Economic Data Watch and Market Outlook
Most global equity markets rose modestly during the past week with the S&P 500 up 47 basis points while the MSCI EAFE rose 97 basis points. Emerging markets in aggregate experienced the largest gains with the MSCI Emerging Markets Index up 1.51%. The Bloomberg Aggregate Bond index rose 95 basis points.
PPI results earlier in the week continued to show that the economy is not quite slowing down. Core PPI, released Tuesday, came in hotter than expected with month over month coming it at 0.3% versus 0.2% forecast. Year over year saw an increase of 2.7% versus a 2.3% forecast. CPI came in slightly higher than expected but Core CPI, which excludes food and energy, came in as expected month over month at 0.3%, and year over year up 4.1%, which largely helped markets remain steady.
Global trade metrics are beginning to show signs that the slowdown we have seen is potentially coming to a close. Bloomberg’s Global Trade Trackers show that four of 10 gauges sat below normal ranges as of October 8th, a shift from the start of 2023 when nine of 10 sat below their normal range. Shipping volume is improving in key ports such as the Port of LA Cargo, Singapore Throughput, and Hong Kong Port Cargo. Consumer demand is improving globally, while Chinese factories are starting to see an uptick in expansion in response to the Chinese government’s stimulus measures. Shipping rates have crept up through late summer but are nowhere near prices seen in the 2021-2022 spike. Prices have crept up recently, rising from just under $2000 for a forty-foot container from Shanghai to LA to just over $2200. For context, during the spike, the same container cost $12,000.
Despite rising funding costs, blue-chip issuers in the US have continued to borrow, with gross new issuance in the US investment-grade market exceeding $1 trillion, albeit hitting that mark one week later than in 2022. This leaves around $200 billion in new high-grade bond sales for the rest of the year. Companies have adjusted to higher rates by issuing fewer longer-maturity bonds, down approximately 10% from recent averages. Estimates suggest that blue-chip debt sales for the year will reach about $1.2 trillion, similar to earlier forecasts, with the third-quarter earnings season and upcoming Federal Reserve decisions being closely monitored for their impact on issuance trends. Numerous major deals have been witnessed this year, including Pfizer’s $31 billion debt sale for its acquisition of Seagen Inc. and Amgen’s $24 billion transaction for the purchase of Horizon Therapeutics Inc. Moody’s Investors Service reports that investment-grade companies face nearly $1.3 trillion in debt due between 2024 and 2028.
Big banks such as Citigroup, JPMorgan Chase, and Wells Fargo all reported positive earnings this week and raised outlooks for core net interest income this year by a collective $4B. Rising interest rates are increasing lenders’ funding and deposit costs, and helping them earn more on cash and loans, particularly credit cards. While banks remain confident in America’s financial stability, they are still expecting consumer credit to weaken. Citigroup has said that its net charge off rates in credit cards should hit pre-pandemic levels by the end of the year which would show a loss rate of 2.72%
Credit card delinquency rates have surged in small banks.
Share prices of regional banks are still off relative to the general banking sector on a year to date basis, down 29.81% versus down 20.31% using the two most widely traded banking ETFs, KBE and KRE.
Equities
Major averages finished the week mixed following a slightly higher inflation reading for September and escalating geopolitical concerns in the Middle East. Equities rose to start the week as rates inched lower following a move to safety from investors and dovish comments from Fed officials that a potential pause in rates is being considered in November. PPI and CPI both exceeded expectations and markets tended to fade to close the week despite Q3 earnings starting off on a positive note from some big banks. Wall street analysts are upwardly revising earnings estimates which is the strongest revision since early 2022.
Dow Jones Industrial Average snapped a three-week losing streak closing in positive territory gaining +0.8%, the S&P 500 gained +0.47% marking the second straight week of gains, and the Nasdaq lost (-0.2%) marking the first negative week return in three weeks. The small cap Russell 2000 fell (-1.5%) and lagged large cap stocks. From a sector standpoint energy was the best performing sector as crude oil prices reversed its recent selloff. Utilities, REITs, industrials, and financials also outperformed while laggards were consumer discretionary, materials, healthcare, and consumer staples.
