Musings on Markets (Dated 10/07/2022)

4th July – 10th July

While we can never really be certain of what will happen in the future, it seems fairly uncontroversial to argue that the present is characterised by a general economic malaise, with growth slowing across the US and Europe, and the SPX currently standing at -18.52% YTD, with XOVER wider by 334bps YTD at 576.

The current “souring” of sentiment has been driven by the unravelling of a policy mistake by central banks (monetary policy kept too loose for too long), and a series external shocks though (Ukraine, China’s Covid resurgence, post-covid reopening supply chain pressure).

However, even unsavoury assets have value at the right price, so we might ask – how bad are things really?

As alluded to above, sentiment is negative, US PMIs are sitting at two year lows, and consumer sentiment is weak across the UK & Europe. However, we’ve seen a significant repricing of commodities in anticipation of a slowdown, which should help cool inflation over the long term. Further, unemployment remains robust (NFPs printed at 3.6% on Friday, unemployment is at 3.8% in the UK). Meanwhile workers are struggling to maintain bargaining power with real wages slipping. Real wages are expected to fall by 0.6% in the US this year, with more stark falls in Europe (2.5% in Germany, 3% in the UK, 4.5% in Spain).

China could be a positive catalyst for global growth, the politburo is mulling a $220bn stimulus package to reawaken the sleeping giant which has been subdued by a zealous zero covid policy & housing market slump. Meanwhile Biden is considering rolling back Trump era tariffs with a nod towards CPI.

One interesting market theme emerging this week is the possible divergence between the US and Europe.

The US has sizable reserves of energy assets and is the largest global agricultural exporter (supersizing didn’t originate in Texas by coincidence). Both of these facts will be important considerations in insulating the country from geopolitical supply side shocks & taming cost push inflation.

Europe faces a different set of changes due its proximity to Ukraine & reliance on Russian energy assets. This reality has been reflected with Germany posting it’s first monthly trade deficit in 30 years (high energy prices are hurting manufacturing competitiveness), meanwhile the USD has been steadily gaining strength against the EURO, and now trades at c.1.0174 with EUR / USD parity in sight. An interesting metric to highlight are German electricity prices which are up 90% YTD, with winter on the horizon.

Stepping back – markets seem to have moderated somewhat from the absurdities we saw in the QE boom of 2020/21 (repricing in equities, crypto, meme stocks, credit spreads). There is still a long way to go in reversing the expansion of central bank balance sheets & getting inflation under control. Yet, humility is often the root of virtue, and unless operating in the realm of the extreme and absurd, it may be best to try and resist market timing at all.

In terms of Credit GBP, HY Corporates returned c.-11.5 basis points (bps) on the week, with Financials under-performing Non-Financials each returning c.-18.2 bps, and 18.5bps respectively. In terms of rating, Double BBs returned 41bps, whilst Single Bs and CCCs returned –30bps and -170bps respectively.

At time of writing (Fri, Afternoon) The FTSE is down c.0.5% on the week. GBP / USD is down 0.7% on the week at c.1.2029. The spread on the iTraxx Crossover (XOVER) – a proxy for the market’s assessment of credit risk (the greater the spread, the greater the perceived risk) tightened by c.10ps over the week to 577.