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Aussie equities: Weekly ASX outlook

Here are the main factors driving the ASX this week according to Pendal investment analyst Elise McKay. Reported by portfolio specialist Chris Adams

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THERE was a lot of thudding last week as valuations fell back to earth in a number of sectors.

  • Used car prices fell in the US, pushing core goods into deflationary territory
  • Bitcoin hit its lowest price in two years as the crypto market reeled after the collapse of the FTX exchange. There is no contagion to other asset classes at this point, but we are watching closely.  
  • The tech sector is in recession
  • The freight sector came under pressure with container shipping rates 75% off their peak and volumes on a downward trajectory

Most importantly, softer lead indicators have started to show up in US CPI data.

One month does not make a trend. But there is now a strong argument for the Fed to slow to a 50bp hike in December and 25bps in February, reducing the risk of overtightening. 

Does this renew hope of a soft landing?

Broader data such as jobless claims — which remain flat — support this argument.

However we see very different trends in different parts of the economy. 

Technology, freight and crypto are clearly in decline, while the broader labour market remains strong so far.  

It is encouraging that core services (excluding shelter) rose only 0.23% in October.

But over any longer period core services inflation and wages are still running at levels more consistent with inflation at 3.5% to 4%, rather than the Fed’s 2% target.

The case for a softer landing may have risen with the latest CPI data, but it is off a very low base.

We still need to see signs of consumer demand and labour markets slowing in coming months to give the Fed the confidence that a decline in inflation is sustainable. 

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We also saw a 50bp easing in Morgan Stanley’s Total Financial Conditions measure on the day of the CPI release — its biggest move this year.

This may also motivate some participants in the Fed’s Federal Open Market Committee to lean against the market move in the near term.

US inflation

Downwards pressure on inflation had been visible everywhere except in the actual inflation data.

This has now changed. 

Headline CPI came in at 0.44% for October (consensus 0.6%) while core CPI rose 0.27% on the month (consensus +0.5%).

On a yearly basis, headline inflation declined to 7.7% from 8.2% in September, while core inflation declined to 6.3% from 6.6%. 

Core goods were deflationary (-0.38% month on month) while services inflation decelerated (0.5% versus an average of 0.6% in the third quarter). 

The biggest drag on core goods came from a 2.4% decline in the used car price component, which surged in 2021 due to chip shortages which reduced supply of new cars.

Rental firms needed to rebuild fleets, which stimulated demand and pushed used car prices up about 68% from their pre-Covid level to a January 2022 peak. 

Supply and demand have now rebalanced and used car prices are dropping.

Apparel (-0.7%) and household furnishing (-0.2%) also declined, showing the impact of easing supply chain pressures.

On the services front, the big stories were a decline in medical services and rents. 

Medical services stepped down from +1% in September to -0.6% in October.

This was driven by health insurance costs, which are estimated based on annual data on retained earnings of insurance companies. 

The refreshed methodology means these low insurance readings will continue for the next 11 months until the next annual data refresh in October 2023.   

The slowdown in housing inflation was one of the biggest surprises. Owners’ Equivalent Rent (OER) slowed to 0.61% from 0.81% in September. Rents of primary residence slowed to 0.69% from 0.84%. 

The transition from falling market rents to CPI is gradual. It’s hoped this is the start of a clear softening in the data, in line with forward indicators. 

Perhaps most interestingly, core services excluding shelter came in at 0.23% month-on-month (annualised 2.76%).

This is a leading indicator of where inflation may be in 18-24 months, perhaps suggesting wage pass-through pressures are less acute than thought. 

This is supported by Evercore surveys of temporary and permanent employment agencies, which show further signs of wage pressure easing this week.

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Certain industries are in significant pain. But is the broader US economy still heading for recession? Or could we end up with a soft landing? 

The risk of persistently hot inflation — and over-tightening by the Fed — has perhaps receded with this inflation print.

But we still need to see how severe the economic impact will be.

The chance of a soft landing has increased — but still remains quite low.

The Fed will need to see further signs of softer consumer demand and labour markets in coming months.

The inflation data was great for the stock market, pushing the S&P 500 ahead 4% and Nasdaq 5.6% on Thursday.

But it doesn’t help the Fed’s cause with Morgan Stanley’s Total Financial Conditions measure easing 50bps on the day of the CPI release. 

This compares with a tightening of 375bps so far in 2022. 

The Fed does not target a specific level of financial conditions. But the size of the move (particularly in real rates) may motivate some FOMC participants to talk down the market’s move in the near term.

