Mutual Daily Mutterings
Quote of the day…
“There are three kinds of people: those who can count, and those who cannot.…” – George Carlin
Chart du jour: CPI vs bond yields…
Source: Bloomberg, Mutual Limited
“Reflation trade revisited …”
- Overview – nothing really done in stocks overnight with key indices globally largely unchanged. Bonds on the other hand were somewhat frisky (yields higher) with a bond-market gauge of US inflation expectations soaring to eight-year highs (10Y break-even rate of 2.4%), underpinned by increases in oil and metal prices, soaring house prices and consumer confidence. There is also the expectation that President Biden will unveil a new “social spending plan”, which will likely be stimulatory and ultimately inflationary. All indicators are pointing to a strengthening US recovery from the pandemic, and fuelling inflationary concerns – and a growing US economy is good for the global economy. Realistically the reflation trade didn’t go away, rather it was just dormant, while those who called it early took profits. Data is now again fuelling interest in the trade. The Fed meets tomorrow, but markets are not expecting any meaningful change to their stance despite market moves and data prints. Talking heads… “all of the better data points to a higher-inflation narrative that the market is reflecting, but the Fed is not about to react to that yet.” A busy day in US reporting, rising from 25% to 35% complete (of the S&P 500). Aggregate sales are up +7.7% QoQ, while aggregate earnings growth is off the charts…literally. Not sure if there is a systems glitch, but Bloomberg is suggesting EPS growth of 1,029,751%…has to be a mistake. Data against consensus estimates is more ‘normal’, with sales sporting a +3.3% beat and earnings +4.0% ahead of expectations. Talking heads….”earnings optimism already was largely embedded into expectations moving into the current earnings period, so investors are looking for substantially outsized positive results, without which stock price advances will be muted and, like today, could take a hit.” All eyes on the Fed tonight, and then growth and inflation data later in the week. Bias is for yields to trend higher, stocks to range trade, but with risk of a correction, while credit will remain stable. Locally we have CPI data, with consensus expecting +0.9% QoQ and +1.4% YoY (vs +0.9% YoY last). Given offshore leads, bonds will be under pressure regardless of the inflation print.
- Offshore Stocks – while the net result on the day was largely unchanged, across the DOW and S&P 500 at least, tech stocks were under some relative pressure with the NASDAQ down more than most – somewhat surprising given some solid results from Alphabet and Microsoft…but here’s why, talking head “the Street was hoping for a stronger top-line beat”. Intra-day markets oscillated between modest gains and modest losses across most indices. Delving further into the mire (S&P 500), more stocks rose than fell, 55% vs 45%, while at the sector levels, only three-sectors rose, which was enough to counter falls in the other seven sectors. Rising on the day were Energy (+1.26%), reflecting rising oil prices, Financials (+0.90%) and REITS (+0.87%). In the naughty corner, the main trouble makers were Utilities (-0.75%), Healthcare (-0.51%) and Telcos (-0.45%). European markets were also in the red, with a slightly darker tone relative to US markets. Asian markets also sporting a reddish hue.
- Local stocks – modest fall in the local market yesterday, with a smidge over half of the index closing lower on the day. As a proportion of the index, Tech (-2.5%) did most of the damage in the loss column, followed by Industrials (-0.98%) and Healthcare (-0.83%). In the winner’s circle, it was the old guard fighting the good fight, with Materials (+0.74%), Utilities (+0.20%) and Financials (+0.09%) holding their heads high. Leads from offshore are generally directionless, but suspect we’ll open weaker, despite futures being up +0.24%.
- Offshore Credit – the big banks are back with Citigroup hitting the market with gusto, pricing US$5.5bn of bonds, becoming the fifth of the big six US banks to tap markets following Q1 earnings reports. These deals have been solid performers for investors, with the newly issued tranches from the big six now -12 bps tighter on average vs issue pricing, with all of them unilaterally trading inside new issue pricing levels. For a point of reference, the OAS for the Bloomberg Barclays US Corporate index is unchanged over the same period.
- Local Credit – Transurban Queensland primary deal was the focus for many yesterday, but not us. Elsewhere, from the traders…”little flow in majors yesterday, we saw ongoing selling of 18-month paper which was competitively bid by the street, 1-2 bps inside of YieldBroker. The FRN curve remains unchanged and we do not expect any notable moves in spreads until the back end of 2021, at the earliest.” I wouldn’t argue with that. Major bank senior spreads unchanged, and same for tier 2, zero movement.
- Still on local credit markets, S&P yesterday affirmed the ratings on the major banks and Macquarie, but left their outlook at negative (reflecting negative sovereign outlook). Paraphrasing some Citi commentary here…S&P highlighted it now has a ‘positive’ outlook on the Australian banking sector’s “Industry Risk” score, which is currently set at “3”. If S&P revises the “Industry Risk” score from “3” to “2” (i.e. a better score), this will lead to a one-notch higher Standalone Credit Profile score (i.e. SACP, which is currently BBB+). This revision process usually takes anywhere from 6-18 months. Recall that the SACP is the starting point of Tier 2 and AT1 ratings and an upgrade in the SACP will be mechanically matched by an upgrade in Tier 2 and AT1 ratings. If this eventuates, importantly, the major bank Tier 2 ratings would go into single-A territory (BBB+ to A-), matching Fitch. Meanwhile the AT1 rating will go from BBB- to BBB, matching Moody’s Baa2. While it’s not explicit, in effect we are now in an awkward period where S&P has put a “shadow” positive outlook on the sub-debt/AT1 ratings, while having a negative outlook on the senior/issuer credit ratings of the banks. An upgrade in the SACP will not have an impact on the senior unsecured/issuer credit ratings of the majors (but it may eventually remove the negative outlook). An eventual upgrade of the Tier 2 ratings to single A territory could have a small positive impact on sub-debt spreads, (noting that Moody’s is still at Baa1), which have struggled to compress further against senior unsecured spreads
- Bonds & Rates – US treasury curves steepened as the reflation trade narrative was dusted off – not too much effort really, it was last in vogue only a month or two ago. I pilfered this from NAB’s morning rates note, which in turn references a JPM investor survey….”the JP Morgan investor survey shows asset managers extended net shorts last week with the all client index at -22 (from -19) while the most active client index is at -30 (from -20). While the CFTC data shows that speculative investors are holding small net longs in US 10-years the average level (for 2y,5y and 10y CFTC positioning) is at a small net short as well (given speculative investors hold a big net short position in 2-years and small net short in 5-years)”.
- Macro – again, from NAB’s morning note…”fiscal stimulus, the roll out of vaccines and re-opening of economies has seen US consumer confidence rise significantly in the past two months (the Conference Board index is up 31.3 and approaching pre pandemic levels). The surge in the latest survey is being driven by assessments of the present situation. Consumer’s assessment of labour market conditions rose significantly with the labour differential (jobs easy to get versus hard) rose to +24.7 (an increase of 16.7)”. With regard to the Fed and their inflation views, I found these comments interesting, from Jeff Gundlach (one of the smarter dudes going around), basically he thinks the Fed is guessing when it comes to inflation. “I’m not sure why they think they know that it’s transitory. How do they know that when there’s plenty of money printing that’s been going on and we’ve seen commodity prices going up really massively.” He further speculated that while bond yields remain very low, it’s hard to figure out who’s going to buy the massive debt market issuance, adding that US stocks are very overvalued compared with Asia and Europe.
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Scott Rundell, Chief Investment Officer
T: +61 3 8681 1907