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.
GLOBAL equities have struggled to push higher recently under the weight of several factors.
US inflation data was again stronger than expected last week, while concern lingered over the impact of the contagious Delta Covid variant.
Global equities dropped — the S&P 500 gave up 0.96% — but the Australian market bucked the trend, rising 1.05%. Merger and acquisition activity and a stronger resource sector continued to lend support.
Markets are in something of a holding pattern while investors look for visibility on a number of unresolved issues.
- Economic growth: How much is it slowing? To what extent is this about temporary supply-related issues? Or is it a signal that pent-up demand is less than expected?
- Inflation: How transitory will this be?
- Covid: To what extent will Delta or other variants affect the recovery and re-opening of economies?
- Central bank policy: How quickly will they need to reduce balance sheet expansion and begin to raise rates?
- Fiscal policy: Do we see more stimulus coming through in the form of infrastructure and other social investment programs?
- China: To what extent is the economy slowing and how material a shift in policy will we see?
- Corporate earnings: How much leverage to re-opening, the impact of rising cost pressures and the ability to raise prices?
These issues are inter-related. Some such as inflation and fiscal policy may take a long time to become clear.
However we should get a good read on most factors through this quarter. This will play into how bonds and the US dollar perform, which will in turn affect the performance of commodities, as well as cyclicals and defensives in the equity market.
We expect markets to consolidate in the near term. Domestic cyclicals are likely to struggle. But we expect concerns around most of the factors above to ease, potentially creating opportunities.
COVID and vaccines
South East Asian countries with low vaccination rates are reporting a surge in new Covid cases. Malaysia, Thailand and Indonesia are running at their highest daily case numbers so far.
But we are also seeing surges in countries such as the UK and the Netherlands, where vaccination rates are high. Rising cases in France, the US and Israel have prompted a return to restrictions.
In Malta 80% of the population is fully vaccinated and a further 5% have had a single dose — yet it is seeing a sharp rise in new cases. There are still questions to be answered — is the spread primarily among the unvaccinated for example? But places like Malta will be important in understanding whether the new wave of Covid will lead to a more restricted re-opening.
The UK remains something of a bellwether. New daily cases are running within 15% of the highs of the previous wave, but hospitalisations are 80% lower.
This suggests vaccines are helping prevent people from getting very sick. But it’s not yet clear if new cases are predominantly unvaccinated people or “breakthrough infections” among those who are vaccinated.
We can also gain insight from the US. There is a clear link between rates of vaccination and infections by county. Counties with vaccination rates of 50-59% have half the infection rate of counties with less than 30% vaccination.
The US is also publishing reassuring data on breakthrough infections and hospitalisations. So far this year vaccinated patients account for only 0.4% of Covid-related hospital admissions. That is running at about 1% more recently, which reflects the Delta strain. Some 75% of recent admissions have been people over 65.
We can make a couple of observations about Australia in light of this.
First, it is difficult to envisage us remaining Covid-free even with high vaccination rates, without keeping international borders shut. This necessitates some shift in policy approach, which will be more complex than first thought. This will be an important factor in elections.
Second, it highlights the difficulty in achieving eradication in NSW. Even if you get cases very low, the latest Victorian wave shows how quickly the variant can spread.
Policy makers will need to decide whether to extend restrictions to contain case numbers until we reach warmer months when the vaccine program can be accelerated. This could take us through to October or November.
If so, we would expect significant offsetting stimulus. Nevertheless it would weigh on the domestic economy and have a negative impact on more cyclical stocks. Given the lack of visibility, we are wary of re-loading on this part of the market despite recent weakness.
Economics and policy
There are some real-time indicators. The Atlanta Fed’s GDPNow estimate suggests economic growth has fallen below market consensus levels for the first time this year, while still remaining strong in absolute levels. This is why bonds have rallied and cyclicals have fallen.
We believe much of this reflects supply bottlenecks in certain areas which — alongside labour constraints — is preventing some businesses from operating or producing as much as they would like. We still expect the effects of pent-up demand, excess savings, low inventories and high wealth effect to help fuel an on-going strong recovery.
That said, the risks to this scenario are rising.
US inflation data surprised to the upside for the third month in a row. Material elements of this – such as used car and holiday accommodation prices – reflect some supply disruptions and a bounce back from last year’s deflation.
But there is also evidence of increases among some longer duration inflation factors. For example there is a pick-up in rents with the ending of restrictions on evicting non-paying tenants. These factors could persist even as more transitory effects roll off.
This is why we believe it is too early to make the call on inflation being temporary — despite the bond market suggesting it is.
Markets remain in something of a lull due to the Northern hemisphere summer.
Last week we did see the start of what could be a correction in global equities, with higher beta growth names underperforming.
The current equity market rebound differs from other post-crisis environments – particularly the post-GFC experience — since we haven’t had any real correction so far.
This is likely due to the degree of liquidity added by central banks. It would be entirely plausible to see a correction given current uncertainty. However the US earnings season which has just kicked off promises to be quite strong, potentially providing support.
Brent Crude fell 2.6% as the OPEC deal came through, even though this assuaged the previous week’s concerns over OPEC breaking down. We expect the oil market to remain tight. Extra OPEC supply is necessary to prevent a dislocation in the market.
The Australian market played catch-up from previous week, although the gain came almost entirely from resource stocks, while tech and banks sold off. The effects of lockdowns hasn’t really hit sentiment yet. But late last week we began to see domestic cyclicals lag the market.
Infrastructure M&A dominated newsflow for the second week in a row. This time it was Spark Infrastructure (SKI, +17.4%) receiving a bid. The 20% premium offered by Ontario Teachers and private equity firm KKR was less than that offered for Sydney Airport. SKI owns only minority stakes in assets and is more heavily regulated.
Sydney Airport (SYD) gained 2.1% last week. While the board rejected the bid and struck a negative tone to selling, there were also some signals that an offer over $9 might be considered. This is steep, but the bidders have deep pockets and a very long duration timeframe in assessing return. They may well move, although the market is not convinced.
Mining and steel stocks generally outperformed on the combination of Beijing’s policy shift, some better data out of China and the prospect of large capital returns in upcoming results. Fortescue (FMG) was up 8% and BlueScope Steel (BSL, +7.48%).
Rio Tinto’s (RIO, +2.23%) quarterly report was disappointing on the production front and highlights on-going supply issues facing many metals. Nevertheless, strong iron ore prices are likely to underpin a very strong result.
Gold stocks were generally better as the gold price recovers. Northern Star (NST) gained 6.24%. Evolution (EVN, +2.63%) lagged as its quarterly highlighted near-term lower production and higher capex as they scale up the plans for their Red Lake asset.
Tech stocks were weaker, led by Afterpay (APT, -12.17%). We saw further evidence of increasing competition in the buy-now-pay-later space as Paypal entered the Australian market with a product that had no late fees.
This comes as no surprise. Rumours that Apple will enter the BNPL space with an extension of Apple Pay is potentially a much bigger threat to the sector.
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