Unlike Morgan Stanley's Adam Parker, who yesterday opted to flip back from bearish to bullish after previously berating and mocking those would blindly buy this "market" (even as he boosted his target S&P500 P/E multiple from 18x to 19x in the "bullish" case), one of our favorite junk bond analysts, BofA's Michael Contopoulos refuses to throw in the towel. Instead, he continues to watch in quiet amazement at what is taking place in the "market", where even Bloomberg has now admitted that "Mario Draghi is creating a monster credit bubble, and he doesn't seem to care. In fact, that seems to be his goal."
His latest notes from his brand new must read series "Coffee with Conto" are a useful glimpse into the mind of those who are forced to provide clients with actionable advice yet refuse to be dragged into the central banks' zombification field.
Here are some excerpts of his thoughts:
Last Friday’s jobs report was weaker than expected, with the US adding 151k jobs in August, compared to the expected 180k and previous 275k. Additionally, wage gains were softer than expected, with average hourly earnings only increasing 0.1% MoM, compared to a consensus +0.2% gain. However, in terms of market performance, this report hit the sweet spot in terms of being just bad enough to delay the Fed from going in September, but not so bad that it sparked growth concerns. Although this wasn’t necessarily a weak report, the logic of bad news is good news is something we have never felt comfortable with, although we acknowledge its impact on markets. We continue to be concerned about a point where investors decide that monetary stimulus no longer works and the reasons for low rates trump the low rates themselves, although think the capitulation from such a change in sentiment may not occur until 2017.
Risk assets rallied in response to Friday’s payrolls report: the S&P gained 0.42%, while high yield returned 0.46%. Perhaps more of a concern than investors losing patience with the efficacy of monetary policy on growth is the market’s reaction to a surprise hike. However, in our economist’s opinion, the Fed will not be able to hike this month if the market-implied odds do not appreciate substantially. In this environment, we think the technical support for high yield will continue to outweigh fundamentals in the near term and the bias will be for additional spread-tightening in September.
ISM non-manufacturing came in considerably lower than expectations, falling to 51.4 in August from 55.5 in July, for the lowest index value since February 2010 (Chart 2). Since at least 1997, the only time the ISM services index has been this low outside of a recessionary environment was a brief two-month dip in 2003. And, while our economics team does not expect a recession within the next 12 months, in our opinion, sub 1.5% GDP growth and a declining services sector is not ideal for high yield in the longer term. In such an environment, we would much rather be invested in higher-quality companies, especially when considering that ex-Energy HY revenue growth has consistently underperformed what is implied by GDP since 2014 (Chart 1).
HY ex-Energy revenue growth has underperformed GDP since 2014
The market response to the disappointing ISM Services was similar to that of Friday's payrolls report, with the S&P rallying 0.30%, high yield +0.15%, and the market-implied odds of a September hike falling to 24%. We think the 'bad news is good news' theme has mostly played out in the near term, and any additional weak economic data will likely be met with market skepticism. Additionally, payoffs are asymmetrically skewed at the moment, with hawkish commentary or a surprise hike likely being met with a much fiercer selloff compared to additional tightening caused by a continuation of the norm.
ISM Non-Manufacturing fell to its lowest level since February 2010
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While we would be delighted if Conto was right, alas we are confident that with a record $2.5 trillion in annual liquidity injections by central banks, we are far beyond the point of no return, for normality to return without a very violanet market reaction.