A COMBINATION of northern hemisphere summer doldrums and limited data is keeping news-flow reasonably quiet.
US and Australian bond yields are both re-testing cycle highs, capturing a lot of attention.
Rising bond yields and a stronger US dollar saw equities fall last week, continuing their consolidation from the end of July. The S&P 500 fell 2.05% and the S&P/ASX 300 lost 2.34%.
The market is also focused on weakness in China’s economy.
Along with talk of inventory reductions, this encouraged a continued sell-off in the lithium complex. Though iron ore miners maintained their remarkable resilience.
Softer Australian employment data helped drive our dollar lower versus the USD.
In local ASX results, season operational performance has largely been solid. But there have been concerns about debt costs for the more leveraged companies.
The Chinese economy remains under intense scrutiny.
This was maintained last week by concern of the imminent default of property developer Country Garden, missed payments from investment company Zhongrong Trust and a continuation of weak economic data.
The challenges are symbolised by Beijing’s decision to stop publishing data on youth unemployment — which stands at about 21 per cent.
Data on land sale volumes and consumer confidence are also suspended in the name of maintaining confidence.
Confidence is the key issue:
This lack of confidence can be seen in a lack of private investment, which is down 7 per cent in the first seven months of 2023, versus state-owned-enterprise investment up 12 per cent.
Concern over property lies at the heart of the confidence problem. New housing starts are down more than 60 per cent from the 2019 peak.
There was a widely-held expectation that the market would stabilise following such a dramatic decline.
But July data indicates the weakness continues.
Goldman Sachs cut its forecast for 2023 new housing starts from -10% to -20% on the previous year and expects the property sector to detract 1.5% from GDP growth.
Beijing’s 2023 GDP target of 5% was initially seen as something of a low-ball target which could be exceeded.
Now the market is cutting GDP forecasts to sub-5% as we see recent trends in retail sales, auto sales and other indicators start to slow.
There have been a number of policy initiatives, including some interest rate easing and bringing forward some spending by local governments.
But these measures have been incremental and unable to reverse deteriorating sentiment.
While this is a bearish portrait, some China-related stocks and sectors on the ASX have held up — notably the miners.
The bulls are taking the view that things are so bad, they’re good — which would increase the chance of a more convincing policy response such as the one we saw in 2015.
They are drawing a comparison with the period prior to the reversal of the Zero-covid policy, where there were incremental signals before the major policy change.
There’s also a theory that Beijing is biding its time, reasoning there would be no point launching an initiative in high summer as it wouldn’t get traction. Beijing may be waiting until September, the theory goes.
If a major policy response doesn’t materialise, we see some risk around bulk commodity producers at these levels.
US GDP surprised to the upside with 5.8% growth in the second quarter.
The market is trying to understand how this can happen.
Some relates to higher investment.
It’s too early for the Inflation Reduction Act (IRA) to be felt, but the 2022 CHIPs and Science Act (CHIPS stands for Creating Helpful Incentives to Produce Semiconductors) of 2022 is having some effect.
Consumption, however, is the main driver.
One observation is that business tax refunds have surged since March, adding an additional $100 billion in potential spending power.
A lot of this relates to small business and is tied to the Covid-era policy of employment-retention tax credits.
This policy, which remains in place until 2025, is seeing business tax refunds run at four times pre-pandemic levels.
The policy’s original costing was US$85 billion over 10 years. It has cost US$150 billion in the past 12 months alone.
This is a good example of how some stimulative fiscal settings have become entrenched and are helping the economy outperform expectations.
The stronger economic outlook can also be seen in the Atlanta Fed’s GDP NOW measure, which is indicating an almost 6% growth in GDP for the third quarter.
We suspect this is overstated. But it still retains a healthy buffer over the 1& to 2.5% range of forecasts from consensus.
The New York and Philadelphia Fed regional manufacturing surveys appear to be bottoming, reinforcing the soft-landing case.
They are also signalling a pick-up in prices received, which may give the Fed some pause for thought.
This more resilient economy means markets are expecting interest rates to stay higher for longer, and reinforce the view that real rates need to stay higher for this cycle.
Combined with structural pressure on the government budget deficit from funding costs and more legislated spending — plus extra supply and lower offshore demand for treasuries — this helps explain the increase in bond yields.
It also suggests that while the market is bearish on bonds — allowing potential for a near-term reprieve — we should not expect a sustained reversal in yields.
Australian equities were down last week, in line with the US.
Only REITs (+1.27%) held up, largely due to the influence of Goodman Group.
Lithium names were weak on a macro trade against them.
Domestic high-yield names were also soft, partly due to the realisation that bond yields were staying higher.
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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