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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STRONG US payroll data and consumer expectation surveys last week painted a picture of an economy that continues to hold up well.

Bond yields rose in response and equities gave back some of their recent gains.

US two-year government bond yields rose 23bps and saw the largest spike since September. At 4.52%, the two-year yield is 46bp above the January lows and is 21bp off its cycle highs.

This led to rotation away from yield-sensitive technology and REIT stocks.

The S&P 500 fell 1.7% last week and the NASDAQ lost 2.4%. They remain up 6.7% and 12% for the year, respectively.

The sell-down was not broad-based and looks more like a consolidation than start of a sharp reversal.

In Australia we saw a sharper reversal in the short end of the bond curve. Two-year government bond yields were up 41bps, as the RBA pushed a more hawkish line on inflation than expected.

The S&P/ASX 300 fell 1.7% and is up 5.6% for the year.

Trends and potential scenarios

It’s too early in reporting season to identify trends, though domestic stocks appear to be holding up better so far. This year’s rally has been driven by signs of inflation and wages easing without a sharp economic slowdown.

This “soft landing” (or ”narrow path” or ”immaculate disinflation”) scenario is the most bullish of the three broad outcomes.

The market likes the idea of a limited earnings downturn combined with falling rates.

There are two other, more bearish, scenarios:

• Structural inflation: Some combination of limited commodity supply, structural constraints on labour, re-arming of nations, re-shoring of supply chains and de-carbonising power and energy infrastructure all contribute to inflation remaining higher for longer.
• Policy is already too tight: A lagged effect – currently hidden – will prompt a recession in the second half of 2023. 

We are in a better place than we were three months ago, but material risks remain.

We need to regularly gauge the scale and direction of economic data to get a better read on which scenario is playing out. 

US Economics and Policy

Rates

A strong labour market – plus signs of housing pressures easing and improvement in consumer sentiment – contributed to the market adding back in an expected rate hike.

This takes the peak to between 5% and 5.25% and means a pause after the May hike, rather than March.

Revisions to historic CPI (following the annual recalculation of seasonal adjustment factors) show the decline in core services inflation (excluding housing) may not have been as material as originally reported.

This means the three-month seasonally adjusted annual rate over the last three months is 3.5% rather than 2.6%. This helped support a shift higher in expected rates.

Labour markets and the economy

Economic contradictions are evident in a number of areas. Lead indicators such as the Conference Board Leading Economic Index (LEI) suggest forthcoming recession.

Meanwhile jobless claims are at historical lows.

The number of employed people is above pre-Covid levels, while the number of job openings is far higher. This all highlights the strength of the labour market.

The Fed is focused on the labour market becoming more entrenched as the transmission mechanism for inflation.

One possible reason for its ongoing resilience – and that of the economy more broadly – is that the lagged effect of tightening is longer in this instance.

Another is that other factors such as “labour hoarding” are working against the traditional transmission mechanism.

There have been a lot of headlines about job cuts in the US.

Last week Disney announced 7000 job cuts, NewsCorp 1250, Yahoo 1600, Dell 3500, Boeing 2000, Zoom 1300 and Affirm 485. 

However aggregate data indicates overall layoffs are still relatively limited and well below levels consistent with recession.

Job cuts are concentrated in the technology sector, where average employee numbers have risen by 40% in recent years. Jobless claims data suggest people are still able to find roles elsewhere.

All this begs the question whether the recent down-trend in wages will continue.

The US economy remains strong. The latest Atlanta Fed GDPNow signal is well above consensus market forecasts for Q1.

Consumption remains a key driver.

Aggregate excess household savings are running down at a rate of $80-90 billion per month. But with $1.1 trillion remaining it could support the economy for another five to six months.

That said, there are some negative signals on the economy:

• The yield curve hit new lows in terms of inversion last week. History suggests a recession within 12 months of yield curve inversion. 
• Money supply is running at -7.8% year-on-year in January.

The risk of recession remains. But history indicates that once rates peak they reverse relatively quickly.

Whether that happens this time depends on the stickiness of inflation. 

Australia

There was an important shift in the RBA’s stance last week. The messaging became more hawkish, in response to December’s stronger-than-expected inflation data.

 

This led to a step up in short-term rate expectations. Rates are now expected to peak around 4%. 

The RBA has noted that while housing construction and house prices have reacted as expected to higher rates, consumption and investment are holding up more than expected.

The reason why is critical to the path of rates – and whether we see only another 50bps to 75bps of hikes, or if a more sizeable increase is required.

The benign case is that strong consumption reflected a one-off “celebration Christmas” post-Covid and that spending falls away quickly.

As it stands there is no data supporting this theory. However the impending step-up in rates for those with fixed mortgages may quickly change that.

The RBA is indicating it needs to jolt consumers into worrying more about the future. This would help contain consumption and would mean fewer rate increases.

The challenge is the RBA’s policy setting is looser than other central banks.

There are several reasons why this may not be logical:

1. Inflation in Australia is still rising, even in durable goods. There is hope that the latter reverses sharply.
2. Unlike the US, rents here are still rising thanks to immigration. Household formation rose through the pandemic. The RBA will be looking for this to reverse to ease pressure.  
3. We need to hope that Australia’s current terms of trade boost does not translate into more investment spend. So far it has not.
4. We need the government’s support for inflation-linked wage increases for low-paid workers not to flow through into higher income groups.

There is a lot on the line.

In the near term the market gets the benefit of earnings holding up better than feared.

The risk will be if this ends up requiring much tighter policy.

Markets

The US equity market is not giving the same signals we saw in April, August and November last year, which led to more significant corrections.

The Australian market saw weakness in REITs and technology, which had been leading the market in 2023. Thematic rotation continued to play a major role in stock performance, but stock specifics also started to come through as results begin.

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

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