Crispin Murray: What’s driving Aussie equities this week

Here are the main factors driving the ASX this week according to our head of equities CRISPIN MURRAY. Reported by portfolio specialist Chris Adams

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US EQUITIES continue to grind higher following resolution of the debt ceiling issue and signals of economic resilience.

The market is buoyed by the possibility of resolving inflation without the Fed pushing the economy in to recession.

The S&P 500 gained 1.9% last week.

Fed governor Philip Jefferson (tipped to be the next Fed vice-chair), indicated that the rate-setting Federal Open Market Committee would hold rates steady in June despite higher CPI and a strong labour market.

Though he was quick to note this should not be seen as a signal that rates have peaked.

Australian equity market returns were more muted, with the S&P/ASX 300 essentially flat at -0.07% last week.

Here, the market was focused on wage increases from the Fair Work Commission, which at the margin pushed the odds of a rate rise tomorrow a bit higher.

There were also rumours of potential economic stimulus from Beijing late in the week.

Global bonds rallied early in the week helped by softer European inflation, Fed signals and a previously oversold position. Though stronger employment data saw the week’s rally reverse by half.

Equity investors remain cautiously positioned in aggregate. Many have been caught out by the recent upswing and the shift to catch up is helping underpin the rally.

The S&P 500 has broken through the 4200 resistance level, which represents the high of February and a 50% retracement of the 2022 bear market.

It is now testing 4300, which was the high of last August.

Market bulls argue that successfully breaching resistance at 4300 will see the market rise to 4600.

Bears counter that a weaking economy will ultimately see the market fail to breach 4300 and sell off. 

While recent conditions have been positive, we are mindful that the range of potential outcomes for the economy and markets remains very wide by historical standards. 

This reflects the combination of:

1. The scale of rate hikes
2. Economic distortions created by the pandemic
3. A range of structural themes such as energy transition, artificial intelligence and rising geopolitical fissures

These factors all remain in play and demand careful management of portfolio risk.

The interplay of these issues is manifesting in a series of contradictions:         

1. Continued resilient economic growth despite a rise in rates and inverted yield curves
2. Strong equity market performance despite broad-based expectations of a recession
3. Divergent equity performance between big tech and the balance of the market
4. Continued strength in services while manufacturing remains weak
5. Rising house prices despite a continued increase in mortgage rates
6. Stubborn inflation despite falling commodity prices
7. Subdued recovery in China post re-opening

The implication of these contradictions is that circumstances and conditions can change quickly.

This emphasises a need to manage thematic and macro risk carefully in our portfolio construction.

US debt ceiling

The debt ceiling has been resolved in a far more bipartisan and benign way than most in the market expected.

The deal’s impact is relatively limited in the near term, with US$30 billion of additional spending cuts in FY24 equivalent to only 0.1% of GDP.

This is only half the effect of resumed student loan payments, with the payment “pause” expected to lapse and drive a more material fiscal headwind. 

The deal also achieved minimal reform on environmental permitting.

This deal slaps some patches on key issues for two years. Both sides are betting they will be better placed to get their preferred outcomes then.

The more interesting point is that the market was positioned bearishly, expecting a far more damaging and protracted negotiation.

A rotation to less defensive exposure can help underpin the equity market at these levels.

The liquidity impact is also important to remember. Treasury needs to fund about US$500 billion in spending in the next couple of months, which may check any rally in bonds as new supply comes to the market.

US jobs and economic data

US non-farm payrolls for May rose 339k, well ahead of 195k expected. There were also net revisions of +93k to previous months.

Payroll growth is running at +2.8% year-on-year.

This is still too strong for the Fed’s comfort in regard to inflation.

It also indicates there is no imminent sign of recession despite the banking crisis, which to date has had no discernible impact on the economy.

