Equities had their worst week for a month and it was all due to the bond market. Technology led the losses on Friday and helped to send the Nasdaq down 3%. Eight out of 11 sectors of the S&P 500 fell. The tech wreck was set up by the news that the Chinese military had hacked the technology giants. And even though was denied by the likes of Intel and Google, the rumour was to prove sufficient and sent the shares packing.
Friday ought to have been a good day but it wasn’t. The labour report was good but a little disappointing because the result was lower than expectations. The Chinese scare in the tech stocks and the bearish bond markets spoilt the equity party. However, we don’t need to get too bearish just yet. The biggest fall for a month has been just 1% and this shows just how difficult it is to scare the stock traders.
Elsewhere in Asia, some tech stocks plummeted. Lenovo was down 15% in Hong Kong trading. And in Europe, miners fell as a consequence of lower metal prices. Danske Bank was routed after news that the U.S. authorities had commenced actions against the bank because it assisted money laundering that originated out of Russia.
And in a siren call, the ratings agencies are now looking to be more vigilant on corporates that don’t meet their promises. The agencies are concerned that rising leverage because of low interest rates is swamping the markets and in particular, the sea of Triple B rated debt. The ratings agencies are becoming more aggressive as seen by the recent downgrade of Ford to Baa3 by Moody’s or GE’s savaging by S&P down two notches to BBB+ ( just these two issuers account for $152 bio of debt). On Friday we saw U.S. high yield spreads widen by about 13 bp earlier in the week (ICEBAML).
Leverage is now becoming a rude word.
However, all this does not address the carnage that is now the treasury market. In a little over a few weeks, the 10-year has now found itself at 3.23% and wanting to trend higher. And this is in a backdrop of increasing trade tensions between the U.S. and China. Should the Fed be concerned? Well, maybe not. The rise in the yield on treasuries justifies and vindicates the recent moves by the Fed, and validates any rises in rates in the near term. The Treasury should be concerned because the interest burden has just increased.
Over the week, the movements in the 10-year and 30-year have pushed bond yields to 7-year and 4-year highs, respectively. For bond bears, this is great news as supports have been taken out and long investors are left to rue their decisions. And we have $74bio of issuance to be auctioned this week in a nervous market.
One of the big bears, Gundlach, has suggested that the era of the great bull run may be coming to an end. He is looking towards another consecutive close above 3.23% to confirm the selloff. With all this selling are a steeper yield curve and higher borrowing costs for corporates. And those borrowing costs are starting to balloon and all of this is in a period of global economic uncertainty caused by trade spats. The market is certainly in an interesting juxtaposition. The bond speculators and hedge funds have accumulated a record net level of shorts and Fund managers have built a record amount of long positions. Meanwhile, volatility is spiking, raising premiums on fixed income options.
In Europe, bonds soared. This month we see the ECB halving its monthly purchases amid a scenario where bond yields are rising. The German 10-year is back to 0.57% and had the largest jump since July. Spain’s 10-year is now 1.59%, the highest since May. And the Italians missed their opportunity on the deficit. And now the Italian 5-year is up 19 bp to close at 2.63% and the 10-year is at 3.4%.
The increase in bond yields has to be now taken in context. The debt load is increasing. The Government debt load is now $21.5 tr and growing. Corporate borrowings have now doubled over the past few years, amid low interest rates, to $5tr and most of that borrowing was to pay for stock buybacks and increases in dividends.
The equity market may sour when it realises that it was duped. Gearing at very low interest rates is easy to fund. But at much higher levels and with strained revenues, rolling loans or issuing bonds becomes problematic. The curse is yet to be revealed. With downgrades on the cards for many corporates, and with maturing debt this becomes messy.
Over the next 3 years -2019, 2020 and 2021 – in each of those years there is triple the debt that needs to be funded that was funded in 2018. For many forecasters, 2018 was the year when the U.S. economy was at its zenith and then the economy starts to turn. Let’s hope it’s a slow turn. Otherwise, there can be carnage and this will all be caused by bond yields rising sufficiently to slow the economy.
Equities: The S&P fell 0.60.68% and the Dow fell 0.75%. The Stoxx lost 0.9% while the Vix closed 14.82.
Currencies: The Bloomberg Dollar Index fell 0.2%. The euro fell 0.1% and the yen climbed 0.2%.
Bonds: The ten-year closed around at 3.233%. The 2-year closed at 2.889% and the 30-year closed at 3.405%. The ten-year bund closed at 0.565% and the OAT closed at 0.899%. The U.S. curve closed on the day with the following closes 2/10 at 34.4 bp, 2/30 at 51.5 bp and the 10/30 closed at 16.9 bp. The U.S. 5-year closed at 3.073%.
Commodities: WTI was flat while gold rallied 0.5% and copper fell 0.3%.
Bitcoin is trading at around $6,527.
Aussie Market Today.
The ASX is likely to be nervous. The cue continues to be out of Asia. However, it’s hard to mount a case for a rally given the rumour regarding Chinese hacking of tech stocks. Expect further weakness given miners in Europe were sold and commodity prices are stalling.
Bonds should be weak again. With new funding this week in the U.S. and a nervous bond market, it’s hard to be positive. The bears appear to be firmly in control. The global trend is one of weakness and unless something material happens, the trend of weakening bond prices looks likely to continue for a little while yet.
On an interest differential basis and weak commodity prices, there does not look like much respite for the Aussie short of intervention by the RBA. I expect the weakness in the Aussie to continue.
Geopolitical risks remain high.