Macro
… Pending …
Rates
End of the hiking cycle. The narrative has shifted away from higher for longer, and the market is rapidly recalibrating yields. The expectation is that rate cuts will start early next year, with FED funds futures now pricing a 60% chance of a 25 bps cut in March. It is also possible that the FED will start cutting later in the year but cut more rapidly. Regarding the shape of the rate adjustment, the consensus is that duration exposure will be advantageous. We can see the changes in market expectations by observing a move and a drawdown of short-term 3M and long-term 10Y yields.
Over November, the long yields had the most significant monthly decline since December 2008. The 10Y yield slid from its 5% peak to a 4.35% spring rally in risk assets. The U.S. aggregate bond index increased 5% – the biggest monthly gain in decades.
Credit
Investment grade credit market spreads are 120 bps, and IG credit is pricing in the best times. IG credit spreads are very tight and remain less attractive than some structured credit products with similar yields. The top-of-the-cap stack structure credit products pay high single-digit yields for less credit risk than the average IG portfolio.
Last year, we were in the middle of a rate shock. We saw the duration of the issuance get much shorter on the curve, borrowers reached private markets, and borrowers more frequently accessed bank debt at floating rates to bridge themselves to the expected lower rate environment. Based on the expectations of declining rates explained above, many will pull it off just on time.
Canary in a coal mine is the private credit deals vintage 2020/21. In 2020/21, private credit investors were underwriting debt with a very rosy outlook on EBITDA and at historically low rates. That’s a recipe for disaster if rates stay high, consumer demand slows, and default rates pick up. And we have already seen more defaults in the last quarter than in any period since 2010.
Equities
In over a year, November was the best month for equities, ending a three-month losing streak. All significant indexes hit high for the year, and volatility has subsided, with the VIX falling to the lowest level since the pandemic. However, it must be mentioned that the decline in VIX is driven mainly by the volume of options on the magnificent seven stocks, which had a solid performance throughout the year. The earning season has concluded with modest growth above the Q3 2023 expectations.
As mentioned at the end of October, from the cyclical perspective, November and December are very strong for equities. This is partially explained by mutual funds’ tax-loss harvesting, which ends at the end of October, and cyclical buybacks and pension fund inflows at the beginning of November. Small and mid-caps performed particularly strongly, as the increased expectations of the end of the tightening cycle and subsiding risk of recession boosted smaller, more vulnerable companies.