Following a long weekend here in Canada, the TSX doesn’t have that much catching up to do. The S&P 500 was down marginally yesterday. Currency markets don’t care about long weekends, and the loonie was off yesterday as the USD continues its advance against most of the worlds’ currencies. With the likelihood of a rate hike remaining high for June and at over 50% for July, investors are being forced to re-align their positions to brace themselves for this situation. Just 30 days ago a June hike seemed quite unlikely. One may still question whether or not the U.S. economy and even the global economy is strong enough to withstand another rate hike, but with the Fed’s multipronged almost coordinated communications you can’t simply ignore the chance.
Michael Mauboussin: Challenges and Opportunities in Active Management And Using BAIT #MICUS
Michael Mauboussin's notes from his presentation at the 2020 Morningstar Investment Conference, held on September 16th and 17th. Q2 2020 hedge fund letters, conferences and more Michael Mauboussin: Challenges and Opportunities in Active Management Michael Mauboussin is Head of Consilient Research at Counterpoint Global in New York. Previously, he was Director of Research BlueMountain Capital, Read More
The DXY index is up to 95.4, its strongest level in eight weeks. It’s weighing on commodities, with gold down close to $10 overnight, however energy assets are up slightly despite the base currencies gain. The Mexican peso is back up to 18.50 against the U.S. dollar, making that all-inclusive vacation that much cheaper. The peso is only about 3.5% away from its low in February; compared to the loonie, it never really appreciated all that much over the past few months so it has less room to retreat back to recent lows. An extremely low peso does hurt the chances of a strong rebound in Canada’s manufacturing sector.
Yesterday the Federal Reserve Bank of San Francisco President John Williams said that the bank is “seriously weighing a June rate hike”. While still data dependent the June meeting will likely have some strong debates between district Presidents when they finally all get in one room. Williams still sees the U.S. economy as able to withstand another hike, with it not likely to have a materially negative impact, especially with deflation fears subsiding. Even Philly Fed president Patrick Harker noted “I can easily see the possibility of two or three rate hikes over the remainder of the year”.
Expecting a Hot June – There are a lot of big events on the horizon for the month of June. The Fed, plus just about every other central bank. Another OPEC meeting and a referendum in the UK to decide whether to stay in the EU or not. Meanwhile investor sentiment is neither overly bullish or bearish, its overly undecided. We believe these confluence of events and factors may well lead to a volatile June. To read more click HERE for the full report.
Good news for Greece overnight as the IMF calls for “unconditional” debt relief. They’ve tried this before but it’s something that Germany has been unwilling to compromise. Greek debt interest will be reducted and maturities will be extended. Greek banks are rallying on the news, and CDS spreads for Greece are off materially overnight, nearing their lowest level in six months.
Chart of the day – the rally in many commodity prices during the past few months has really reversed in the past month. Yet the diversified mining companies in Canada have held up. While we don’t think the two should track each other perfectly, after all a mining company has replacement value, leverage and other aspects, the two lines don’t diverge often. The chart of the day is the Canadian diversified miners, including names such as Teck, Lundin, Hudbay, First Quantum, Turquoise Hill and Nevsun. The LME price includes copper, nickel, aluminum, lead, zinc and tin. This is certainly cautionary for the sector at the moment.
AAA Debt is Nearly Extinct
Triple A companies are nearly extinct. In the US, there are only two left – Johnson & Johnson and Microsoft. This comes after ExxonMobil was downgraded last month; it was initially assigned a AAA rating in 1949.
Ultra-low borrowing costs have enticed companies to lever up. According to BOAML, “investment grade and junk-rated companies have added nearly $4 trillion of debt to their balance sheets since the start of 2008.” One of the reasons for the limited number of AAA issuers is that rating agencies are pricing in the possibility of a loss of access to the capital markets. During the financial crisis, liquidity dried up, “leaving groups with immediate financing needs on the ledge.”
