Climbing back to the peaks

After a stumble, equities are climbing back to the peak. A day after the Nasdaq reclaimed record territory, the S&P 500 has followed on Wednesday, while Europe’s Stoxx 600 is just shy of last month’s peak.

The dip in the wake of the growth scare triggered by the coronavirus outbreak looks pretty minor. Still, China’s CSI 300 has some room left to claw back its losses from its mid-January high, presently about 9 per cent. As for commodities such as copper and oil alongside emerging market currencies, there also remains plenty of scope for a more significant rebound given the scale of recent losses. That likely requires a definitive all-clear on the pace of infections, which for now remains nebulous. 

The strength of the rebound in equities and other risk assets was underscored by how bullish equity markets remained despite the World Health Organization downplaying Chinese media reports of a breakthrough in attempts to find a cure from the coronavirus. “There are no known effective therapeutics against this 2019-nCoV,” a spokesman for the international body told the Financial Times. 

Here’s how some of the major equity benchmarks are faring after their coronavirus-induced dip, with the tech-heavy Nasdaq on Wednesday easing back on to its recent record-setting pace. 

With economic data this week highlighting some pick-up in global activity as the year began, risk-market sentiment has focused primarily on expectations of more monetary and fiscal stimulus that minimises the economic fallout from the virus. This was reinforced on Wednesday with Thailand’s central bank cutting interest rates by 25 basis points to a record low of 1 per cent, citing a rising economic risk from the epidemic. Singapore’s dollar slid as the country’s central bank said there was “sufficient room” within the currency’s trading band to accommodate easing of the exchange rate. But the big driver of risk appetite for now is China and the scale of Beijing’s fiscal and monetary response over the coming weeks.

TS Lombard’s Larry Brainard and team write:

“The balance between deleveraging and growth is likely to be tilted towards stimulus in order to make up ground lost due to the virus and quarantine.”

They add:

“The leadership’s need to ensure that expansion stabilizes around the official target of 6% is all the greater because of other challenges it faces: notably, the unrest in Hong Kong and the DPP [Democratic Progressive party] victory in the Taiwan elections as well as the future of relations with the US after last month’s ‘Phase 1’ deal.”

But there remains a danger that equities are whistling past the graveyard at the moment. Even Wall Street and large-cap tech stocks are not immune to the headwinds that will blow from China.

Oxford Economics estimate the coronavirus could shave between 0.1 and 0.2 percentage points off US GDP growth in 2020, “assuming immediate disruptions to tourism, supply chain restraints for the frail manufacturing sector, and heightened uncertainty restraining business and consumer outlays”. 

Kathy Bostjancic, chief US financial economist at Oxford, believes:

“The intensifying coronavirus outbreak constitutes a large negative economic shock to China that will ripple through the global economy.” 

That prospect helps explain the only limited rise in leading 10-year bond yields in recent day as risk assets bounced. US Treasury and other sovereign benchmark yields remain some way below their levels before the coronavirus erupted. True, the US 10-year note yield has backed up from 1.5 per cent towards 1.64 per cent, but a test of the 1.8 per cent area requires an all-clear signal from health authorities fairly soon or those growth forecasts will take another leg down.

Previous episodes of the 10-year breaking 1.5 per cent — in 2012, 2016 and last year — merited a subsequent rise towards 3 per cent, 2.5 per cent and 2 per cent. See the pattern? Each test of 1.5 per cent has prompted a smaller rise than the one seen before.

This pattern of smaller corrections in yields over time, argues Steven Ricchiuto at Mizuho Securities, “reflects the liquidity evident in the markets as a result of central bank policies”.

Steven adds:

“The liquidity story suggests that backups in the market are simply opportunities to buy, even though the terminal level of rates is clearly a moving target. Our read of the price action suggests investors will look to grab yield somewhere between 1.75% and 2% on the 10-year note.”

Contained low yields have long played an important role in supporting risk premiums for credit and equities via a pronounced hunt for returns, or what is commonly known as “Tina” (There Is No Alternative).

