US data and market narratives
- US economic data
- Our direct equity positioning
US economic data crushed expectations, which were already quite high, overnight.
Empire sales, initial claims (perhaps even more importantly, continuing claims) and retail sales all exceeded consensus, and risky assets were bid, with yields falling.
We’ve talked a lot about the importance of narratives, in asset allocation, and today’s market reaction might just be the birth of a new market narrative (to add to the 3 or 4 other major one’s we’ve talked about here [see our most recent Quarterly Investment Report for more, or reach out to us]).
That narrative is “peak data” might have been reached, with the market assuming this is “as good as it gets” for eco data, and hence longer dated yields begin to move lower, in the standard flattening-of-the-curve that happens when you enter the long phase of an economic expansion.
We think that’s baloney, and not at all likely, as we go onto explain below.
Both initial claims (freshly unemployed persons looking for unemployment benefits) and continuing claims (those still drawing on benefits) continues to fall.
Graphically, the rise and fall is quite stunning, and even though we celebrate the declining number, the absolute level of the number is still quite astounding. Half a million people looking for income support (which is why the Biden stimulus package unemployment benefit section was so crucial in maintaining/supporting the economic recovery).
Retail sales was a fairly mindboggling result, but, entirely consistent with pull-forward demand via stimulus checks. People with cash, and in many instances little to do with it in terms of experiential spending (i.e. services like haircuts or concerts or leisure travel) buy things, whatever those things may be (cars, homes, TVs, change the furniture).
The pull-forward part seems consistent with yields falling, as “peak data” might be priced.
Macro market data
And falling yields was exactly what we saw. In part, this is why gold was bid overnight, as gold tracks the movement in real yields almost perfectly (rising when real yields fall, and vice versa, because of the cost of carry, inventory, and opportunity cost channels).
Risky assets like commodities, and equity markets ground higher, and spreads continued to tighten. Note, by the way, the amount of compensation over and above the risk free rate that is on offer in the high yield market (e.g. the spreads in HY below). They are extremely tight. That is why, despite the yield pick up in absolute terms, we have almost no sub-investment grade credit exposures across our diversified portfolios.
Is “peak data” and hence peak-yields-soon-to-fall-yields the correct angle? We think not.
Firstly, note that the retail sales data isn’t what moves the treasury market. Put very simply, the market cares more about some prints than others. Non farm payrolls moves the market, but not the core retail sales data.
The good use of correlation analysis, and event study analysis, bears this out in the data.
If that sounds a tad surprising, consider the Australian PMI data, which almost no one cares about, yet PMIs matter in the US. Some things just fail to capture the attention.
Secondly, as per our earlier macro market graph, the yield on the 10 year was about 2% pre-pandemic. Little has changed to the structural parameters of the economy over the past year, COVID or no COVID, and as such, we expect that rate to prevail again.
Given the stimulus package does have a good chance of causing the economy to temporarily butt up against supply side constraints, the prospect of a yield overshoot is very real, suggesting, to our minds, a number closer to 2.5%, which we are presently quite a way from.
Equity index movers
The lower yield move is good for secular growth stories, and as such the stronger sectors overnight were tech and healthcare. The reason is because their very large “earnings runways” are many years out in the future, and lower discount rates make these income streams more valuable, in contrast to value stocks in which nearer term earnings are often more important (for example, not getting any worse, an idea which is quite indifferent to the present level of the interest rate).
No change to our equity portfolio positioning. For the most part, at first blush, our portfolio isn’t overly exposed to a change in interest rates, rather it is the movements in the Aussie dollar that determine our performance on a given day. This is for a quite a few nuanced reasons.
1) The change in rates do matter, but they make their impact felt through foreign exchange markets
2) We invest in quality companies, which tends to be international conglomerates who have successfully exported their business model overseas
3) This means revenue streams often denominated in (or earn the majority thereof) in USD, which tends to lead to a “short AUD” stance across our portfolios
The AUD at near $0.80c has weighed on our direct equities portfolio (much less impact to our diversified, multi-asset portfolios where we make explicit use of hedged vehicles).
The stronger AUD is also largely a function of the strong underlying commodity price environment, which has driven stocks like BHP, RIO, FMG et al.
Given we see the commodity prices as largely unsustainable, we own few of them. BHP we have for index construction purposes, [it is hard to have a portfolio that looks anything remotely like the benchmark if you don’t have at least a BHP or RIO in it, or a NAB or CBA in it] and Alumina (AWAC) as the “value” play within commodities.
Ultimately, we expect both weaker commodity prices and a weaker dollar, of the medium term.
In the interim, it does suggest some further pain, until that plays out. The horizontal black line in the graphs below depict the benchmark value (from the graph in the top left, which is imposed on all the other graphs, so you can see if a given stock is above or below the benchmark over the YTD time period shown).
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