WE SEE constructive signs emerging in recent market action after a period of consolidation.
Concerns over inflation and China remain heightened and persistent. Inflation, in particular, is likely to remain a key issue for markets for some time. But there are indications of small improvements at the margin for sentiment on these issues.
Further indication that concerns on these issues have peaked — combined with continued economic recovery and a period of seasonal strength in markets — could set up equities well into the year’s end.
It is far too early to declare victory in this regard. But equities moving higher despite ostensibly bad news, as we saw last week, can be a strong positive signal. The S&P/ASX 300 was up 0.65% and the S&P 500 1.84%.
Whether or not this continues in coming weeks is likely to rely heavily on US earnings season and Chinese data and policy signals.
The market has 3 broad concerns at the moment;
At this point there are signs that each of these issues may have reached a near-term crescendo, which is helping markets rally.
In the US, Congress and the Biden administration have been able to delay the debt ceiling issue to December. It hasn’t disappeared, but they’ve bought time.
There are signs that China is addressing power shortages. Beijing is looking to source coal and gas from all available sources – including Australia, despite previous embargoes.
This will not flow through immediately, but the signal is that China is looking to solve the problem and not stubbornly stick to old policies.
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Property remains more complex in China. The Evergrande issue has seen credit spreads blow out in the property sector. So far this looks contained within that sector and has not spread to other parts of the market.
There are indications in the data that monetary policy is too tight in China. There are various committee meetings this week which may result in some indication of easing.
Inflation is the greatest long-term threat to markets.
In the past few weeks there has been a shift in expectations including a realisation that inflation is likely to be higher and more durable than previously thought.
At his Jackson Hole speech on 27 August, Fed Chair Powell was able to calm inflation concerns with the idea that it was transitory. His key reasons were:
Since then inflationary pressures have strengthened, due to:
What was “transitory” is now being described as “transitory for longer”.
This is because the “transitory” argument is now falling foul of its own rationale outlined in the Jackson Hole speech:
The market realises the Fed is in something of a bind. It wants to promote growth while being mindful of the need to keep inflation expectations anchored.
The balance in recent weeks has been a shift in expectations to the Fed having to move sooner on tapering and rate hikes.
As a result we saw a “bear flattening” in bond markets, with two-year yields rising while 10-year yields remain flat. Despite this, equities and commodities made gains.
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One factor could be that supply chain fears have perhaps reached their nadir. Freight rates from China to the US east and west coasts have rolled over recently.
Surveys suggest the proportion of US firms reporting inventories as “too low” has also rolled over.
The Biden administration has recognised the importance of this issue. It’s been working with stakeholders to keep the Port of Los Angeles open 24/7.
This alone won’t solve the problem. But combined with factories re-opening in Asia and private companies adapting their sourcing, it can help calm fears on the issue.
We see inflation as a key issue for markets going forward. But signs of alleviation in supply chain pressure, coupled with marginally better news on China and the US debt ceiling — plus expectations of good US corporate earnings — may continue to support markets in the near term.
While the big risk issues are marginally improving, the outlook for US growth is also encouraging.
US retail sales were better than expected at +0.7% m/m, with positive revisions for the previous month. This means it’s holding up despite a surge in the past year. There is strength in discretionary spending (clothing, sporting, e-commerce) which was up 13.9% year-on-year (and 15.6% ex-autos).
Fiscal stimulus has played an important role in this. It also goes some way to explaining some of the supply chain issues we are seeing.
Consumer spending is expected to shift from retail to the service sector as restrictions are rolled back. It remains supported by $US2 trillion in excess savings as a result of stimulus. Income growth also remains greater than expenditure.
We are seeing some important and positive signs, such as:
In conclusion the market signals are more positive than the media headlines. This is often the right signal to watch for.
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.
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