At some point, buying equities reaches valuation limits, but Unigestion analysts argue that sustained global quantitative easing has resulted in declining risk premia, which “will remain as long as monetary policy stays accommodative — and we think it will”. 

As for buying the equity dip, here’s an update from Tobias Levkovich at Citigroup. Earlier this week, Market Forces highlighted that the bank’s panic/euphoria model had entered the danger zone, indicating the risk of a major pullback in the S&P 500.

Tobias highlights the degree of complacency at the moment: 

“Pretty much every client we talk to wants to buy the dip, and that is not comforting. It implies that people are very long the market and are willing to let share prices go higher. When we are asked what factors made the Panic/Euphoria Model move into euphoric territory, we highlight one of the inputs (though several caused the shift), as it looks at premiums paid for puts versus calls, and the prices have dropped for puts. Fewer deem the need to pay up for insurance, which indicates substantive complacency.”

Quick Hits — What’s on the markets radar

Tesla’s surging stock price hit a pothole on Wednesday, tumbling over 17 per cent and clipping its year-to-date rise to about 70 per cent. A delay to planned deliveries of the Model 3 Tesla in China was the catalyst for the retreat after a stunning rise in recent days. Much attention has focused on the stock’s short-sellers getting burnt, but things are never so cut and dried in finance.

IHS Markit’s Sam Pierson thinks “convertible bond arbitrage may constitute half of reported short interest”, while the hedging of call options sold on Tesla may also be contributing to the price rally seen in recent weeks. 

Sam notes:

“If the owners of the convertible bonds have fully hedged the shares into which their bonds could be converted, that would imply 12.7m shares short, just over half the short interest reported for January 15th. Given the 50% increase in share price since January 15th it seems reasonable to assume some amount of directional short covering.”

The lack of a real short interest squeeze leaves other reasons for why the stock has surged, pushing its market cap to about $160bn on Tuesday, second only to that of Toyota among carmakers. One likely rationale for buyers jumping on the bandwagon, beyond demand from those deploying an ESG mandate, is that the company could soon join the S&P 500. 

DataTrek explains that analysts expect Tesla will make enough money during the current quarter “to satisfy the trailing 4-quarter/current profitability rules” for a stock to enter the S&P 500. 

“A lot could still go wrong; this is not a company with a predictable earnings stream. And the S&P committee would have to make the final decision, of course. But TSLA meets all the other requirements, from a US domicile, to a 1-class stock, liquidity and seasoning (not a recent IPO).”

Some in the US Treasury market has dubbed the resumption of 20-year government bonds as “millennials”, with the new sale likely happening in mid-May according to the Treasury Department. A group of dealers and investors, known as the Treasury Borrowing Advisory Committee, noted in their latest quarterly report to the Treasury:

“Dealers expected an inaugural size of $10-13 billion for the new issue with subsequent monthly re-openings of $8-11billion (in the following two months), for a total coupon size of $26-35billion. Dealers broadly expect the size of the 20-year to increase over time as Treasury’s financing needs grow.”

A robust private sector hiring estimate for January was a fillip for equities and a warning that Treasury yields have further room to rise. But the latest ADP figures only arouse a degree of scepticism ahead of the official US monthly jobs report on Friday. The ADP estimate of private sector payrolls was a gain of 291,000 last month, blowing past a forecast 158,000. 

HFE’s Rubeela Farooqi notes: 

“The data look much higher than seems consistent with consensus expectations for the private sector portion of payrolls in the BLS [Bureau of Labor Statistics] report on Friday. There may be some upside risk, but we continue to forecast a 160K rise in total payrolls, with private payrolls up 150K.”

Joshua Shapiro at MFR added:

“The ADP and the official Labor Department results have deviated sharply in the last two months, and therefore today’s ADP report could represent further catch-up after the government’s blow-out November report far outpaced ADP’s tally that month, or it might be a reasonably accurate precursor of Friday’s government data.”

At any rate, prospects for US consumers keeping the economy running depends on a robust job market.

Source: Economy - ft.com