A CONTINUED drop in bond yields, a weaker US dollar and lower oil prices helped markets squeeze higher last week in a relatively quiet period on the macro front.
The S&P 500 rose 1.6% and the S&P/ASX 300 lifted 1.5% last week.
The key question is whether we are seeing the US economy slow enough to relieve inflationary pressure via labour markets and commodity prices.
This would allow the market to conclude the forward pricing of rate increases had peaked, regardless of Fed rhetoric.
The other related issue is how weak the economy gets and what this means for earnings.
There are several possible scenarios:
Equity markets are tied to the US dollar, the oil price and bonds yields.
It will be important to watch how oil performs following the OPEC meeting on December 4 and any potential Moscow reaction to price caps.
Bond yields are hostage to the outlook for inflation. The US dollar would likely weaken on signs of a softer economy and the rate outlook easing off — but would bounce back on signs of persistent inflation.
Minutes from the Fed’s last meeting suggest it is likely to pause rate hikes, reflecting the need to weigh up the lagged and cumulative effects of rate increases so far.
There was a reference to some members seeing the ultimate peak as higher than previously thought. This was the point Powell used in his press conference to try to contain any easing in total financial conditions.
Fed speakers continue to emphasise a lack of consistent evidence that inflation is coming down.
They continue to see embedded inflation as the key risk — and as a result prefer to err on the side of over-tightening.
A variety of lead indicators such as shipping prices, import prices, crude oil prices and surveys of expectations are moving in the right direction.
Two issues continue to underpin inflation:
There are some anecdotal signs of softening in labour demand.
The US National Retail Federation — the world’s biggest retail trade association — expect seasonal hires of 525,000 versus 670,000 last year. This week’s US employment data will be an important test of this.
Initial reports for Black Friday weekend indicate strong retail sales (partly due to inflation.
Mastercard data suggest in-store purchases increased 12%, e-commerce sales rose 14%, apparel sales climbed 19%, restaurants jumped 21% and electronics lifted 4%.
There are widespread reports of protests about Covid lockdowns. Whether this leads to more loosening or harsher clampdowns is unclear.
It is hard to get a near-term read on China.
Covid cases are rising as the country goes into winter with limited hospital ICU capacity and no new vaccines yet approved.
The resources sector has remained largely resilient. The market is choosing to look through near-term weakness to focus on the re-opening trade.
As expected, the People’s Bank of China further reduced its bank reserve ratio requirements by 25bp to 11%.
This is part of an effort to bolster the economy in the face of rising cases and lockdowns.
The ASX has now recovered back above its August highs.
Financials, energy and resources have led the way. Staples, property and small caps have lagged.
Stocks expected to benefit from lower bond yields led the market higher last week. REITs, industrials and banks were the strongest sectors.
Miners lagged, driven mainly by weaker lithium stocks.
Chinese spot lithium prices have been falling. Monthly sales of electric vehicles (EVs) fell 21% in October, though there was some seasonality and impact from lockdowns.
EVs made up 19.4% of new registrations in October, versus 21.8% in September. There is some concern of excess lithium inventory in the channel. This is a volatile sector with a lot of momentum and is prone to sizeable drawdowns. Unlike other commodities the outlook for demand remains very strong and supply is likely to be constrained. Any inventory issue is likely to be short lived.
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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