MARKETS enjoyed a good, broad-based rally last week. This was despite a continued rise in bond yields and ongoing concern about Chinese growth.
The diminishing probability of a hike in US corporate taxes helped sentiment. So, too, did generally supportive US earnings.
The S&P/ASX 300 rose 0.72% and the S&P 500 1.67%.
Case trends in the US and Asia are generally headed in the right direction, though there are concerning signs in Europe.
A renewed wave in the UK suggests it may be following the same path as Israel, where case numbers picked up as vaccine protection waned.
German cases are also increasing. Some Eastern European countries, where vaccination rates are low, are also seeing a surge. Romania is a case in point.
There is also an outbreak in Singapore, which is notable since 81% of the population is vaccinated.
We may be at an inflection point for a renewed surge in cases, led by Europe. The critical relationship between vaccinations and fewer severe infections and hospitalisations continues to hold, but needs to be watched.
Pfizer released results from its first booster trial.
A sample of 10,000 vaccinated people showed five new Covid infections among the half who received the booster and 109 in the remainder who had a placebo.
Importantly, there were no severe infections in either group. This reinforces the idea that while a vaccine’s ability to prevent infection wanes, its ability to prevent severe infection may be more enduring.
It was generally a good week for data. Flash PMIs, a leading indicator of activity, came in better than expected in Japan and the EU.
In the US, the manufacturing flash PMI was weakened by supply chain factors, but strength in the services PMI more than made up for it. This is important, since the service sector — which is benefiting from re-opening — is roughly five times larger than manufacturing in the US.
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It is worth watching US credit growth. This was persistently disappointing in the post-GFC era, one symptom of the lacklustre recovery.
It has remained muted in this cycle due to excess household savings accrued during Covid. But US bank results suggest we might be seeing credit growth building. If this occurs it will further support the sustainability of economic growth.
So the demand environment remains firm.
If this coincides with alleviation of supply chain pressure, it should be a positive environment for equities.
Inflation and yields
The inflation issue remains very live.
The UK is seen as something of a bellwether. September inflation data in the UK was a little softer than expected, but forward expectations are rising sharply. The market is pricing in a 21bp rate increase in November as the Bank of England needs to be seen to react to rising inflationary expectations.
Longer-term indicators of US inflation — such as house prices, wages and retailer pricing power — continue to rise. So too are prices in the service sector.
This is flowing through into a continued re-pricing of the short end of the bond curve.
US two-year government bond yields have doubled from about 20bps to 46bps in October, reflecting expectation of tightening. The consensus view is that when tapering begins it will do so at the higher end of the range (about US$20 billion per month) and the first rate hike will come in June.
Negotiations around President Biden’s reconciliation bill are nearing a conclusion. The final package looks likely to be around US$1.8 trillion rather than the original US$3.5 trillion plan.
The debate over how it is funded has been interesting. Democrat senator Kyrsten Sinema of Arizona refused to withdraw an objection to any change in corporate, capital gains or personal tax rate. If corporate tax hikes don’t eventuate — which is now quite possible — US earnings expectations could rise 5 per cent.
In China, beleaguered property developer Evergrande paid interest on its first bond, due just before the end of a 30-day grace period. It has avoided default for this week. But another payment is due Friday and there are more after that.
Meanwhile Beijing is dealing with another Delta outbreak — 10 of 31 provinces have reported cases. Restrictions have been imposed, potentially providing another economic drag.
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The central government is telling provinces to accelerate their issuance of government bonds, to use up the 39% of annual allocation they have remaining for 2021. The spending is unlikely to make an impact this quarter, but is supportive of Chinese growth in coming years.
This week the European Central Bank will meet. At this point the market is pricing a 40bp hike in rates by the end of 2023. It will be interesting to see if there is any push-back by the Bank — or if it acknowledges building inflationary pressure.
While inflation pressures remain significant, there is a case for nearer-term stability in bond yields as China remains in a slumber, global Covid cases start to rise again and supply chain pressures ease.
This would support a rotation back to growth.
We retain a material growth exposure with companies targeted at corporate or institutional end markets, rather than the consumer.
About a quarter of the US market has reported quarterly earnings so far. Some 65% have beaten consensus expectation by more than one standard deviation. If this holds it will be another strong quarter with earnings running 8% ahead of estimates.
Revenue growth has exceeded expectations in 57% of companies compared to a long-term average of 35%.
The market is focused on labour costs, which are rising. But to date most companies have indicated they can offset this via higher prices.
While the quarter looks strong, this has not flowed through to large consensus upgrades for CY22, since the market remains wary of supply chains and labour costs.
It’s worth noting that social media company Snap Inc’s result highlighted a second-order effect of supply chain issues: companies with less product to sell are scaling back advertising.
This may provide read-through for Google and Facebook, which are yet to report.
Stocks leveraged to Chinese supply chains started to do better, reflecting our observation last week that signals such as power availability and freight rates were improving.
We saw a disconnection in commodity markets. Oil remained well supported but there were corrections in other commodities. It is worth noting technical signals that some commodities such as aluminium have peaked for now.
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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