MARKETS are range-bound due to two competing factors.
On one hand, there is concern that a recession could harm company earnings.
On the other hand, there is hope that a possible end to rate hikes could support the market’s valuation.
As a result, the US S&P 500 index is oscillating between 3800 and 4200.
At the moment, risk is skewed towards markets breaking higher, due to better-than-feared earnings and signs that inflation is easing.
In Australia, the S&P/ASX 300 gained 0.75% last week while the S&P 500 was off 0.24%. Bond yields shifted slightly higher.
The only move of any note was a fall in base metal prices, with copper down 4%. This reflected ongoing disappointment in the China-recovery story.
In the US we saw slightly better inflation numbers and signs that credit conditions were tightening (indicated in the latest Fed survey of senior loan officers at banks, known as Senior Loan Office Opinion Survey).
These raise the odds of the Fed holding rates flat in June.
On the stock front we saw an announcement of consolidation in the lithium space, with a proposed tie up between Australia’s Allkem (AKE) and US-listed Livent.
A number of reassuring inflation data points emerged last week.
While inflation data has improved, it remains too high for the Fed’s liking.
There are also signs this may be flowing through to longer-term expectations.
Five-year inflation expectations have risen to 3.2% annualised — a new high for this cycle.
This data series is volatile and did reverse after spiking to 3.1% last year.
But central banks fear this kind of shift, because it represents an embedding of inflation expectations.
Tighter US credit conditions
Each quarter, the Fed surveys senior loan officers at US banks about their lending practices and the current state of the credit markets.
The latest Senior Loan Officer Opinion Survey (SLOOS) suggested a small tightening of credit conditions.
The market remains undecided about how far bank failures will slow the economy. The expected impact ranges from 0.4% to 1.2% of GDP.
The case for the lower end is that the tightening is limited to regional banks rather than global systemically important banks such as Bank of America and JP Morgan Chase.
Lending from the regional banks is already constrained, so this limits the additional impact.
The counter argument relates to the scale of the deposit reduction and how policy makers are dealing with crisis.
So far, the approach has been to allow banks to go under before allowing bigger banks to take them over, with risk -sharing deals.
As a result, regional banks are now extremely cautious, which may lead to a more material effect on lending.
The combined market cap of US regional banks is now less than JP Morgan Chase.
A combination of slowing inflation and slowing credit growth raises the likelihood of a pause in US rates.
US rates may now have peaked, which has been supportive for the market.
We remain mindful that the scale and pace of hikes in this cycle has not been seen for 40 years.
There is still a degree of unpredictability around the economic impact we need to factor into portfolio construction.
After rebounding in March, China credit growth came in weaker than expected for April at RMG1.2 trillion versus consensus at RMB2.0 trillion.
It remains stable at 10% year-on-year.
The total amount of credit growth at this time of year is below 2020 and 2021 — s well as pre-Covid.
This highlights a lack of confidence in the corporate sector, and particularly in the household sector.
The housing market remains subdued, which is affecting commodity markets.
Realised volatility in the US equity market continues to fall — and is now lower than almost any point in 2022.
This suggests a market that is becoming less unsure about the outlook.
The recovery in growth stocks — especially mega-cap US tech — is stunning.
This is explained partly by their ability to manage earnings, but also in the growing belief in Artificial Intelligence as a driver of long-term growth.
This trend also explains the outperformance of US versus Australian equities year-to-date.
One result is that breadth in the market has fallen to low levels. This is usually a negative signal for the overall market.
We are also seeing a significant breakdown in base metal prices. Copper — historically regarded as a good proxy for global growth — is breaking down to new 2023 lows and approaching levels not seen since China reversed its zero-Covid policy.
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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