Rates spike, stocks not cheap enough and credit risk
Let’s recap few market drivers and forecast
Today, it seems the bear market on bonds continue punishing investors with global yields touching new peaks.
U.S. 10-yr real yield is at highest since 2011
U.S. 2-yr Treasury yield touched 4%, the highest level since Nov. 2008
German 2-yr Treasury yield touched 1.67%, the highest level since Nov. 2011
U.K. 10-yr yield at highest since 2011, up almost 20bps on the day
BTPs 10-yr yield at 4.19%, the highest level since 2013
In this dire rates context, no one can expect risk assets can be insulated.
A very well example is provided by the correlation of Tech vs Real yields. The forward price-to-earnings ratios of the Nasdaq 100 and the Stoxx 600 Technology Index have been inversely correlated to the move in the 10-year inflation-protected Treasury yield (TIPS), which reached its highest level since 2018.
Bernstein - Tech has become marginally more expensive. Tech has become marginally more expensive (relatively speaking) and now trades at a 33% premium to the market relative to its historical average of 25%. The driver of this has been purely multiple expansion given tech’s fwd. 12m earnings expectations declined slightly. This also coincides with the fact that growth tech has outperformed value by 14% since the end of June (thought it still lags by 3000bps YTD). That said, tech’s 5-year growth expectations vs. the market ex-tech are below historical averages.
Morgan Stanley, and Goldman warn of valuation risk as earnings wilt. After a hotter-than-expected inflation print and FedEx Corp.’s shocking profit warning, top Wall Street strategists see mounting risks for US earnings and equity valuations. Both Morgan Stanley’s Michael J. Wilson and Goldman Sachs Group Inc.’s David J. Kostin said headwinds to profitability are building, highlighting tighter monetary policy and pressure on company margins as key concerns. According to Wilson, who has been one of the most vocal bears on US stocks, “there is still a long way to go before reality is fairly priced.”
JPMorgan's Kolanovic's is, as usual, an eternal optimist and talks about reasons for "limited downside". However this is a "tad" less bullish view than what we have heard from Marko previously.
"....any downside from here would be limited given:
Better than expected earnings growth and signs revisions may be bottoming.
Very low retail and institutional investor positioning.
Declines in longer term inflation expectations from both survey-and market-based measures".
Banks are slowly moving S&P 500 target price lower:
Bank of America’s Michael Hartnett warned in a recent note that earnings cuts will be the catalyst for a deeper sell-off and sees the S&P 500 teetering towards 3,600 – and even 3,000 in the bear case.
Morgan Stanley's Mike Wilson: probability of our bear market bottom price targets of 3,400 (50%) and 3,000 if recession (40%). June 2023 price target remains 3,900.
On the other hand, European stocks are near the cheapest they've ever been versus US peers, with the Stoxx 600 trading at a discount of over 30% to the S&P 500. But we know cheap things, can get even cheaper.
With the region facing headwinds including a protracted war and an escalating energy crisis, even these bargain basement levels aren't tempting investors. European earnings are more exposed to higher gas prices and the possible rationing of energy, said Fabiana Fedeli at M&G. European equities trade two standard deviations below where they typically trade vs. US equities on a P/E basis:
Goldman Sachs - Peak hawkishness. In our view this is a bit forward looking, but worth to remember.
"We think a peak in US 2-year rates will be a key signal for peak hawkishness and provide some relief across assets. Historically, 2-year yields have peaked at a higher level and before the Fed fund rate - in between a month and a month and half before - but we think we are not yet near such a turning point."
The era of cheap capital to fund businesses has certainly ended. Credit risk is a new reality now and we are seeing few cracking signs emerging.
The unwinding of the credit cycle to tighter lending standards is always pretty tough on corporate balance sheets, but it could be particularly brutal this time given the monetary policy experiment.
Consider the $1.4 trillion-plus leveraged loan market, which comprises borrowings of the most indebted companies. Such debt has doubled in just seven years. More troubling, the biggest share of the market compromises loans to the riskiest credits. “Junk” credits now make up more than 28% of such loans, according to the data trackers at Morningstar.
Read the full New York Post article here
Finally, BofA said about US$ 74bn of US CLO loans had their ratings cut so far this year, or about 9% of total portfolios. The share of defaulted loans is set to rise, due to about US$ 3bn of issuers filing for bankruptcy over the past few weeks.