Here’s what’s driving Australian equities this week according to Pendal’s head of equities Crispin Murray (pictured above). Reported by portfolio specialist Chris Adams.

• Find out about Crispin Murray’s Pendal Focus Australian Share Fund

THE MARKET spent last week digesting the shift in Fed messaging.

The S&P 500 rose 2.8%, while the S&P/ASX 300 fell 0.8% as sentiment wavered in the face of the Sydney lockdown.

The US economy remains strong heading into its reporting season. We are also seeing economic and earnings momentum build elsewhere in the world.

Coupled with a stable bond market and receding fears of a policy mistake this bodes well for markets grinding higher.

Covid and vaccines

The key question is how the Sydney outbreak and the impact of the Delta variant will affect domestic economic re-opening.

Cases are likely to spike in the next few days while the lockdown takes effect. The lockdown in the Northern Beaches outbreak last Christmas led to a deceleration in case growth within a week.

The higher transmissibility works against containment. But on the positive side improved track-and-trace capability means there are fewer unknown cases leading to unexpected outbreaks than in previous instances.

Uncertainty remains elevated. But on balance we do not expect the overall market to fall on fear of the economic consequences of a more severe lockdown.

The regularity of these outbreaks prevents any earnings momentum building in the re-opening related stocks. We do not expect the most exposed re-opening trades to outperform until we are further along the vaccination path.

Impact of the delta strain

The big issue is whether the delta variant changes the outlook for growth in Australia and globally.

Will there be more widespread outbreaks in Australia? Will this more contagious strain lead to a slowing of momentum in the US and Europe?

On the former, we think the speed of response means we’re unlikely to see a repeat of last winter’s Victorian experience. We are also better prepared medically.

Globally we are still tracking the effects of delta strain outbreaks. The UK continues to experience only limited growth in hospitalisations despite a surge in new cases. This reflects the effect of vaccinations, though it could still change.

New cases in the US have plateaued. The delta strain is likely to become dominant there in the next few weeks. It is particularly prevalent in areas of the mid-west and north where there are low vaccination rates. We will need to watch the impact on hospitalisations in the next few weeks.

The higher transmissibility of delta raises the threshold on herd immunity.

In the US it’s believed up to 20-25% of the population has already had Covid. With vaccinations at 53% we may still be quite close to herd immunity. This will need to be tracked.

Economics and policy

US economic data remains strong. Companies are running low on inventory and struggling to replenish in the face of strong consumer demand.

There are signs that excess savings are being put to work. Personal consumption has held up despite the end of fiscal aid. There is a rotation of spending from goods to services as mobility increases — and a great deal of scope for this to play out further.

All this should provide a good outcome in the upcoming earnings season in the US. Australia will be different due to the stop-start nature of our re-opening.

On the policy side key Fed members assuaged market fears on a pivot in policy. The key message last week was that having effectively achieved their goal on an inflation overshoot this year, they will not need to see inflation remain above target thereafter.

They also acknowledged they are factoring the risk of higher-than-expected inflation into their deliberations.
These messages reinforce the view that the Fed is not as potentially reckless as some had feared.

In this context speculative trades such as crypto could come under more pressure.

The counter argument remains that the Fed does not have the degree of control it currently believes, given the combined degree of fiscal and monetary stimulus. But this will not be apparent for some time.

Elsewhere in the US the odds of a bipartisan infrastructure bill are rising, however it is not expected until the Northern autumn.

The Australian labour market continues to do better than expected. Overall employment is back above pre-Covid levels. Full-time employment has rebounded better than casual labour. Regional areas are doing better than cities, which reflects the effect of lost tourism and a strong mining sector.

Slack in the labour market is becoming a lot more limited. Measures of “excess” workers — those working few hours due to economic reasons — have returned to pre-Covid levels. The number of jobless looking for work has also fallen to eight-year lows.

This makes it difficult to see how the RBA continues with the mantra of no rate rises for the next three years.

Markets and stocks

Markets remained largely benign. US bond yields rose a little following the strong rally. Commodities were generally stronger and growth sectors continued to lead US equities higher.

Last week we saw rotation to tech growth names and miners in the local market. Financials and health care were the weakest sectors. The latter was dragged down by CSL (CSL, -6.7%).

CSL was hit by a ruling in the US that Mexicans crossing the border to give paid plasma donations will be considered illegal work. This could have an impact of 5-8% of CSL’s total collections. Plasma collection recovery has been a key factor in the CSL’s bounce, so this sets back the company.

Oil Search (OSH, -5.5%) fell despite oil price strength as the Abu Dhabi sovereign wealth fund divested part of its stake. We continue to remain positive on the oil sector given very favourable supply and demand dynamics.

Banks underperformed, led by Bendigo Bank (BEN, -5.1%) and Commonwealth Bank (CBA, -4.3%), which reflected weakness in the US financial sector the previous week, in response to the Fed’s more hawkish tone.

Insurers were also weaker, with QBE (QBE) off 3.8% and IAG (AG) down 3.4%. This was partly in response to Victorian floods and news that the High Court had rejected the insurance sector’s appeal against having to pay out on Covid-related business continuity claims. This issue is not yet settled, given there are still very few test cases.

Afterpay (APT, +12.8%) continued its run. This was partly given its high leverage to the rotation to growth. It also announced the launch of a “shop anywhere” option which will allow some customers to pay in instalments at non-affiliated merchants in the US. This is initially limited to 11 retailers including Amazon and Nike, with Afterpay benefiting from referral fees. The market also liked Paypal’s decision to increase prices 25% for their buy-now-pay-later service in the US. This only applies to a small percentage of their gross merchandise value (GMV) — mainly small businesses who do not have a negotiated price. The true impact is debatable, but it does reduce one of the competitive risks for APT.

Boral (BLD, +8.3%) announced the sale of much of its North American business at a higher price than most expected. We also saw the next act of the Seven Group (SVW, -5.8%) takeover offer play out. SVW raised its offer price for BLD stock (to $7.30 or $7.40 depending on the take-up) and extended the offer period.

Mining stocks bounced back as commodity prices rebounded. Independence Group (IGO, +5.6%) did best, followed by South32 (S32, +5.4%). Other deep cyclicals such as BlueScope Steel (BSL, +5.0%) did well on this trend.

Woolworths (WOW, -0.1%) de-merged its liquor and hotel business Endeavour Group (EDV, +1.3%) without triggering much of a stock response. We remain cautious on EDV — capital intensity and regulation both loom as potential headwinds. WOW now trades on about 28x price to earnings, which is high given the limited growth.