A NUMBER OF issues combined to prompt a pause in equity markets last week following a strong run.
The S&P 500 fell five days in a row. While there was no specific, material market driver, we note these issues:
We think it is too early to read too much into this drop.
We are still constructive on the outlook for equities, but we are mindful of a number of issues to watch.
We are in a period of shifting policy, which engenders some risk. It is harder to get a read on underlying economic strength at the moment because of the supply bottlenecks.
Cooler weather in the Northern Hemisphere may also have an effect on Covid case numbers.
The S&P/ASX 300 fell 1.3% last week. All sectors lost ground. Real estate (-2.35%) was the worst and communication services (-0.4%) held up best. The S&P 500 ended down 1.7%.
Covid and vaccines
We are seeing new Covid case numbers decline in the US, Europe, Asia and Israel. So far the return to school has not led to a large resurgence in cases, though this is still possible.
There may also be some impact from colder weather. But at this point the trend is positive.
In the US, 41 States (about 83% of the population) are now more than 5% below peak infection levels and the number of hospitalisations is starting to decline.
In Australia, NSW is on track this week to reach 80% of the population with one dose. This is despite a fall in the daily vaccination rate. Second doses are running a month behind.
There are some concerns over the “Mu” variant of the virus.
Newly classified as a “variant of interest”, there is speculation Mu may be as transmissible as Delta and more resistant to vaccines. The latter may be true — as it was for the Beta variant — but it’s not yet clear according to initial studies.
Macro and policy
The European Central Bank struck a dovish tone, signalling a “moderately lower pace” of bond-buying and emphasising that this wasn’t tapering.
In practice, this means reducing monthly bond purchases from EUR80 billion to EUR70 billion, but with flexibility to do more. The next big policy decision moves to December.
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Part of Friday’s US market weakness related to a story in The Wall Street Journal which suggested the Fed would signal in this month’s meeting that tapering would be announced in November, start in December and be completed by June 2022.
This is a little more aggressive than current consensus expectations.
The market is concerned that the Fed’s view of current economic softness as Delta-related — rather than a more structural issue — could be incorrect.
As a result, they risk tapering into an already slowing economy.
The market is looking for a read on the strength of the underlying US economy. The Q3 GDP signal continues to weaken. The Atlanta Fed GDPNow estimate — a reasonably reliable indicator — is now below 4% quarterly growth. This is well below the 5-8% range in market consensus.
There is no doubt Delta-driven disruptions and supply chain bottlenecks are playing a major role. Auto and light truck sales have dropped materially, for example, driven by issues with getting stock into the yards.
Inflation also remains an underlying concern, which may potentially place central banks in something of a policy bind. There is plenty of data that demonstrates higher prices.
While iron ore is down a lot, plenty of other commodities are running hot. Some of this is due to temporary supply disruptions, such as in aluminium and natural gas.
But there are also longer-term issues at play, such as the impact of carbon pricing on coal in Europe and higher power prices in China.
In contrast there is still plenty of evidence that points to strong underlying economic momentum.
Despite weak August payrolls, job opening are at record levels. Wages are also strong, which drives consumption. Excess savings also continue to rise, up 12% year-on-year.
If we get a sense that Delta is becoming less of a threat — and if Biden’s plan can drive vaccination rates higher —this may help release some of this pent-up potential demand.
It is notable that US bond yields are not making new lows despite the weaker economic data.
Falling yields in April and May signalled that the economy was slowing despite strong data. Now the opposite may be true. It is also worth bearing in mind that Quantitative Easing means yields are probably 30bps lower than they otherwise would be.
Australian equities held up better than the US, helped by optimism around the vaccination roll-out and the path for re-opening.
However resources remained weak, driven by concern over China’s property market and rhetoric around weaker steel demand.
There was little news on the stock front last week in the wake of reporting season.
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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