Week ended Sept 17th 2021: US CPI & retail sales, and Evergrande feature
The market moving news this past week was limited, with the focus Stateside being on August CPI (Tues release) and August retail sales (Thurs release). US economic data continues to be a mixed bag, with CPI showing declining inflation even as retail sales surprised on the upside. It’s the perfect cocktail of data to support a US economy that is continuing to move forward albeit at a slower pace. August economic data provides support for the “inflation is transitory” narrative of the Federal Reserve, increasing the likelihood that the Fed will stay on course and begin tapering towards the end of this year.
Aside from economic data in the US, there was a lot of focus this week on Evergrande, the Chinese property developer that appears to be in trouble. With some $300 billion of liabilities, Evergrande will likely default on its maturing bank and bond debt if its liquidity lifeline is cut off. The question though is – given the systemic importance of Evergrande to the Chinese economy – will Beijing step in to provide life support to Evergrande, avoiding a painful default that would be very negative for other Chinese property companies and for Chinese banks, most of which are state-owned? The Evergrande situation, in conjunction with the Chinese government continuing to apply regulatory pressure on tech companies, is putting Chinese stocks under renewed pressure. Although the Shanghai composite was down 2.4% this week, the index is still only 2.7% off its high for 2021 that was reached earlier this week. For some reason, Chinese equities feel a lot worse that this because there has been so much turmoil and uncertainty recently. Whilst the Chinese equity market was under pressure and US and European indices were drifting lower, the star performer of the week was again the Nikkei 225, which was up 0.4% W-o-W and managed to close above the important floor of 30,000. The Japanese stock index is up 12.9% since August 20th.
The prices of US equities and US Treasuries fluctuated in a narrow range during much of this rather uneventful week, although both felt more pressure on Friday. It is increasingly clear that the easy work in terms of prices of nearly all financial assets increasing across the board is over, as heady valuations continue to cap further upside. Of course, given the dearth of investment alternatives that offer a reasonable return, a sideways drift in equities perhaps isn’t so bad. Still yet, investors will have to be increasingly selective as far as US stocks, tilting towards a more value-oriented approach, including investing in less sexy defensive stocks and less expensive global equity markets. As you can see in the table below, the worst performing indices of the week were the S&P 500 and the NASDAQ Composite, with only the (value proxy) Russell 2000 delivering a positive performance.
US Treasuries fluctuated but were little changed until Friday, in spite of the CPI and retail sales data releases. On Friday, UST yields headed higher in the intermediate and longer maturities, reversing the trend that had characterised much of the week. This does not feel like inflationary concerns per se, but perhaps reflects the fact that tapering might be just around the corner.
In spite of the tremors caused in the global bond market by the deteriorating Evergrande situation, developed market corporate bond yields improved and spreads tightened, at least through Thursday. This occurred in both the investment grade and high yield indices. I suspect the $20 billion or so of off-shore bonds of Evergrande are part of an emerging markets bond index, not the US and European high yield indices I track. According to an article I read in Reuters, Evergrande's bonds are trading at around 25 cents on the dollar. I am slightly surprised there has not been at least some modest contagion into other corporate credit markets.
As far as safe haven and other assets, the most significant moves this week were in gold – which was down 1.9% W-o-W (close $1,753.90/ounce) – and oil.
Gold is signalling declining inflationary concerns amongst investors, with no evidence of concerns about market risk. The price of WTI crude oil, which was up 3.2% W-o-W (close $71.96/bbl), is signalling growing global demand and the concurrent willingness of OPEC+ to keep supply in line with current quotas. As I have said before, oil prices are subject to surprises and manipulation on the supply side, which can cause its price to diverge with what might be expected given the demand outlook. Even so, the price increase of WTI crude since its recent mid-August low ($61.86/bbl on Aug 20th) has been impressive. The US Dollar has also continued its slow, steady march higher. UST yields seem range-bound and it’s hard to see visible market risk elsewhere, but the Dollar was well bid all week.
Extra: US CPI and PPI releases
CPI or August came in about on expectations on Tuesday, at 5.3% for the 12-months ended August 2021, and 4.0% excluding food and energy (“core inflation”). For the month, CPI was 0.3% in August, down from 0.5% in July and 0.9% in June. The BLS release for August is here. These levels jib with the Federal Reserve’s ongoing assertion that inflation is transitory not persistent, although the definition of “transitory” is open to interpretation. The reaction of US equity markets suggested that investors believe inflation is becoming less of an issue. Perhaps more important but less discussed was PPI, released on September 10th (BLS press release here). PPI is often viewed as a better forward indicator of inflation than CPI. 12-month PPI ended August coming in a whopping 8.3%, but similar to CPI, suggests a downward trajectory. Both CPI and PPI are heady figures compared to recent history, but the Fed remains committed to its view that inflation will not last long. As a result, I continue to believe that tapering will be started late 2021. The much more interesting side story to me is how the Fed will react if equity investors bail out of equities and stock prices collapse. The Fed’s signalling followed by execution will require precision. It would be disingenuous for investors to jump up and down and say that they did not see a more hawkish tilt coming.