Globally the MSCI World Index finished the week positive +0.6% and emerging markets outperformed developed markets as the MSCI Emerging Markets Index finished the week +1.51% while the MSCI EAFE Index finished the week 97 bps. Emerging market stocks have fallen to their lowest level versus US equities since 1987 per Bloomberg data. Japanese markets were a positive standout as the Nikkei 225 finished the week positively up +4.3% and the Chinese Hang Seng HSI finished the week +2.0% as China’s golden week added a boost to the economy even though the property sector still continues to have turbulence as Country Garden failed to make an international debt payment this week after it’s apartment sales dropped in September. Most Asian emerging market currencies and equities dropped Friday as the dollar strengthened and Treasury yields rose following the strong CPI print.
Fixed Income
Bond markets were closed on Monday leading to a shortened week of trading which saw Treasury yields fall across the board. The 2-year Treasury yield fell 4 bps, the 10-year Treasury yield fell 15 bps, and the 30-year Treasury yield fell 17 bps. Major bond indices rose in response as bond prices rise when yields fall. The Bloomberg US Aggregate Bond Index rose +0.95%, the Bloomberg US Corporate High Yield Index rose +0.53% and the Bloomberg US MBS Index rose +0.74%. In response to hotter than expected CPI data, Treasury yields spiked then quickly retreated from their early morning highs as investors grappled with how this could potentially impact the Fed’s next move. Hawkishness is certainly expected going forward, but most investors believe that only one more rate hike is coming this year with the CME Fed Watch tool shows a 28.8% chance of a 25 bps hike at the feds December meeting.
Treasuries have seen a massive rise in volatility this year, creating challenges for investors looking to dampen volatility. Currently the three-month implied volatility for the iShares 2+ Year Treasury Bond ETF [$TLT] is over 4% higher than the SPDR S&P 500 ETF [$SPY]. Historically TLT has been around 3% lower in regard to this volatility metric. TLT has faced struggles in this rising rate environment, down from $148.19 on December 31st, 2021, to $87.61 as of Fridays close. Despite the massive drawdown, investors have poured $17B into the ETF so far this year in anticipation of when yields do reverse.
This week bond ETFs also saw high levels of volume with the iShares iBoxx High Yield Corporate Bond ETF [$HYG] seeing over $10B in volume on Wednesday alone, as this was the highest volume of trading the ETF has seen since its inception 16 years ago. TLT saw its largest surge in volume since the height of the pandemic.
Hedge Funds as of Thursday October 12th
Performance was challenging this week given the market volatility as equities traded inversely to hedge funds (HFs) positioning tilts, leaving them to navigate sharper reversals in pockets of the market with elevated short exposure. The average global HF captured just under 10% of the upside in the MSCI World as they gained 14 bps WTD (vs. MSCI +1.5%), while the US-based long/short (L/S) group fared slightly worse as they ended down 2 bps through Thursday (vs. S&P 500 +95 bps). EU-based funds similarly did not capture a meaningful portion of the upside this week as they gained only 31 bps (vs. Euro STOXX 600 +2%), while Asia-based funds were up 97 bps (vs. MSCI Asia +2.9%). It’s also worth noting that China based L/S funds posted the strongest relative returns this week as they gained 1.1%.
