Crispin Murray: what’s driving Australian equities this week

Here are the main factors driving Australian equities this week according to Pendal’s head of equities Crispin Murray. Reported by portfolio specialist Chris Adams.

WE HAVE seen positive developments on two fronts in the past week.

Firstly, Fed Chair Jerome Powell was relatively dovish in his Jackson Hole speech, calming fears of aggressive tightening.

Secondly, there are signs that Covid cases may be peaking in the US.

In response, we saw bond yields rise slightly in a controlled manner, commodities rally and equity market gains. The S&P/ASX 300 rose 0.57% and the S&P 500 1.54% for the week.

The domestic reporting season remains a small positive.

Last week’s theme was the return of the unloved. Some of the re-opening stocks rallied as investors got a better gauge on near-term risks and were prepared to look through them.

We see four key issues facing markets:

1. Economic growth: Having reached peak momentum do we see material downside surprises as a result of fiscal cliffs and the re-emergence of structural issues?
2. Covid: Does a combination of the Delta variant and waning immunity lead to an environment of perpetual new waves that require on-going restrictions, limit the service sector recovery, hit confidence and lead to weaker growth?
3. Inflation: Will it be higher than expected if recent drivers prove to be more than “transitory” and a tight labour market drives wage growth?
4. Policy: Is there a risk of policy mistakes as central banks exit quantitative easing (QE) and attempt to reconcile the need to anchor inflation expectations and support growth?

Good news on Covid and policy should help support markets into the quarter’s end.

Fed policy outlook

At this point, the Fed is managing its message well.

The minutes of the last FOMC meeting indicated that QE tapering would occur sooner than previously indicated.

Cautious statements from some committee members raised concerns that Powell may have struck a more hawkish tone.

While Powell did clearly suggest tapering is coming this year — probably announced in November and started in December — he also signalled:

1. There is almost no chance of tapering in September
2. The Delta strain is a clear risk to growth, which may offset the impact of positive employment data on policy decisions
3. The decision to taper is distanced from the decision on rates. Rate rises may not follow on the heels of QE tapering as quickly as many expect
4. He still sees recent inflation as transitory

The analogy is that, in taking the foot off the accelerator of QE, the Fed is not yet ready to start pumping the brakes of rate rises.

At this point the risk of a 2013-style taper tantrum is low as long as unemployment or inflation data does not materially surprise.

This time around the Fed has been very careful to seed the market and manage expectations.

Tapering looks set to align with a reduction in the issuance of treasuries as stimulus measures fall away. There will be less of an issue with over-supply as a result.

Economic outlook

US savings rates have fallen from close to 35% at the peak of early 2020 to a more normalised rate of just under 10%. But this is still well above post-GFC levels.

Although the rate has fallen, the high levels of the past 18 months have left a significant amount of pent-up household savings which can be deployed.

Spending on goods appears to be rolling over from very high levels in the US.

It will important to see how far this falls in individual sectors. But we are also mindful that spending on services has only just returned to pre-Covid levels and is still well below trend growth.

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Delta may see some near-term pressure on this, but longer-term this is an additional source of spending growth in the US.

In Australia, retail sales have fallen quickly. Annualised growth was -15% in July, down from -1% in June.

Much of this is driven by NSW where sales fell 35% in July. By comparison, sales were up 11% in Western Australia.

This highlights risk in areas such as household goods, which are still well above trend growth levels.

Some 36% of Australians were under lockdown in July — and likely around 50% in August.

At this point Q3 GDP is expected to be down 3-4%. CY21 is now likely to step down to just over 1% GDP growth.

These near-term issues will affect growth and earnings, but it is clear there is still a lot of confidence in corporate Australia.

This is evident in capex intentions outside the mining sector, which continue to rise.

It has also been reinforced in our company meetings. A lot of management teams are pointing to how quickly demand snapped back once restrictions were lifted previously.

Covid outlook — international

Most regions are seeing a stabilisation in case trends.

Europe has so far avoided a Delta wave similar to that seen in the US and UK, reflecting ongoing caution in re-opening rules.

Israel continues to experience a surge in cases. But the number of hospital patients has stabilised at just over half the January peak.

Markets are focused on the US wave because of its potential to affect the global growth outlook.

Here, we have seen case growth and hospitalisations begin to decelerate.

Risks remain with the return to school and the fact that 38% of Americans live in areas where ICU occupancy is over 85%.

But there is evidence that the peak is close.

The effective reproduction (R eff) number — which measures the average amount of people an infected person goes on to infect — has fallen below one in some of the first-hit states such as Florida.

Testing positivity numbers have also started to fall.

It is becoming apparent China is continuing to get on top of its Delta outbreak. The number of districts categorised as “mid-risk” have halved from the peak. This is also helping sentiment on global growth.

Covid outlook — Australia

Australia is now reaching vaccination levels equivalent to the peak levels in other countries.

Some models suggest that at the current R eff of 1.34, NSW cases will peak in late September at about 2500 per day.

If restrictions lead to an R eff 0.06 lower, the peak could be below 2000 per day.

As vaccination starts taking effect, case numbers could then drop quickly, back to 300 per day by the start of November, and negligible by December.

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The same analysis for Victoria implies a peak of 400 cases per day in early October at the current R eff of 1.36.

While modelling of Covid has often proven wrong, this highlights that we may be facing a significant bow wave of new cases in September.

Markets

Powell’s speech helped push all markets higher and increased breadth. Growth and value sectors both rallied last week. 

Key commodities bounced from oversold levels. Copper rose 4.4% and iron ore 10.1%. Brent crude was up 11.5% as Kuwait flagged a potential pause on output increases.

The AUD gained 2.5% against the USD.

We saw a recovery among lockdown-affected stocks.

This was partly better macro sentiment, but also resulted from greater context around the near-term risk.

In several instances the market was been reassured by management’s reminders about how quickly demand bounced back after restrictions were lifted.

About Crispin Murray and Pendal Focus Australian Share Fund

Crispin Murray is Pendal’s Head of Equities. He has more than 27 years of investment experience and leads one of the largest equities teams in Australia. 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. 

Find out more about Pendal Focus Australian Share Fund here.  

Contact a Pendal key account manager here.