CHAIR Jerome Powell’s hawkish tone after the Fed’s 75bp rate hike weighed on markets last week.
Though signs that Beijing may getting ready to roll back zero-Covid by March prompted a Friday rebound, helping contain the damage.
In Australia the RBA reinforced its more dovish rate path, choosing to take a risk on inflation to avoid triggering a damaging recession.
The S&P 500 fell 3.3% last week and is trading in the middle of the 3500-3900 range.
There was substantial rotation as growth and technology stocks suffered on the rate outlook. But cyclicals — and particularly metals and energy — did well on the signals from China.
Other global equity markets fared better, given a more cyclical skew.
The S&P/ASX 300 rose 1.6%. It is down 4.2% for 2022, versus -19.8% for the S&P 500 and -32.6% for the NASDAQ.
The medium-term outlook still depends on the degree of economic downturn and its impact on earnings.
There is some debate about the degree of leverage earnings will have to the downturn.
Historically, recessions have led to an average 20 per cent fall in earnings. Though this is often in a low-inflation environment, when nominal GDP (a proxy for corporate revenue) is low.
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In this instance the bulls argue that three factors may mitigate earnings decline:
The Fed’s initial press release indicated a coming deceleration in the pace of rate hikes and an extension of the hiking cycle.
But Powell ensured this was not interpreted as the longed-for dovish pivot. The peak in rates would likely be higher than previous forecasts, he noted in a press conference.
This is expected to be released in December’s quarterly “dot plot” — likely 5% to 5.25% by the end of 2023.
This is 50bps higher than the September indication and 25bps more than consensus forecasts.
Two-year US government note yields rose 24bps and 10-year bond yields were up 14bps for the week in response.
Higher rates and a further hawkishness put a nail in the “pivot” trade and saw growth stocks underperform.
October’s payroll data showed 261,000 new jobs, versus 193,000 expected.
This strong print was somewhat mitigated by a weaker household survey, which showed a decline in employment of 328,000 and an increase in unemployment from 3.5% to 3.7%.
Less helpfully, the participation rate for the “prime” age cohort fell from 82.7% to 82.5%.
Average hourly earnings were stronger than expected at 0.4% month-on-month versus consensus of 0.3%.
However this series has been softening. The three-month moving average is now down to 3.9% annualised, well below the annual rate of 4.7%.
All wage data series are rolling over, but growth is still too high at around 5%. It needs to fall to 4%.
Earlier in the week we saw job-opening data reverse the previous month’s decline.
A range of indicators show the labour market softening and lay-offs picking up. But the data is still too strong for the Fed to feel comfortable on inflation.
Finally, manufacturing data (the ISM index) weakened more than expected, though not enough to indicate a recession.
The week’s most significant surprise came from China with rumours of a shift in thinking on zero-Covid.
Some of these stories were walked back at the weekend — especially after a surge in Covid cases, particularly in Guangzhou.
We are careful not to extrapolate too much from this. There is a view that it would make more sense for Beijing to roll back zero-Covid once the northern hemisphere winter has passed.
But the market reaction highlights how far consensus positioning was caught out by a shift in sentiment on China.
Chinese stocks moved about 18 per cent on the week. Resources stocks and the Australian dollar also moved sharply on Friday. There were moves in resources with oil and copper up.
This highlights the issue that Chinese re-opening could renew inflationary pressure.
Finally, Beijing also sent a message to Russia cautioning against the threat of nuclear weapons.
This was seen as an important attempt to reduce geopolitical tensions.
As expected, the RBA raised rates 25bp to 2.85% last week.
The message remains far more benign than the Fed. This is seeing a divergence in outlooks for domestic and internally-focused stocks within the ASX.
The RBA expects rates to peak at 3.5%, versus 5% to 5.25% in the US. Inflation is expected to peak at 8% this quarter and fall to 4.7% a year later, with GDP slowing to 1.4% in 2023.
The risk is inflation does not drop so quickly, given this level of growth.
The combination of a hawkish Fed and hope on Chinese re-opening led to a major rotation in the market last week.
There was a 9% relative move in the S&P 500 mining sector and 8% in the S&P 500 energy sector versus the NASDAQ.
US earnings season deteriorated to below long-term averages in term of beats and above in terms of misses.
Most telling was the poor performance of the technology mega caps, where there was a second wave down. As always, it seems “the generals are the last ones to be shot” in a bear market.
Apple unwound all the previous week’s performance.
Atlassian fell 28% post result and is now down 73% from its peak 12 months ago. Twilio fell 34% on its result, taking the decline from its Feb peak to 93%.
Both these companies are leveraged to the tech sector as service providers, so their slowdowns are compounded.
The rotation is also reflected in earnings.
Exxon quarterly earnings have now caught up to Microsoft. Though the energy sector’s proportion of the S&P 500 is back only to 2019 levels — still well below its highs of a decade ago. The Australian market’s sector mix and skew to resources/energy and financials continued to provide resilience.
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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