Even though there are no substitutes for AAA debt, historically, there has not been much difference between triple A and double A bonds. “Corporate debt rated triple A suffered a loss of 0.02 cents on average because of default over a five-year period, says Jeffrey Rosenberg, chief fixed income strategist at BlackRock. In comparison, double A bonds lost 0.2 cents on average over the same period.” More from the FT here.
Diversion: The perfect blend of real life and minimal CGI. Drone Star Wars is really well done.
Canadian oil sands facilities are preparing for the return of their workers as rain in the area has elevated the risk of the inferno spreading further. Suncor, Syncrdue, ConocoPhillips andNexen have all stated that they are no planning to restart operations in the region, which took about 1mm barrels of production offline. BestBuy is lowering in premarket trading after reporting lower than expected earnings and the departure of their CFO who has been instrumental in managing the latest exodus of big box retail. General Electric has reach a deal with several industries in Suadi Arabia outside energy that will help the country diversify their GDP production. The initial investment is for $1bb, for this year, with the chance of $2bb more in years to come. Bombardier reaffirmed their business jet aircraft orders, expecting to make 8,300 deliveries over the next 10 years.
Iron Ore prices are continuing their precipitous slide toward $50 a metric ton, as supply continues to grow and demand from Chinese steel mills which are taking a more risk adverse approach. Inventories at China’s ports have exceeded 100mm tons last week. The oligopoly that is in charge of the majority of the world’s supply warned that this could be a possibility but have done little in the way of shuttering to control the issue. Gold prices are down another $10 this morning, marking the worst string of losses since November as the speculation of a FED rate hike in June intensifies. Oil futures are flat this morning as Canadian oil sand producers plan to bring supply back online are being balanced with a growing supply glut in the U.S.
FIXED INCOME AND ECONOMICS
John Williams (the San Francisco Fed President, not the renowned composer) raised some eyebrows over the weekend when he suggested that the path of Fed rate hikes is perhaps even more aggressive than we thought just last week. While many are suggesting that the risk of a Brexit vote would temper the likelihood of a tightening move, he said, but any market reaction is unlikely to throw the U.S. economy too far off course. “It’s a factor in the decision for June obviously because you have an event right after, and we can obviously hold off until July if we wanted,” Williams, speaking to reporters here, said of raising rates at the next two policy meetings. Adding to that, Williams suggested that given continued labor market improvement and some indication of inflation strength, he expects two or three rate increases this year. There will be “maybe one or two more next year so maybe three or four next year,” he said at the Council of Foreign Relations. That’s a much quicker pace than currently priced into the market where we stand at 32.0% for June, 55.1% for July and 64.1% for September. Note that Williams is a non-voting FOMC member in 2016.
The Bank of Canada rate announcement tomorrow is the primary focus on participants north of the 49th where we are expecting to get a first-hand official update on the impact to GDP from the wildfires in Alberta. Respondents in a Bloomberg poll were nearly evenly divided over what impact the wildfire would have on the central bank’s policy stance, with 14 saying it would make them a bit more accommodative and 12 saying it would not. Q1 output should remain intact in the 3.0% range while the second quarter should be getting significant downward revisions. The tone of the accompanying statement will be more dovish overall but don’t bank on rate cut talk just yet with oil and metals prices rising steadily over the past month. Additionally, the Canadian dollar has retraced some of their gains in the past two weeks, falling from 1.2500 to 1.3190 earlier this morning. A weaker loonie is expected to keep the export sector humming and Poloz & Co. at bay for now.
A quick tangent on the Bayer-Monsanto talks that may see the former acquire the latter in an all-cash $62 billion transaction. Bayer AG has debt is rated A- while Monsanto Co. is rated BBB+. This would be viewed as credit positive for the bondholders of the St. Louis-based chemicals company, however it should be noted that Bayer has over $16 billion in debt outstanding while Monsanto has just $8.5 billion owed to creditors. That potential ballooning amount of indebtedness has the Monsanto bonds trading lower as a result with their 2024 senior notes off nearly 4% from last week and their longer 2044 paper down five points to 93.00 over the same period.
CHART OF THE DAY
QUOTE OF THE DAY
Don’t tell me the sky’s the limit when there are footprints on the moon.
– Paul Brandt