Wall Street: Investors flee for the exits as fears the 'bondcano' is about erupt

Posted February 04, 2018 05:44:23

In the space of just a couple of days, the market's sunny disposition leading into corporate reporting season has suddenly turned very apprehensive.

The positive signals — rising earnings expectations and improving global and local economic conditions — are still there, but then Wall Street swooned.

On Friday the Dow Jones index plummeted 2.5 per cent, its biggest one-day fall since global investors were caught off-guard by the Brexit vote two years ago.

It lost more than 4 per cent over the week.

The US bull market's rampage through last year and into January had equity cowboys cheering and the more circumspect worried.

The dust has not yet settled on the past couple of sessions' selling, but some general observations can be made.

As J.P. Morgan's head of cross-asset strategy John Normand noted, it has been one of the most volatile starts to the year in more two decades.

"Only once in 20 years have stocks rallied this much in January [2001] or bonds sold off this much [2009],' Mr Normand said.

That both happened at the same time is extraordinary and troubling.

Rising bond yields and a few wobbly results from the tech sector may have sparked Friday's conniptions, but there had been warning signs the exuberance was becoming irrational.

Daily highs on the key market indices were becoming ho-hum, then the Merrill Lynch's bull-bear indicator, which has an infallible record predicting 11 out of the 11 US stock market corrections since 2002, sent out a "sell" signal.

A nod is as good as wink to a tiring bull and sell orders duly flooded in.

The big investors who had been looking at their increasingly expensive and lower-yielding equities portfolios and watching tumbling bond prices — and the corresponding rise in bond yields — had just been looking for an excuse to switch.

The reasoning is simple.

10-year US Treasury bond yield has now topped 2.85 per cent — the highest level since 2014 —and probably heading for 3.5 per cent this year.

That risk-free return is starting to look compelling against the earnings yield of 5.5 per cent now offered by a frothy S&P 500 index.

Historically, the S&P500 offers something closer to 7 per cent as a reward for investors dabbling in a bit of risk.

The steady increase in bond yields over the year accelerated on Friday on the belief that the dormant threat of inflation was awakening.

Certainly monthly payroll data showing the largest spike in US workers' wages since the GFC indicated tight employment conditions were at last starting to force employers' wallets open.

"One of the key mantras of the bull market has been stocks are inexpensive relative to bonds, and bonds are getting cheaper, especially at these highs," Michael O'Rourke, chief market strategist at JonesTrading told Reuters.

"So people are taking profits and they probably should be."

Allianz chief economic adviser Mohamed El-Erian told the Wall Street Journal the current gyrations in the bond and stock market sell-offs are not about to end any time soon.

"People are questioning the conditioning that every dip will be bought," Mr El-Erian said.

Beware the bondcano

So what does it all mean for equities markets and is this the start of the "big one"?

Credit Suisse's Australian equity strategy team warned investors while the steady rise in bond yields have yet to trouble stock markets, things were about to become a lot more dangerous.

"We believe investors should tread cautiously around the bondcano, as there are more eruptions ahead," Credit Suisse's Hasan Tevfik said.

"Rising bond yields from low levels have yet to be the headwind for stock markets — rather it has been a signal of continued recovery and expansion.

"We suspect that rising bond yields from higher levels will signify clearer tightening and are set to be more testing times for equities."

And that is particularly bad news for expensive "growth stocks", big dividend payers and gold miners, according to Credit Suisse

Earnings expanding

Putting aside the idea investors may be living under the bondcano, conditions leading up to the February reporting season have been pretty comfortable.

Confession season has been relatively benign, unless you are an investor in the likes of Retail Food Group (two profit warnings and shares down more than 20 per cent in the month alone), Myer and Webjet.

Telstra trotted out some garbage too, writing down the value of its "bigger than YouTube" play to zero, but most investors had already either forgotten about Ooyala, or tried to forget about the $500 million spent on it a long time ago.

Nonetheless, earnings upgrades and downgrades have been relatively balanced in recent months.

The global economy accelerated to around 4 per cent growth in the last quarter and Australia is chugging along at a tolerable pace, but somewhat behind.

UBS strategist David Cassidy forecasts Australian market earnings growth this year should be a respectable, slightly above-trend pace of around 7 per cent.

"However, this looks somewhat pedestrian compared to the rest of the World, with 14 per cent earnings per share [EPS] growth achieved last year and 10 per cent expected this year," Mr Cassidy said.

Take the rapidly recovering resources sector out of the Australian equation and EPS growth comes in under 6 per cent.

While the CBA is the only big bank with results in coming weeks, Mr Cassidy said banks overall will be a drag this year.

Beset with economic, regulatory and legal "issues", the banks' earnings are expected to grow less than 3 per cent this year on UBS figures, while industrials have been pencilled in for 4.5 per cent EPS growth.

"Strongest sector growth rates are expected for utilities, health care, general industrials and other financials," Mr Cassidy said.

US tax cuts

One of the intriguing issues bubbling up may well be commentary from US dollar earners about the impact of the Trump tax package and related legislation.

US tax cut beneficiaries have generally performed well leading into the results season, although early thoughts from the likes of Ansell, Brambles and Resmed is there will be little material change.

