Mutual Morning Mutterings

Quote of the day…

“I know what you’re thinking.  ‘Did he fire six shots or only five?  Well to tell you the truth, in all this excitement, I kind of lost track myself.  But being that this is a .44 Magnum, the most powerful handgun in the world, and would blow your head clean off, you’ve got to ask yourself one question: Do I feel lucky? Well, do ya, punk?” – Clint Eastwood as Harry Callahan, “Dirty Harry”, 1971

Themes … ”it’s official, we’re in correction territory …”

Overview – risk assets puked overnight as coronavirus angst continued to dominate the narrative and governments around the world warn of a coming pandemic, with preparations under way.  Risk assets (stocks and credit) were a bit slow to the coronavirus threat party relative to bonds, but they’re falling into line with the smart money (bonds) now.  I have been saying over the past week that if the virus makes landfall in the US in any scale then we’d see the then nascent downtrend accelerate…and that is what we’ve seen.  Overnight the Governor of California confirmed authorities are ‘monitoring’ some 8,400 for coronavirus, with 33 testing positive.  In Japan, all educational institutions have been shut down and Microsoft issued earnings warnings on the back of supply change disruptions.  But, is it really all that bad, the virus that is?  Read below under “So, what does it all mean Basil?”.

Stocks – European stocks haemorrhaged massively overnight, down over 3.0% – 3.5% across key indices.  Not one to be shown up by the Europeans, it was a slaughterhouse in US stocks overnight with the biggest one-day loss in nine years.  The S&P 500 tanked straight out of the blocks early, down 3.9% at its initial worst before staging a modest recovery to be down just 1.0%.  Then it turned to absolute custard again with markets plunging to be down over 4.4% – 4.6% across the DOW, S&P 500 and NASDAQ.  We’re hearing there are a lot of volatility hedges coming through, which is fuelling the fire and no doubt with key technical support levels smashed, the algo’s are triggering sell orders.  Markets are now officially in correction territory and in free-fall.  The S&P 500 and Euro STOXX 600 are both down almost 12.0% over the past six sessions, which represents the quickest >10% correction from record highs on record.  Valuations have lost some froth with the 1Yr+ PE on the S&P 500 down to 17.2x from YTD highs of 19.5x and below the 12-month average (18.0x).  The ASX 200 is down 7.1% before today’s action, which will likely be another 2.0% down day I would suggest (futures indicating down -2.5% at the open).  Local PE’s have dropped to 17.8x from highs just last week of 19.1x.  The knife is well and truly falling, and I’d be wary of trying to catch it, let it hit the floor and stop quivering before you jump in.

Bonds – markets are now pricing three rate cuts by the Fed by the end of this year as traders and price makers signal they’re not buying the Fed’s ‘wait n see’ approach to the virus.  It’s a similar story in Europe, however the ECB has very little ammunition to fight with, basically all they have is a cap gun.  While the Fed doesn’t necessarily have a .44 Magnum, they at least have something to work with.  US treasuries are at new all-time lows.  Yields on the 10 year are down 64 bps since the virus first surfaced, from 1.907% to 1.277%, the curve however has bull steepened 8 bps to 20 bps as the market ramps up rate cut expectations.  Aussie 10Y yields are -6 bps lower at 0.857%, while the front of the curve has been a little more constrained with probability of a rate cut next week just 17%, and 40% for April.

Credit – nothing doing in primary markets globally, companies have put the shutters up, bought some tinned peaches, a shotgun or two and are bunkering down to wait out the zombie apocalypse.  Since the stock market’s correction began a week ago, global credit indices have also sold-off.  US IG corporate spreads are +10 bps, while US Fins are +11 bps.  US HY, the canary in the coal mine of risk assets is +69 bps, or a +20% move – and further to go.  More muted in EUR Fins, +4 bps, while corporates are +14 bps.  Closer to home, the AusBond indices are marginally wider for now, +2.0 – 2.5 bps across fixed and FRN’s.  We wouldn’t be surprised to see major bank 5 year quoted +80/72 bps, while tier 2 paper has also widened with NAB’s longer dated Tier 2 at +193 bps (mid) on YB, +20 bps.  The VIX spiked from 27% to 37%, five-year highs, which flowed through to synthetics, CDX (US) +7 bps, MAIN (EU) + 4 bps…Aussie iTraxx will be +5 bps this morning I reckon.

Data – RBA’s private sector credit growth today with consensus calling for MoM growth of +0.2%, however this will be totally ignored by local markets.  Local markets are passengers on the global roller-coaster, we are the play thing of global markets.

So what does it all mean Basil? – The WHO has yet to declare a pandemic, but that is all semantics, it’s happening, move on.  But, is it really all that bad?  So far globally we have 83,000 infected and ~2,800 dead in the space of two months – official figures, but conspiracy theory boffins see numbers much higher.  Regardless, according to CDC data for the 2018-2019 US ‘flu-season’, there were 647,000 people hospitalised because of flu and 61,200 died.  According to CDC data, that’s a pretty typical season.  So in the context of ‘normal’ flu seasons, it could be argued government (over)reaction to coronavirus has or will have done more damage to global growth than the virus itself – although I’m not an expert in this field, so I could be wrong.  With expected monetary and fiscal policy to come charging to the rescue, likely in the second half of the year, buying opportunities are just around the corner.  But not just yet…hold your horses for now.

This day in history – Thurs 28 Feb:  In a leap year, we’ll skip ahead to the 29th and spare a thought for the pirate, Frederic, unfortunately apprenticed until his 21st birthday.

Note to readers – as per usual, feel free to share etc.  Next week we’ll usher in some minor changes to the daily.  It’ll be a tad shorter, with ‘Basil’ to become a weekly note rather than touched on daily.  As always, appreciate any feedback, good, bad or otherwise.

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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 0.85%
• 3yr Govt Bond down 5pts– implied yield 0.56%
• 10yr Govt Bond down 7pts– implied yield 0.85%
• 20yr Govt Bond down 5pts– implied yield 1.15%

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