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The disconnect continues

By Henry Adams on 2020-07-17

A sense of optimism with potential vaccines and easing of lockdowns in most jurisdictions is helping keep the buy button in stocks busy.

The CSI 300 (China Securities Index top 300 companies by market capitalisation) had, up until Thursday, added almost $2Tn in value since January. Whilst the Chinese economy grew more than expected in Q2 (3.2% vs 2.4%) the consumer was still AWOL. In Europe both Swiss and Swedish exchanges are close to flat on the year, the NASDAQ has held on to its staggering rise of around 16% and the S&P 500 (-0.80) and Dow Jones (-6%) are both clawing back losses since February at quite a pace. This continues to seem detached from the reality that is a record number of daily cases globally, where on Thursday alone a further 230,400 new infections were reported, with one quarter of these on US soil. Several reports of “unknown origin cases” in various cities if true is once again humbling. Unfortunately, it seems we still know very little and certainly not enough. Another record one would rather not be breaking is the level of debt issuance. Since January $2.1Tn in corporate debt has been created since the beginning of the year in a world where revenue and ability to repay are clearly heavily hampered. The tail on that swoosh sadly seems to be getting stretched.

Yesterday we heard from the ECB, with all key rates on hold along with reaffirming use of the full EUR 1.3Tn earmarked for buying financial assets under its Pandemic Emergency Purchase Program (PEPP). Whilst ECB President Lagarde cited some signs of recovery, unless there are significant surprises to the upside, the view is every last cent will be used. The ECB is also keen that EU leaders finally agree terms on the EUR 750Bn package due to be made up in part of grants with the balance in loans. Common ground is still proving difficult to find here. Whilst yields have remained steady in the government space, we have seen an increasing number of clients facing a cliff-edge on deposit rates in the month of July with banks now unwilling to artificially support the coveted 0.00% on deposits even for the biggest and brightest customers.

As predicted, we did see the first negative print in UK Treasury Bills two Fridays ago. Since then, rates further out the curve have held at the tights with 5 years continuing to print near -0.10%. This is helpful for the Government at a time when debt issuance is at a record high. The Debt Management Office announced supply for the latter part of the year this week which would take the 12-month program to a rather large £450Bn. To put this into context, this is almost double the record set during the GFC. Chancellor Sunak, keen to eventually bring debt down and balance the books, is revisiting capital gains tax, raising speculation of adjustments to bring this in line with income tax. UK unemployment figures for the 3 months to the end of May beat expectations, with evidence of the rate of firings reducing over the quarter, although most commentators seem to agree it is the silence before the storm of the pain of June and July where big well-known names have been drastically reducing headcount, leading to higher numbers, and soon. The end of furlough at the beginning of November will be another potential watershed moment. Despite Treasury bills and the base rate this close to zero there is still opportunity to increase yield whilst reducing risk and, on a percentage basis, this has probably never been larger!

In the US, earnings season for Q2 has begun. Some of the big US banks have already given us a good indication of their financial health and profitability through recent dislocations. Fortune has favoured the brave with appetite for risk and the ability to navigate it. Goldman Sachs increased revenue from bond trading by a staggering 150% versus the same period last year and far ahead of forecast. Total revenue was over $3.5Bn higher than where analysts predicted the numbers would come in at a mere $10Bn. Citi and JP Morgan both also fared well, with trading businesses racking up chips through these uncharted waters. What else was exposed? Parts of the sector that are likely to fall behind. Wells Fargo, with its large corporate and retail presence did not do so well, printing a loss in excess of $2.5Bn. Relying on net interest margin in a world without a rate is going to make for a tough few quarters. The one common theme was an increase in loss provisions, doubling from the previous quarter for these four banks alone to $30Bn. Wall Street sees the end of more direct stimulus having merely postponed what could become quite a turn in the credit cycle. Initial jobless claims weekly data continues to exceed 1 million people whose lives are being disrupted, not helped by safety measures being removed (probably too hastily) and then put back in place. Unlike the EU and UK, US treasuries continue to offer a yield and a reduction in risk with preferred measures by the Federal Reserve being curve control over cutting of interest rates.

Worth highlighting is a recent letter from the Chairman of the Financial Stability Board, an international body formed following the last financial crisis to make recommendations about the global financial system. The corporate sector came into this with a high level of debt which has since risen. Volatility may well return, including further liquidity shocks. Lessons must be learnt from vulnerabilities that have been highlighted both in credit and the Non Bank Financial Institution (NBFI) sector in terms of leverage ratios, liquidity mismatches, heightened correlation and thereby the need for extraordinary measures to calm markets. This includes investor behaviour related to fund structures sold as liquid and cash equivalent but have been proven otherwise. Full letter below worth five minutes of reading something factual in a world of media hype.

To G20 Finance Ministers and Central Bank Governors

Articles of interest:

Professor Whose Formula Predicts Bankruptcies Has a Big Warning

Top US tech companies sold bonds as yields plunged

An FTF or Fixed-Term Fund is a regulated fund investment that offers exposure to a single investment-grade obligor for a fixed term, without the need for any client infrastructure. An FTF has many of the same characteristics as a term deposit, but can offer exposures outside of the banking sector. TreasurySpring is originating FTFs with sovereign, financial and corporate obligors.