Market Drifting – Just off all-time highs
This was a slightly negative week for global stocks with all major US indices drifting a little lower after hitting all-time highs in the middle of the week
The US Corporate quarterly reporting season continues, and many large cap companies have already reported numbers. As we have noted for the last three weeks, most large companies are beating expectations on both Revenues and Net Profits. This pattern was repeated this week with strong revenues from some fast-growing technology companies such Twilio, Shopify, SolarEdge and Applied Materials.
Two major factors driving the market this week were Commodity Prices and the Economy “Opening – up” Post vaccine trade. Both these trends suggest that the market increasingly feels that the Covid slowdown is in the rear-view mirror and is looking ahead to a broad cyclical recovery.
Like the stock market, commodity prices have been rising steadily in the last 12 months as shown in the chart of the Bloomberg Commodity index below:
Source: Bloomberg Global Markets (1 Year Chart of Bloomberg Commodity Index)
The same trend can be seen in oil prices as shown in the last six months chart of the Oil contract and the one year chart of copper prices.
Source: Bloomberg Global Markets (6 Month Chart of WTI Oil Contract)
Source: Bloomberg Global Markets (1 Year Chart of the CMX Copper Contract)
All these charts point to higher prices and these have boosted stocks such as Freeport-McMoran (FCX) in the USA (up 18.4% last week) and in the UK, Antofogasta (up 19% last week), Glencore and Anglo American, Rio Tinto and BHP Group – all of which rose at least 7% last week.
The rise in commodity prices reflects expectations that the global economic recovery will boost demand for commodities. This is likely to be a sustainable medium-term trend and resource stocks have gone nowhere for the last five years and look good value at these levels and look set for a meaningful move from these levels. BHP posted the best first-half profit of $6.49 bln in last 7 years, boosted by record production and sharp rise in iron-ore prices.
Economy “Opening – up” Post Vaccine Trade
As the number of people who have been vaccinated has increased especially in the UK and the USA, markets are increasingly looking ahead to the opening-up of the economy trade which was also a feature in November 2020. Last week leisure travel sector US stocks such as Carnival Cruises and Royal Caribbean Cruises both rose by almost 17% and airline stocks American Airlines and United Airlines where both up 10% in the week. Similar trends were seen in the UK as stocks like IAG (up 10%), Whitbread (up 6.5%), TUI (up 12.6%), Easyjet (up 8.6%) and WH Smith (up 8.8%). These types of stocks have suffered a lot in the last year and should have further to run.
Last week, we noted the sharp rise in Bitcoin and noted that there are many other less risky ways to benefit from the Bitcoin boom other than buying Bitcoin. We suggested buying companies such as Tesla, MicroStrategy, PayPal, Mastercard, Square, Nvidia and AMD which would be indirect beneficiaries of higher Bitcoin prices. Except for Tesla, these stocks have performed well and we expect them to continue to do so.
Last week, we noted that the global shortage of semiconductors presents opportunities for investors at many levels of semiconductor industry value chain. We cited stocks such Taiwan Semiconductor, Samsung, Applied Materials, Lam Research KLA Tencor, Nvidia AMD, Synopsys, Cadence Design and ASML Lithography. The case for these was underlined by the strong numbers reported this week by Applied Materials.
In our funds and client portfolios, we continue to look to invest in top quality, profitable and highly cash generative companies. Our stable of recommended names continue to feature companies such as Nvidia, Microsoft, Apple, Facebook, Mastercard, Moodys, S&P Global Inc, Visa, Trex, Idexx, Games Workshop, Alphabet, PayPal, Howden and so on. This week we initiated a new position in Square Inc. If the share prices of these and other similar companies should happen to fall – perhaps due to some market panic – we would be happy to buy more as their long-term potential for compounding remains unchanged.
Equity – Linked Structured Products
The markets remain calm with the VIX Index trading in a narrow range of 19 to 21 in the last week and a far cry from the elevated levels seen in the previous week, VIX declined significantly back to around 22 as shown in late January when the short squeeze in stocks such as Game Stop was in full play.
Source: Bloomberg Global Markets (1 Month Chart of the S&P Volatility Index – VIX)
In this arena we focus on Autocallables on baskets of three or four stocks. We tend to look only at good quality companies where we have done detailed analysis of the fundamentals. Our structures always have guaranteed coupons, a maturity of 15 months or less and have a low strike of around 75% so that investors will not suffer capital losses for the first 25% of the declines of the worst performing of the stock.
Coupons are in the range 9% to 11% p.a. in US dollar denominated notes of this type. This week we did several trades where we achieved coupons of 10 to 12% for 12 months Autocallables notes for clients with underlying equities from sectors like logistics, semi-conductors and streaming services.
Higher inflation, higher bond yield, higher debt equals steeper yield curves.
As we noted last week, while short-term interest rates remain anchored close to Zero, bond yields are rising and the steepness of the yield curve has increased to the highest level in four years (about 123 bp in the case of 2 year -10 year spread) as shown in the chart below:
Source: Bloomberg Global Markets (5 Year Chart of the 2 Year – 10 Year US Treasury Bond Spread)
The 2 year – 10-year US Treasury Bond Spread was zero in September 2019 and has been rising steadily since then. This move has been mainly driven by the rise of the 10-year U S Treasury Bond yield as short-term interest have fallen form 0.5% in September 2019 to 0.1% currently.
This in part reflects an increase in inflationary expectations. The US 10 year break even inflation rate have risen sharply from a low of 0.5% in March 2020 to the current level of 2.2%, the highest level in six years. This is clearly shown in the graph below:
This rise in inflation has been driven by the steady increase in Oil and other commodity prices we noted above. So far bond markets have been relatively stable in the face of the sharp rise in US Treasury yields in 2021, but markets feel a bit cautious. New issue activity was subdued, and this was partly due to the Chinese New Year holiday break which affected activity in China and the Far East.
Some interesting new issues in USD bond market were 3.625% National Bank of Kuwait Tier 1 Perp, call 2026 (+0.0), 4.625% BNP Perpetual, call 2031 (+0.25), 2.95% Expedia 2031 (+0.0)
We recommend avoiding exposure to bonds of 10 years and above and to stick to medium term 3 to 6 years bonds.