US economy

Initial jobless claims rose to 225,000 from 218,000. Consensus was 220,000.

This is in line with the existing flattish trend.

We are seeing some industries such as tech cut headcount. But the broader trend is a slow-down in hiring rather than laying off staff. 

Nevertheless there is stress in certain pockets of the economy.

Rising interest rates have led to real pain in the technology industry. November is on track for the worst month this year in terms of lay-offs. Open job ads have halved from the peak earlier this year. 

There is a long-term positive. We should see increased discipline on return on investment (ROI) for capital deployed across the tech sector.

This should also allow tech workers to move into other parts of the economy (eg financials, industrials) where they have been in short supply in recent years.

The freight industry is also under pressure. 

Global container trade volumes declined 8.6% in the year to September. The third quarter was down 3.9%.

Global freight rates have fallen 75% from their peak (though they are still above pre-Covid levels). There are indications this could deteriorate further.

FTX, the world’s second-biggest cryptocurrency exchange filed for bankruptcy after a liquidity crunch caused by a bank-run-style exodus. 

This was triggered by claims that the balance sheet of Alameda (a crypto hedge fund owned by FTX’s founder Sam Bankman-Fried) held billions of dollars of FTX’s own cryptocurrency and had been using it to collateralise further loans.

The liquidity crunch morphed into solvency issues with an estimated $US8 billion shortfall.     

The crypto market’s entire value reached a peak of $US3 trillion in November 2021. It is now worth about $800 billion. 

So far this has not led to contagion into other asset classes. Though the risk — and that of a financial crisis — needs to be watched.

The FTX collapse caused pain among venture capital (VC) investors who are facing losses and write-downs in crypto-related investments. 

VC investors (including the biggest and most respected institutions) had invested $1.8 billion in FTX’s fundraising rounds over the past two years, with the first write-offs to zero being flagged. 

Expect more pain to come in other crypto-related organisations. 

UK heads for recession

The US not clearly in recession, but it is a different case in the UK.

British GDP contracted by 0.2% in the September quarter. This is expected to be the start of a lengthy recession, though the decline was less than expected.

China Covid pivot

Beijing is finally easing Covid-related restrictions, but has stopped short of declaring an end to the zero-Covid model.

More than 4 million people remained locked down in Guangzhou.

China announced 20 measures including shorter quarantine times for close contacts and travellers, plus efforts to improve vaccination rates and medical treatment.

This sparked big moves in commodities last week, including iron ore (+4.7%), copper (+2.6%), alumina (+5.9%), nickel (+3.9%) and Brent crude (+2.4%).

The AUD gained 4.1% against the USD for the week. 

The Hang Seng gained 7.7% on Friday.

US politics

An expected red wave did not materialise in the US mid-term elections.

The Democrats retained control of the Senate. The Republicans look on track to take the House majority with a tighter margin than expected.

The most likely outcome on the economy is more of the same, though it reduces the tail risk of some more extreme and destabilising policy measures. 

The real winner is perhaps Ron DeSantis, who has emerged as the de-facto leader of the Republican party.  

Markets

Market were buoyed last week by the positive surprise on inflation.

The S&P 500 gained 5.9%.US ten-year bond yields dropped 35bps, which helped the NASDAQ gain 8.1%.

More than 90 per cent of the S&P 500 market cap has now reported third-quarter results with overall sales growth of +11.6% (2.5% beat) and earnings of +2.4% (1.6% beat).

Despite this, the average stock fell 0.3% post results with significantly more pain than usual on the downside.

The inflation data supported a strong move in the trade-weighted US dollar index (DXY) which was down 4% for the week and triggered a 4.7% gain in gold. 

Heading into the CPI print, hedge funds were the most under-weight in info-tech stocks versus the S&P500 in many years. This resulted in tech ripping on Thursday. 

In Australia, weekly performance was driven by macro themes. All sectors were up for the week except energy.


About Elise McKay and Pendal Australian share funds

Elise is an investment analyst with Pendal’s Australian equities team. Elise previously worked as an investment analyst for US fund manager Cartica where she covered a variety of emerging market companies.

She has also worked in investment banking and corporate finance at JP Morgan and Ernst & Young.

Pendal Horizon Sustainable Australian Share Fund is a concentrated portfolio aligned with the transition to a more sustainable, future economy.

Pendal Focus Australian Share Fund is a high-conviction equity fund with a 16-year track record of strong performance in a range of market conditions. The Fund is rated at the highest level by Lonsec, Morningstar and Zenith.

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

Contact a Pendal key account manager here


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