Crispin Murray: what’s driving Australian equities this week
Here’s what’s driving Australian equities this week according to Pendal’s head of equities Crispin Murray (pictured above). Reported by portfolio specialist Chris Adams.
MARKETS were broadly flat last week — the S&P/ASX 300 returned 0.35% and the S&P 500 fell 0.39%.
However we did see material rotation: tech rallied and the high-momentum areas of commodities and crypto fell — in some cases sharply.
A combination of factors were behind this:
- A sense that concerns over inflation were at a crescendo, which was not translating into a significant bond yield spike. This suggests the market is very long on the inflation trade.
- Early signals that the Fed may kick off the debate over tapering a couple of months earlier than expected.
- Comments from Beijing on an excessively rapid rise in commodity prices raised concerns they may act to curb prices. There was also a warning on the surge in Chinese interest in cryptocurrencies. This is a reminder of Beijing’s desire to retain control of its financial system and launch its own digital currency.
So far equities have held up well, consolidating in a range rather than correcting like other risk assets. In our view equities remain well supported by corporate earnings, driven in turn by the strong economic recovery.
Macro and policy outlook
The market latched onto a number of potential signals out of the Fed last week:
- Minutes from the Fed’s recent meeting noted that if the economy continued to make rapid progress towards its goals, it may be appropriate at some point to begin discussing a plan for adjusting the pace of asset purchases.
- Other comments such as a need to be “nimble on policy” reinforced this change in tone regarding tapering.
- Federal Open Market Committee member Richard Clarida maintained a line of current inflation as transitory. But he went on to say the Fed was “attuned and attentive to incoming data” and “monetary policy is as much about risk management as it is about the baseline”.
All this was accompanied by dovish comments regarding timelines. But it may represent an adjustment in the Fed’s tone, signalling a focus on ensuring that inflation expectations remain under control.
So the tapering debate has potentially begun. The real question is ‘will this end the equity rally?’ We remain of the view that it will not.
The reasons for inflation concerns are clear: strong demand, supply-chain bottlenecks and surveys showing companies feel they have cost pressures coming through.
We agree the risk of inflation is higher than it has have been for some time. But it is not a forgone conclusion.
There is an alternative perspective which may yet come to pass. There are a number of arguments supporting the case against widespread inflation, including:
- Supply bottlenecks may quickly be unwound. We are seeing a demand spike with supply still lagging. But there is evidence the supply response is coming, for example in export data from Taiwan and Korea.
- Commodity prices have not been a good lead indicator for broader inflation for the last 25 years.
- Productivity: Wages can go up without a big shift in core inflation if productivity is also rising. We have just seen the US GDP recover to pre-Covid levels with 8 million fewer jobs — an indication that productivity has surged.
- Supply of labour: This is likely to rise, particularly in the US after September as benefits return to pre-Covid levels, alleviating wage pressure.
- Plateauing demand: We may have reached peak levels of demand in a number of key segments. Durable goods, housing and auto sales are at levels that are likely to plateau. This would lead to inflationary pressures easing.
- Debt levels: The US has record debt just shy of 380% of GDP, although it has shifted from households to the government. History suggests high debt levels lead to declining velocity of money. M2 money velocity ratio in the US is sitting at just over 1.1 compared to 1.4 pre-pandemic. US bank results suggest they are still not extending credit — a necessary pre-requisite to see some inflation.
- Household spending: A third of US stimulus payments are paying down debt rather than increasing spending. This is a sign that people are wary of overall debt levels, which may subdue spending.
- Tax: The prospect of tax increases may reinforce caution among consumers.
- Demographics: Populations are aging and older people tend to spend less — so ageing can be deflationary.
- Technology continues to provide opportunities to deliver services and products more efficiently.
There is anecdotal evidence of wage pressures, but so far nothing is showing up in the data.
A lot is made of the rise in the breakeven inflation rates. But the inflation sceptics point out that this is highly correlated to commodity prices. They cite the Cleveland Fed’s long-term expected inflation measure as a better historical indicator of wage pressure and inflation. This has barely risen, suggesting no sign of wage-push inflation.
In conclusion there are many reasons to be wary about building inflation and rising bond yields. This seems to be the consensus view and reflects broad market positioning.