Looking at flows, HFs were net buyers of global equities led largely by North America (NA). The region made up close to 70% of global buying, followed by Japan and Europe, while flows were mixed across AxJ. In NA, ETFs drove the buying due largely to long additions and to a lesser extent short covers. At the single-name sector level, consumer discretionary was the most net bought as HFs covered shorts in broadline retail and specialty retail, while adding longs in hotels, restaurants & leisure, textiles, apparel and luxury goods. However, despite HFs having some longs in leisure names (largely as the trade rallied nearly 2% on Monday), short positioning in the group remains elevated and likely worked to HFs’ benefit this week given Morgan Stanley’s leisure short basket fell -3.2% WTD. HFs were also buyers of consumer staples via distribution & retail and food products, as well as financials largely via diversified banks into earnings. On the flip side, HFs continued to sell TMT-related industries led by software and interactive media. Across other regions, Japan was the second most net bought region due to a mix of long additions and short covers. To note, equity L/S funds made up the bulk of the flow. Looking at the sector level, tech led the buying, followed by consumer-related sectors, industrials and financials. In Europe, HFs were buyers in lighter amounts led by consumer staples and utilities, while HFs sold consumer discretionary names and energy to a lesser extent. To note, the EU buying was led by NA and Asia based HFs, while EU-based HFs were net sellers of the region. In AxJ, flows were more mixed at the country level as HFs were sellers of Taiwan, India and Australia, and buyers of South Korea (following September being the largest month of selling in the region YTD), and China to a lesser extent. Digging into China further, the entirety of the buying was driven by Asia-based HFs, though the group continues to remain the most underweight China than they have been since 2014. The bulk of buying took place across consumer discretionary and tech names, while HFs were sellers of industrials and energy. In the MENA region (Middle East, North Africa), Saudi Arabia saw its largest redemptions in 16 months.
Private Equity
Private debt has seen significant investor interest, making it the second most popular private market strategy in terms of fundraising, following private equity, according to PitchBook’s H1 2023 Global Private Debt Report. In the first half of 2023, private debt attracted $94.9 billion in committed capital, surpassing its position at the same time last year. The year is expected to close with over $200 billion in fundraising, marking the fourth consecutive year of such success.
Among various fund strategies, direct lending dominates, contributing to 30.2% of private debt fundraising and maintaining this position since 2017. Notably, mezzanine debt is rapidly gaining ground, accounting for 27.9%, a significant increase from its five-year average of 12.3%. Mezzanine lenders’ flexibility in accepting paid-in-kind structures has made them popular with borrowers.
Special situations funds claim a 22.3% share of private debt fundraising, while pure distressed debt has declined to just 2.3%. Special situations credit offers more flexibility, typically involving structured debt and equity investments, making it appealing to borrowers.
Mega-funds (raising $5 billion or more) have increased their share in private debt fundraising to 42.1% during H1 2023, up from 20.9% in the previous year. Emerging managers (those with three or fewer funds) have also made significant gains, capturing 12.8% of the market in H1 2023, compared to 7.5% in 2022.
In the realm of leveraged buyouts (LBOs), private credit is the primary source of financing. In Q1 2023, there were 70 private credit transactions financing LBOs in the US, compared to just five syndicated loans. In Q2, 38 private credit loans supported LBOs, while syndicated loans numbered seven.
Private credit has also played a more substantial role in non-LBO financing, especially refinancings. In Q1 and Q2, there were 114 and 93 non-LBO private credit transactions, respectively, compared to 63 and 93 syndicated loan transactions in Q1 and Q2.
Analysts predict private credit is poised to continue its significant role in these markets, even as traditional syndicated loans are expected to recover in the second half of the year.
Authors:
Jon Chesshire, Managing Director, Head of Research
Elisa Mailman, Managing Director, Head of Alternatives
Katie Fox, Managing Director
Michael McNamara, Analyst
Sam Morris, Analyst
Josh Friedberg, Fall Associate
Data Source: Apollo, Barron’s, Bloomberg, BBC, Charles Schwab, CNBC, the Daily Shot HFR (returns have a two-day lag), Goldman Sachs, Jim Bianco Research, J.P. Morgan, Market Watch, Morningstar, Morgan Stanley. Pitchbook, Standard & Poor’s and the Wall Street Journal.