MACRO
This weeks macro focus was on slowing growth in China, and how this may affect global economy.
US consumer still remains strong with shrinking but still reasonably large cash reserves (10.6% of total household assets), above the pre-covid cash reserves (10.5% of assets), and significantly above pre-GFC reserves (9%).
Student loan repayments starts in October and will affects 48 million consumers who need to start repaying over $200 per month, which will directly affect their disposable income and reduce spending.
RATES
Over last few weeks rates analyst commentary was focused on the big changes to the long-term rates. Just a few months a go market was pricing in a high probability of a recession, with positioning tilted towards the long duration. Now we are seeing record high levels of short future positions in 10Y notes, with 10Y hitting cycle high at 4.36 bps (intraday) on 22nd of August.
Bear steepening continues as yields on the longer dated maturities raising faster than a short-term yields. 10Y-2Y negative spread gap, shrunk nearly 30 bps since the end of June. Markets starts pricing in ‘higher for longer’ rates and moving in the belly of the curve closer to the FED’s fund rate. Since 2000 during nearly all periods of ‘bear steepening’, equities rose in value, however we only had a one instance with ‘bear steepening’ while the yield curve was inverted and that was close to the 2007 peak, before the GFC.
Recent divergence of the monetary policy and rates across the world, lead to more volatile currency markets and increase in capital flows. They also offer ample opportunities to leverage differences between different bond markets and yield curves. Across all the bond markets, Treasuries looks particularly appealing, but this may change if the US economy suddenly starts teetering.
CREDIT
Tighter financial conditions and less lending from banks should create more opportunities for the private credit. Private credit funds without legacy issues, are now starting to step in where the banks have pulled back. Blackstone’s president Jonathan Gray calling it a “golden moment” for private credit. Attractive private opportunities will increase over next 2-3 years, due to increase in the maturities coming due that need to be refinanced.
In recent years US credit market saw especially large increase in the leverage loans space. In this space specialize lenders arranging bespoke loans for companies shunned by big banks and too small to tap the bond market. Big part of this market is dependent on a constant influx of fresh money to allow borrowers to refinance, which makes it most prone to the stress in the economy. In addition recovery rates are far below the recovery rates in public markets. Private loans are also very illiquid as they are not designed to be traded. As of now most vulnerable loans are the ones offered to companies operating in the real estate industry, especially commercial real estate sector, already suffering heavy losses.
Yield is a double edge sword. From one hand offering more income to credit investors, form the other it puts stress on borrowers who need to make a significantly higher interest payments. Higher rates require investor for better credit picking as they can signal more distress, especially in the more risky parts of the market.
EQUITIES
Cross assets indicators getting less favorable for the equities as the bonds are becoming more attractive a those yields. In addition we are seeing international flows coming out of the US stock market, as it becomes more expensive on a relative basis. We see outflows specially from the high-growth areas which so far, have been the best performers this year.
US large-cap stocks were largely flat over the past week, and down 4 to 5% for the month of August. Top 2 caps Apple and Microsoft which now represent 15% of the S&P500 ($5.5t) broke their uptrend in August and could contract further their generous multiples of over 30 PE (compare to the average PE of 21). Keeping this valuation will be especially difficult for Apple, which shrunk its revenues over last 3 quarters. Other members of magnificent 7 are also facing technical weakness, and without this leadership tech, it will be difficult for indexes to remain its current levels.
Blue-chips of S&P 500 and NASDAQ100 are less connected to the overall US economy than the average stock. Therefore earnings are more important to blue-chip performance than the macro pressures coming from the higher rates. We saw upwards earnings forecast revisions for both 2023 and 2024, with less dispersed sector setup as earnings lagers are expected to accelerate their growth leading to convergence between sector differences. More recently we are seeing upward revision of healthcare and energy, which drove their strong performance in August. Subsiding inflation could become a drag on revenues, and create a pressure on earnings.