At its most simple a cut in company tax from 35 per cent to 21 per cent should represent a 20 per cent earnings upgrade for US dollar earners. But nothing in tax is so simple.

With the headline cut partly funded by reforms to broaden the tax base, as well as the limited corporate disclosure of tax and earnings at the geographic level, things become rather messy and opaque.

CBA, Rio Tinto, AMP report

While there were a few results last week, the mega-caps start cranking out profits (or in some cases maybe losses) this week with the once staid, now headline-hogging-likely Commonwealth Bank dominating most column inches.

CBA's half-year cash profit is likely to be record of around $5.3 billion, heading to a full year in excess of $10 billion which will come in handy if the money-laundering action goes badly.

Margins should up and bad debts still near record lows. Good stuff for a bank, but hardly the point this time around.

It will be chief executive Ian Narev's last results presentation, but hardly a high-fives all around sort of event.

Much of the focus — as well as investor and media grilling — will hammer away at reputational damage under his watch, as well as the mounting cost associated with various legal and regulatory "issues".

Rio Tinto's Jean-Sebastien Jacques should have a much jollier time trotting out his maiden set of full-year numbers.

An expected underlying profit of $8.5 billion would be around 66 per cent higher than the profit left by his predecessor Sam Walsh.

Mr Jacques has benefitted from 12 months of booming bulk commodity prices and could well shower his shareholders with unexpectedly large returns.

Citi is forecasting a full year dividend of $US3.10 a share, well up on the consensus call of $US2.75.

RBC says a 50 US cent special dividend is likely, but it may be returned in the form of another share buy-back.

AMP also puts out full year results and should return to the black after last year's ugly $344 million loss.

The problematic wealth protection business which was the focus for all the wrong reasons this time last year will again be the first thing analysts look at this time around.

Investment income should be strong and shareholders may well be rewarded for hanging-in.

RBA stays put

Rested and relaxed after their traditional summer break, the RBA board will get down to business on Tuesday and do nothing.

The official cash rate has been parked at the historic low of 1.5 per cent since the last cut back in August 2016.

Last week's lower than expected inflation figure guarantees the monetary policy jalopy will not be wheeled out the garage any time soon.

The RBA will also post its quarterly statement on monetary policy (Friday) including its latest forecasts for such things as GDP growth and inflation.

The forecasts are likely to be a bit of a cut-and-paste job this time, given inflation was dialled down three months ago.

In between, RBA governor Philip Lowe has his first public outing for the year in a speech to a Sydney lunchtime gathering on Thursday.

On the data front, retail sales and trade figures (Tuesday) are likely to be swamped by the RBA's "nothing happened" meeting, such are the vagaries of the news cycle.

Perhaps just as well, as retailers don't need to be reminded again that things are not great in their patch.

Results season

Date	Event	Forecast
Monday 5/2/2018
Tuesday 6/2/2018	Magellan Financial H1 results	$110m interim profit forecast +30pc on prior corresponding period
	Janus Henderson FY results	$470m FY profit +23pc on pcp
Wednesday 7/2/2018	CBA interim H1 results	$530m interim profit forecast +8pc on pcp
	Rio Tinto FY results	$US8.5bn interim profit +66pc on pcp
Thursday 8/2/2018	AGL H1 results	$500m interim profit forecast +28pc on pcp
	AMP FY results	$929m profit forecast after a big loss last year
	Mirvac H1 results	$570m interim profit forecast +7pc on pcp
	Tabcorp	$100m interim profit forecast, update on Tatts merger will be a focus
	NAB Q1 trading update	Solid number expected, focus on margins
Friday 9/2/2019	News Corp FY results	$US300m forecast compared to $US740m loss last year
	REA H1 results	$300m interim profit forecast +30pc on pcp

Australia

Date	Event	Forecast
Monday 5/2/2018	Services index	Jan: Measures from both AiG and CBA expected to show activity in services sector expanding
	Job ads	Jan: ANZ series. Dropped in December, but job growth is still very strong
Tuesday 6/2/2018	RBA rates meeting	No changes, rates to stay at historic low of 1.5pc
	Retails sales	Dec: A weak spot in the economy. Few expectations of a pre-Christmas splurge
	Trade balance	Dec: Surplus should expand to $1.5bn on stronger commodity exports
Wednesday 7/2/2018	Construction index	Jan: AiG survey, activity holding up well
Thursday 8/2/2018	RBA speech	Governor Lowe speaks in Sydney
Friday 9/2/2019	RBA SOMP	Quarterly update of economic forecasts. Inflation continues to undershoot, but growth looks solid

Overseas

Date	Event	Forecast
Monday 5/2/2018	EU: Retail sales	Dec: Forecast to ease back, but still OK
	US: Composite PMI	Jan: Solid expansion across the economy
Tuesday 6/2/2018	US: Trade balance	Dec: Another big deficit around $US50bn tipped
Wednesday 7/2/2018	EU: ECB economic forecasts	Insights into ECB thinking
Thursday 8/2/2018	NZ: BoNZ rates meeting	No change
	UK: BoE rates meeting	No change
	CH: Trade balance	Jan: Exports will be watched closely. PMI showed regional demand was slowing
Friday 9/2/2019	CH: Inflation	Jan: Both producer and consumer prices likely to be weaker