Are we going into a US corporate downgrade cycle?
Local market had a positive day on weak turnover. Markets are stuck on flip flop mode in recent weeks where one day’s move gets reversed the next day. It seems like the US market is moving on the problem (i.e. macro risk) while the rest are moving on the symptoms (i.e. risk off trade delivering lower yield). We are in the 12th consecutive week with daily turnover below $9b when ignoring the index change day. Property and Tech were the best of the green sectors while Energy and Miners were the worst of the red sectors. Victorian covid cluster may have spread into other states but historical trend suggests that all the states are good at getting it under control.
The main macro event tonight are ECB policy update and US inflation update. The first one is a given as EU has gone too far down the Japan type ponzi scheme where money printing is inevitable. Inflation is going to bite but they have no choice. Japan runs into negative annual GDP growth rate on a 3-4 year cycle. EU is going into that cycle and expect to see low real growth and volatility to rise. ECB will keep stimulus going and talking positive because there is nothing else they can do. EU is already in double dip recession. Pandemic waves are still hurting. Structural problems still remain from pre pandemic stage. ECB will keep building a bigger debt problem with continues stimulus while expecting something different to what has happened for the past decade. Trend is not your friend on this strategy!
The main show and the only show in town is the US inflation update. The current US administration is expected to keep delivering stimulus and driving up inflation while debasing USD well into 2022. US Fed knows that the vested interest groups do not want them to blow up the asset bubbles. Everyone knows that US Fed is the main player capable enough to draw the line in stimulus and asset bubbles as the global currency and major economy. And it goes without saying that US will have to inflate and tax their way out of the debt in the end. As with most ponzi schemes, if any major superpower economy does endless stimulus with no reform or new taxes, it becomes an inflation bomb. US is at the inflexion point of things going wrong. US Fed has used QE to hide the symptoms while the structural problems kept getting worse. The current strategy of bottom-up stimulus is a clear indictment on top-down stimulus failure over the decade. As with anything, if you design a top-down stimulus to favour the top, then it fails the economy. Globally we have all made this mistake. Whitehouse knows inflation is going to run hot and taxes will have to go up. It is not by some accident, it was always the plan to rebalance the US economy. Reflation will deflate asset prices and taxes on the rich will pay to support the poor. Time will tell if this works or politics gets in the way as it always does!
That being said, every data point around the world on inflation, producer prices, supply side issues, currency effects, transport costs and lack of capex suggests that US inflation should be hot. US inflation is already at a decade high. Can it go higher? Yes it can!
The question is not that inflation is strong or if it is transitory. The question is that costs are rising for US corporates. US reporting season starts in July and the cycle looks to be setting up for downgrades while the multiples are setting up for upgrades. Chinese corporates are already in a downgrade cycle due to inflation driven higher costs. Reality check is coming to US and ignoring or hiding that won’t change anything.
Let us run through the main data points released in the last 24 hours…
Brazil’s annual inflation rate climbed to 8.06% in May of 2021, the highest since September of 2016, and beating market expectations of 7.93% mostly due to the base effect as prices remained subdued last year due to COVID-19 restrictions. The main upward pressure came from food and beverages (12.54%), transport (14.94%), household items (12.59%), and housing (7.58%). Among the country's largest metropolitan regions, the highest inflation rates were recorded in Curitiba (9.86%), Rio de Janeiro (9.57%), Belo Horizonte (8.68%), Porto Alegre (8.20%), and São Paulo (7.28%). On a monthly basis, consumer prices went up 0.83%, faster than forecasts of a 0.71% rise.
Producer prices in Japan rose by 4.9% yoy in May 2021, after an upwardly revised 3.8% gain a month earlier, beating market consensus of 4.5%. This was the third straight month of producer price inflation and the highest since September 2008, amid surging commodity prices. Prices went up faster for beverages & foods (2.2% vs 1.9% in April), chemicals (9% vs 7.6%), petroleum & coal products (53.5% vs 39.5%), iron & steel (7% vs 5.4%), metal products (0.3% vs 0.2%), non-ferrous metals (41.6% vs 35.6%), and other manufacturing industry products (0.1% vs 0.1%). Meantime, prices pf electronic components were flat after falling 0.1% in April. (-0.5% vs -0.3%). In contrast, there were falls in cost of transportation equipment (-0.1% vs -0.1), electrical machinery & equipment (-0.8% vs -1%), production machinery (-0.3% vs 0.5%), general machinery (-1% vs -1%), and information (-2.2% vs -1.8%). On a monthly basis, producer prices went up 0.7%, after an upwardly revised 0.9% rise in April.
Comments on US market last close…
US market started slightly positive and rolled over into negative territory on inflation worries becoming real. China inflation update confirmed that costs are high and going higher and Central Bank can’t fix that. NASDAQ -0.09%, S&P -0.18%, DOW -0.44% and RUSSELL -0.71%. Yields are rolling over with US 10 and 30 year are now below 50 and 100 day MA...potential death cross technical pattern coming. Last time we had such a trend change after running up for more than 6 months was in late 2018 and that was not positive for markets. Similar to late 2018, it looks like money is moving from equities to bonds on risk off. USD ticked higher and dragged commodities lower. VIX is moving higher again. Health Care and Utilities were the best sectors while Miners and Energy were the worst.
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Over 25 years’ experience in the finance/tech industry. Mathan has worked extensively in all parts of the finance sector (i.e. County NatWest, Citi, LIM, Southern Cross, Bell Potter, Baillieu Holst and Blue Ocean Equities). Currently Founder and...