That said, the picture is complex and there were a number of mitigating data points to offset too bearish a read on the data:

1. The Household Survey, another measure of jobs growth, saw a drop of 310k jobs. This gap has been widening for some time, but this is one of the biggest divergences in recent times. The reason is causing debate. But a shift from self-employment to working as a paid employee seems to be playing a role. The key point is that both sides of the argument around jobs growth can draw something from this month’s data. 
2. The unemployment rate rose from 3.4% to 3.7%, due to the drop in the Household Survey. This is the highest rate since October.
3. There is a rise on permanent unemployed, as opposes to temporary layoffs. This is seen historically as a lead indicator of recession. 
4. Average weekly hours worked fell to 34.3 and has now fallen in three of last four months. This suggests employers are cutting back hours rather than laying off workers.
5. Average hourly earnings growth slowed to 0.3% month-on-month and 4.3% year-on-year which compares to 6.4% annualised at the start of the year

Employment, hours worked and average hourly earnings combined provide a proxy for income — which has slowed to +0.2% monthly for May, but is still high at 6.2% year-on-year.

The US Job Openings and Labor Turnover Survey (JOLTS) came in stronger than expected in April. Job openings increased 358k to 10.1m, pushing the ratio of openings to unemployed back up to 1.8.

This has been regarded as a lead indicator of any loosening in the labour market which could alleviate wage pressures — but it continues to hold up more than expected.

One more helpful signal was a decline in the “Quits” rate (a proxy for employee confidence in finding a job) which could signal a decline in the employment cost index.

US monthly job layoff data has also plateaued after rising in late 2022 and early 2023. 

The May ISM manufacturing index (a survey of purchasing managers at US manufacturing firms), dipped to 46.9 from 47.1.

The decline was due to fewer new orders, which fell 3.1 points to 42.6 as inventories fell for the fifth straight month (by 0.5 points to 45.8).

This is now in-line with the Covid low and highlights that manufacturing remains soft.

It also gave a clear indication that inflationary pressures in goods are easing and should help reduce overall inflation further.

Our current conclusion from all this is that the US economy is holding up better than most thought. It seems clear that most companies remain reluctant to lay-off works at scale.

This underpins income growth, which helps to hold up the economy.

There is also evidence that inflationary pressures are falling, which means the potential for wage growth to normalise without a dramatic increase in unemployment remains a viable option. This is constructive for markets.

The bear case is contingent on an accelerated economic downturn affecting earnings. There remains little evidence yet that this is set to happen.

Expectations around rates are shifting as a result, with less easing now priced in for the end of the year.

Rest of the world

Eurozone HICP Inflation data came in weaker than expected, prompting a more moderate outlook for rate hikes and providing support for bonds.

Friday saw some chatter about a policy reboot and more economic stimulus from Beijing.

This remains speculation for the moment, but did help sentiment in the resource sector, which had been very weak.

Australia

We saw the long-awaited Fair Work Commission wage recommendations last week.

The outcome is a 5.75% increase in award wages, which benefits 20.5% of workers. There is also an 8.65% increase for the national minimum wage, which affects 0.7% of all workers.

There is an additional 4% of workers on enterprise bargaining agreements and individual agreements tied to this.

So the net effect of all this is about a quarter of the workforce getting an average wage increase of 5.8%, versus 4.6% last year.

This was broadly in line with expectations, though there is a view the Reserve Bank may have baked a little less into its figures, which therefore raises the odds of a rate rise on Tuesday.

This will also flow through into the September quarter wage price index, which is likely to accelerate to a rate over 4% annualised.

At a corporate level, the greatest impact will be felt by supermarkets and retail. Even though the outcome was close to expectations, these sectors underperformed for the week.

One specific issue that may lead to sustained high inflation is the rise in unit labour costs (ULCs), which historically have had a strong link to services inflation.

The RBA is focused here, concerned that productivity remains low and therefore the impact of wage increases may prove more inflationary.

ULC data will be updated for the March quarter with next week’s GDP data.

To date they have been high, reflecting the ability of Australian workers to grow overall wage income well above the level implied by the wage price index, once bonuses, role changes and the extra income from additional jobs is factored in.

All these factors allow households to supplement income and explains the resilience in the economy.

The growing number of hours worked is reducing GDP per hour worked, implying reduced productivity.

 

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About Crispin Murray and Pendal Focus Australian Share Fund

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.

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

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