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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.

JEROME Powell struck a more nuanced tone in a speech about US inflation and jobs last week.

The chair of the US Federal Reserve told a Washington DC thinktank that the central bank was mindful of overtightening as well as potential distortions in the CPI calculation.

The market interpreted this as a less prescriptive — and less hawkish — stance on rates than previously feared.

As a result, the S&P 500 gained 1.2% and US 10-year government bond yields fell 19bps. The S&P/ASX 300 was up 0.2%.

This outweighed the negative news of another firm payroll and average hourly earnings print.

There were reminders that the Fed may have to hold rates higher for longer than the market is expecting.

Optimism around China continues to support mining stocks and help underpin a rise in commodity prices.

It would not surprise us to see the market pause in the short term, given a) the equity market is approaching technical resistance levels, b) volatility has fallen to the low point of its range this year and c) key inflation data points are yet to come.

The depth of any economic downturn — and its effect on earnings — is the key swing factor for the medium-term outlook.

An important signal

Powell’s speech to the Brookings thinktank was an important signal.

There was not anything specifically new. He is still flagging a deceleration to 50bp in December and notes that the ultimate peak in rates may be higher than they expected in September.

The importance lay in the speech’s tone — which was far more balanced than his previous hawkish statements.

There were fears he would reprise the Jackson Hole speech, talking down markets after a strong rally.

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Instead, his speech implied he did not feel the need to drive Total Financial Conditions higher in the near term.

(Total Financial Conditions indices try to pull together changes in key indicators — such as mortgage rates, credit spreads, equity markets and currency moves — as an early indicator of the market impact of stimulus or tightening).

Powell introduced a sense of both upside and downside risks. He noted several key points:

  1. The view that peak rates may need to go higher than September expectations was his own opinion, and wasn’t necessarily shared by members of the Federal Open Market Committee (the Fed’s chief monetary policy body)
  2. The probability of an economic soft landing was “very plausible”
  3. The Fed could slow the pace of rate hikes as a “risk management” technique, to reduce risk of over-tightening
  4. Taking rates beyond the expected peak would not be his “first choice”. He would prefer to hold rates at high levels for longer
  5. Goods inflation is coming down
  6. Housing inflation is mechanically higher due to low turnover; rents on some new leases are now dropping and will flow through with a lag
  7. Services inflation was driven by wages, which have been affected by lower immigration and the great resignation

Without overstating its significance, this suggests the Fed is not looking to micromanage near-term financial conditions.

This more nuanced assessment of inflation — and the policy response — suggests the market does not need to react so violently to each individual data print.

The caveat, of course, is that Powell’s stance may change depending on the data.


US economic data insights

Jobs

Non-farm payroll data, while decelerating, continues to be stronger than expected with 263,000 jobs added.

Headline layoffs are still not countering broader employment gains across the service sector.

But the reaction was not as negative as might be expected.

There were seasonal elements at play, which may be subsequently revised down. The household survey showed a 138,000 fall in jobs and unemployment stable at 3.7%.

It was interesting to note that job leavers as a percentage of unemployed fell for the second consecutive month. This suggests people are more reluctant to leave jobs, which may be an indicator of a softening labour market.

Wages data remains incompatible with inflation falling below 3%. Private workers saw a 0.6% gain in hourly earnings. The three-month moving average stepped up as a result.

Powell highlighted a key challenge for the labour market: the section of the workforce that has not returned to work.

While the participation rate for 25-to-54-year-olds has rebounded, the same rate for over-55s has not recovered.

New job openings and labour turnover data was more positive for labour market softness as job openings continue to roll over.

However there is still a reasonable way to go here before the labour market has loosened up enough to lead to a step down in wage inflation.

Consumption

Earlier in the week we had the Personal Consumption Expenditures data — the Fed’s preferred inflation gauge.

It came in lower than expected, at 0.22% month-on-month versus a consensus expectation of 0.3%. The year-on-year figure is 4.98% versus 5% expected. 

The issue here is while underlying inflation has decelerated, it remains too high.

Manufacturing

The Institute for Supply Management manufacturing index fell from 50.2 to 49, versus 49.8 expected.

This confirms slowing manufacturing.

There were constructive signs. The employment component continued to fall, indicating softer labour markets. Pricing was lower and the supply component indicated backlogs reducing, which will help on the inflation front.

When you pull all this together, we conclude that the economy remains relatively resilient. There are clear pockets of weakness — notably in housing and some manufacturing.

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But four factors indicate we still have a long path to sustainably lower inflation:

  1. Catch-up in service sector spending
  2. Real incomes holding up as a result of wage and employment growth and falling inflation
  3. Excess savings remain in place (roughly US$1 trillion of the peak US$2.2 trillion still in place)
  4. Lower participation rates

What’s changed is that earnings in the next couple of quarters may hold up better than feared — and the Fed is now more likely to hold rates higher for longer, rather than go for a higher, short-term spike.

This reduces some of near-term risk to markets. But it does not open the door to a more sustained rally.

We are likely to remain in something of a holding pattern.

China

Protests appear to have prompted a conciliatory policy response from Beijing.

Chinese vice premier Sun Chunlan avoided references to “dynamic clearing” (ie zero Covid) in a speech and said the virus was in a less dangerous phase.

Some lockdown measures were lifted in Guangzhou and Chongqing.

China is now aiming for vaccination of over-80s by the end of January.

However re-opening will be staggered and slow due to constraints such ICU capacity and desire to keep deaths low.

We may see more signals from the politburo and central economic work conference later this month.

Australia

Headline CPI data headline fell 40bp to 6.9% versus 7.6% expected. The trimmed mean fell 10bp to 5.3% (versus 5.7% expected).

Food prices fell more than 6% as the impact of floods receded. Holiday and travel prices fell 6.4%.

This is a short-term reprieve for the RBA which will help make the case for slowing rate increases.

However the firmness of the economy suggests inflation is unlikely to have been beaten yet.

Markets

Volatility — as measured by the VIX index of market expectations for near-term price changes — has fallen back to its lowest levels for 2022.

Historically, this has been a signal that markets are near a local high point.

This prompts caution. (Though it may also signal lower expectations of a significant policy mistake from the Fed and the market is getting more comfortable with the 2023 outlook.)

Overall, markets remain hostage to the inflation data and the degree the economy will slow.

Bears note that markets historically bottom three-to-six months after a recession has begun — and after rates peak, not before.

The Australian market was broadly flat last week, led by miners. A recovery in growth stocks and small caps indicates risk appetite has picked as bond yields have fallen.


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 an independent, global investment management business focused on delivering superior investment returns for our clients through active management. 

Find out more about Pendal Focus Australian Share Fund  

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