Crispin Murray: What’s driving ASX stocks this week

Here are the main factors driving the ASX this week according to Pendal’s Head of Equities, Crispin Murray. Reported by portfolio specialist Chris Adams

Higher bond yields, a stronger US dollar and the expectation of a US recession before the end of 2023 continued to weigh on markets last week.

A bout of panic in the UK bond market added some spice. A government ‘mini’ budget triggered the rout and demonstrated the currently fragile state of the financial system. The Bank of England was forced to buy long-dated bonds to maintain solvency in the pension fund system.

Finally, geopolitical risk remains elevated. Sabotage of the Nordstream pipelines and Putin’s speech signalled the potential for the conflict with Russia to escalate.

The S&P 500 shed -2.9% for the week. The S&P/ASX 300 continues to outperform. It was down -1.6% for the week, helped by a weaker AUD, which broke down versus other currencies.

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US economy and policy.

The Core Personal Consumption Expenditure (PCE) index – which is the Fed’s preferred measure of inflation – came in a little higher than expected for August.

A headline of 0.6% growth versus 0.4% expected caused some alarm, although the actual number of 0.56% versus 0.44% made for better reading. July was also revised down from 0.1% to 0.0%.

Rent increases, which comprise 17% of the index, drove the increase. There is some debate about whether the lagged effect is giving the Fed a false signal as lead indicators of PCE rents – such as the Zillow Home Price index – may have rolled over. However these lead indicators also suggest that inflation in rents is much stronger than is being reflected in the PCE measure. So it probably is not right to discount this component.

Core Services PCE remains resilient, up 0.6% month on month and 4.7% year on year.

All told, this data likely cements in the 75bp November rate increase.

Consumer spending on autos and services continues to hold up and is expected to support 1% growth in real consumption in Q3 2022, helped by a fall in the savings rate. This demonstrates the current resilience in the US economy, given the headwinds from energy and other prices rises.

With real incomes on the rise again, savings rates are likely to rebound higher in Q4. Current estimates have US households running down US$63bn of their excess saving so far, around 30% of the total. This leaves US$1.5tr remaining – around 5.5% of GDP. This helps explains the Fed’s challenge in slowing the economy.

Finally, it is worth noting the downgrade from Nike, which pointed to substantial excess inventories in North America. This will lead to discounting; another sign of easing prices for goods.

Australia

The ASX fell 1.6% and is now -10% in 2022.

The more rate-sensitive sectors led the market lower last week, reflecting concerns over financial stability and rising credit spreads. Financials were down -3.1% and Real Estate -2.9%.

Resources (-1.0%) held up better, helped by a weaker currency and also gold beginning to rally.

Traditional defensives did best, with Health care (1.6%) and Communication Services (0.7%) up on the week.

UK bond market chaos

The fiscal largesse of the UK mini-budget shook confidence and triggered a selling loop in UK bonds, sending the market into tailspin.

The issue is many UK pension funds hold their long-dated exposure via synthetic 30-yr government bonds. This theoretically matches their long-dated liabilities. The problem is that there is a liquidity mismatch. When the bonds start falling, the funds are forced sellers of bonds to raise the liquidity to meet the margin call. This was reinforced by broader positioning in the market.

At one point the UK 30 year bond had fallen almost 50% in value since August, with the yield rising from 2.5% to north of 5.0%.

The Bank of England (BOE) intervened, promising to buy bonds to ensure the market was functioning. Their quantitative easing (QE) did the job, with UK 30-yr yields rallying back to 3.8% by the end of week.

It also saw the British pound bounce back from 1.05 to 1.11 versus the US dollar. This coincided with a broader fall in the latter.

The BOE has said they will continue to buy bonds through to mid-October, which buys time for the pension funds to raise liquidity.

This highlights the current risk of forced liquidations from some market players – another headwind for equities.

The challenge is that the interest rate the BOE should target, given fiscal policy, is likely to be too high for many households to service their mortgages. This could trigger a housing bust.

So the expectation is that they will tolerate higher inflation to hold rates lower and probably sacrifice the GBP.

The BOE’s intervention and Whitehall’s decision to reverse tax cuts may help calm the bond market.

Extreme risk aversion saw money parked in US dollars. With this crisis seemingly averted, this may reverse and we may have seen a near-term top in the US dollar and bond yields.

These signs of financial strain may have a perverse silver lining for markets, in that it may prompt a less severe tone from the Fed.

We may have seen this on Friday where Fed Vice Chair Brainard noted the need to consider time lags with monetary policy. She also noted how the spill-over impact of rate hikes can amplify the tightening of conditions, which appears to be a nod to the risk of some form of financial contagion.

We see three scenarios which could lead to a Fed Pivot:

• Inflation looks to be under control,
• The economy falls into a major downturn, or
• A major financial shock.

At this point the latter two appear more likely but would result in further equity market falls before bouncing back once the Fed pivots.

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Australia

We continue to see the Australian market as more defensive. It trades on a P/E of 12x, versus the S&P 500 at 17x, while the economy is supported by higher savings, a less aggressive central bank, supportive terms of trade and immigration.

The issue for Australia is as much as the RBA may want to limit rate rise, there may be a limit to the gap between our short-term rates and those in the US, before it creates issues with the currency which would exacerbate inflationary pressures.

About Crispin Murray and Pendal Focus Australian Share Fund

Crispin Murray is Pendal’s Head of Equities. He has more than 30 years of investment experience (including 28 years at Pendal) and leads one of the country’s biggest equities teams.

Crispin’s Pendal Focus Australian Share Fund has beaten the benchmark in 12 years of its 16-year history (after fees), across a range of market conditions.

Pendal is an independent, global investment management business focused on delivering superior investment returns for our clients through active management. 

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