling a downward trend.  Volatility is also on the rise with the risk premium traders are pricing in to short-dated options near or at their highest level in the past three years.  Local futures are pointing to another down day.

Bonds – fears of coronavirus touring the US and playing all the big cities kept bonds well bid with UST 10’s hitting new all-time lows.  Markets are now pricing in 2.7 rate cuts this year by the Fed, up from just one cut several weeks ago.  Growing expectations of further Fed rate cuts has seen the curve bull steepen to 18 bps (from 12bps yesterday). For the RBA, while the March meeting (next week) looks to be a dead rubber, April looks to be a live meeting with markets pricing a 50% probability of a rate cut.

Credit – when volatility spikes, synthetics tend to get taken to the cleaners.  The latest turn of events supports this.  The VIX has doubled from 14.4% just over a week ago to 28.4%.  We’ve not seen these levels in over 12 months, or during the Q4’18 ‘the Fed is tightening’ correction.  Consequently, synthetics have risen ~10 bps over the past week or so, or ~20%.  Last night we saw a further 1.5 – 1.9 bps widening across MAIN (EU) and CDX (US).  In the context of the past year, synthetics are still closer to the bottom half of their trading range than the top.  The local index is at 57 bps vs a 12-month range of 47 – 78 bps.  We’re seeing similar ranges across MAIN and CDX, give or take a basis point or two.  On the issuance front, intra-day volatility and general market edginess kept issuers largely on the sidelines.  In time this halt to issuance should provide a modest spread tailwind, but for now offshore spreads are leaking wider.  The bid offer in AUD credit has widened and the slant has been moderately wider – but a fraction of what we’ve seen offshore.  Spreads will remain under pressure while volatility in equity markets remains elevated.

Data – little data of significance in offshore markets overnight, while locally we saw Construction Done data released locally.  No real surprise, it was a weak number, but in its own right shouldn’t materially move the RBA rate cut call dial.  Today we have AU private capex data for Q4, consensus is at +0.5% vs -0.2% in the prior quarter.  Tomorrow we have private sector credit growth, with consensus at +0.2% MoM for January…I’m calling +0.3%, just because of the growth in house prices.

So, what’s it all mean Basil? – not a dip worth buying…well not just yet anyway…be patient.  While I’m no virologist, my gut feel is there is worse to come.  Specifically, as and when the virus makes landfall in the US in scale, which it has to at some stage.  This could precipitate another leg down in risk assets.  Threats to global growth and consequently company earnings are hard to ignore.  Travel restrictions, supply-chain disruptions etc will all have an impact.  Toward the second half of the year we’ll likely see a tidal wave of stimulus, which should provide a boost to fundamentals.  Arguably the stimulus has already started with Chinese central monetary authorities loosening lending restrictions to small to medium business, and Hong Kong has loaded up a Chinook chopper (as Arnie would say), with a shed load of cold hard cash and is dumping it on the population, around US$15bn (helicopter money).

This day in history – Thursday 27 Feb:  1988 – Katarina Witt (GDR) wins 2nd consecutive Olympic figure skating. This will have more relevance to fans of the Billy Birmingham.

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Contact:

Scott Rundell, Chief Investment Officer

T: +61 3 8681 1907

E: Scott.Rundell@mutualltd.com.au

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Interest Rate Futures

• 3m Bank Bills – implied yield 0.86%
• 3yr Govt Bond down 3pts– implied yield 0.61%
• 10yr Govt Bond down 1pt– implied yield 0.92%
• 20yr Govt Bond down 1pt– implied yield 1.20%

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