But it is not certain that we are seeing a secular shift in inflation. There are good reasons to argue against betting the farm on an inflationary outcome.
This goes to the issue of managing for different scenarios in our portfolios.
We have exposure to stocks that will benefit from higher inflation. But we also see the need to maintain some hedges on low inflation — notably quality growth names such as Xero.
COVID and vaccine outlook
Here there are two areas of notable risk:
- A continued spread of Covid in emerging markets and countries without access to vaccines
- Effectiveness of vaccines against new variants.
On the first issue we are seeing more positive trends in India as new cases and positivity rates continue to fall. (Although there are still questions about the accuracy of data.)
Overall new case numbers are dropping globally.
One key concern for Australia is that countries with strong track records such as Taiwan and Vietnam are seeing new waves of cases higher than any before. This is leading to lock-downs and dramatic reductions in mobility.
This brings the focus onto vaccine provision.
Global doses are approaching 30 million per day but only about 8% of the global population has been vaccinated.
The US is making more vaccines available (20 million doses by the end of June). The WHO approved the Sinopharm vaccine, allowing it to be exported.
On the issue of efficacy we had positive news this week from the UK. Due to detailed genomic analysis British scientists are now able to assess effectiveness of vaccines against the more infectious Indian B.1.617.2 strain.
In the UK those with two doses of vaccine are showing a high degree of protection against the Indian strain. Those who catch it are not getting as sick.
Health trends in the US remain positive, supporting the re-opening trade. As consumer confidence begins to rise significantly we are seeing clear signs that the next leg of recovery is kicking in.
Travel interest has returned to pre-Covid levels, according to data from travel-related apps. We are yet to see this translate materially in improved airline demand, but we suspect this could shift quickly.
Equity markets held up well last week despite a sell-off in commodities and the cratering of crypto.
Gold continued to rebound, resuming its status as a defensive asset class. Brent crude was off 3.3% on rising expectations of an Iranian deal which would allow more supply into the market.
The Bitcoin sell-off looks like the last domino to fall among the proxies we have been tracking for excess liquidity. Other indicators such as renewable energy ETFs, IPO ETFs and speculative technology stocks have also had significant corrections. This is a healthy sign for markets, suggesting speculative froth has receded.
The Australian market has held up well in face of a sell-off in cyclicals. It has consolidated over the last month, following a 15% move from early November.
The liquidity supporting the market is evident as banks continue to grind higher. We note that Commonwealth Bank is now about 21x next-12-month price/earnings, suggesting people are looking to park cash in safe-haven equities due to low rates.
Carsales.com (CAR, -8.2%) was the worst performer in the ASX100 after announcing a deal to buy 49% of a US online caravan site in the US. There was a degree of market scepticism over this strategy.
Concerns over tapering dragged on cyclicals. BlueScope Steel (BSL, -6.6%), Santos (STO, -5.7%) and Alumina (AWC, -5.3%) were hardest hit.
James Hardie’s (JHX, -2.6%) result was complicated. North American volumes disappointed, although this was offset by better pricing and demand in Europe.
Technology stocks benefited from the rotation.
Appen (APX, +19.4%) was the strongest performer in the ASX100. Management announced an organisational restructure and confirmed its recently downgraded guidance which helped the bounce. It is still down about 70% from its August 2020 peak.
Xero (XRO, +13.1%) bounced back strongly after last week’s reaction to its result. It seems the focus has shifted to potential growth in FY22 and FY23 as the UK pushes more small businesses onto cloud accounting through the “making tax digital” program.
Ampol (ALD, +9.2%) and Viva (VEA, +2.5%) benefited from a long-awaited government fuel security package. This provides scaled support for sector-based refiner margins for six years (and potential for nine years). The government will pay for 50% of capex needed for upgrades to improve fuel standards. This is supportive for the long-term rating of both companies.
Aristocrat (ALL, +8.9%) upgraded earnings ahead of today’s result. Its gaming and digital businesses are going well. The former reflects the US re-opening.
Qantas’s (QAN, +6.5%) quarterly update indicated that cash flow is now positive.
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 , as this graph shows:
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