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Crispin Murray: What’s driving the ASX 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.

ASSET markets remain weak due to the US Fed’s hawkish tone, renewed concerns about Europe and China’s Covid lockdown in the south-western city of Chengdu.

Ten-year US government bond yields last week rose 15bps to 3.19%. Commodities were also weaker: iron ore was -9.8%, copper -8% and Brent crude -8.5%.

The S&P/ASX 300 fell 3.1% and the S&P 500 lost 3.2%. The latter has unwound quickly and is now 9% off its August 16 high. It now sits on a key support level, just above 3900.

US employment data was somewhat positive for markets. There is emerging evidence that labour force participation is recovering and wage growth slowing. This may be enough to swing the Fed to a 50bp move on September 21. All eyes will be on the Sep 13 CPI data.

Our domestic reporting season was broadly in line with historical averages in terms of revisions.

FY22 delivered 23% EPS growth, driven by 38% EPS growth in resources. Bank EPS rose 15% as bad debt charges fell and Industrial EPS was up 7%.

Consensus now expects market EPS to grow 3% in FY23. This is essentially unchanged over the past month.

Resources EPS is expected to fall 3%. Industrials are expected to grow 9%. This is down from 11% a month ago, but still looks optimistic, in our view. 

There are two very different paths forward from here:

  • Positive case: The combined effect of diminishing supply chain pressures, slowing labour demand and rising participation allows the Fed to avoid raising rates too far. Falling inflation requires only a moderate economic slowdown.  Risk premiums fall, along with the outlook for rates, enabling markets to recover.
  •  Negative case: Inflation remains embedded too high. Combined with the European power crisis and ongoing lockdowns in China, this forces central banks to raise rates into a global economic slowdown. Such an environment may induce some form of additional financial shock, further exacerbating the downturn and market pessimism. 
Economics and policy

US employment data was firm, but dovish on balance for the rate outlook. This was reflected in US 2-year yields dropping 13bps on Friday.

August payrolls rose 315k, but prior months were revised down 107k.

The 3-month moving average has slowed from 437k to 378k as a result. This is positive, but ultimately it needs to get down to sub-100k to meet the Fed’s objectives.

There were three dovish aspects of the data:

  1. Average hourly earnings growth was stable at 5.2%. This was +0.3% month-on-month (0.1% lower than expected). On a sector-adjusted basis it was also lower than expected.
  2. Labour force participation rose more than expected, up 0.26% to 62.4%. The unemployment rate increased to 3.7% as a result. Greater labour supply is key to slowing wage growth.
  3. Weekly hours were down. This meant aggregate hours for the month were slightly lower, demonstrating the labour market is marginally easing off.

All this raises the odds of a 50bp hike in September rather than 75bp. CPI data will be key in this call.

We remain of the view that Fed chair Jay Powell’s tough talk is aimed at holding inflation expectations down, allowing the Fed to avoid raising rates as far as feared.

Job openings data was more negative — there was no sign that the worker shortage was improving in the latest Job Openings and Labor Turnover survey.

However job ads on Indeed.com are falling and the “quits” rate has begun to decline. This suggests employees are a little less confident on the labour market outlook.

On balance, employment data is better. But it’s a long way from the degree of cooling required to solve the inflation problem. Consider these factors:

  1. The employment gap — measured relative to what is considered sustainable employment —remains near historic peaks. This is consistent with wage growth staying too high.
  2. This is reinforced by a sector breakdown which shows the service sector is still catching up to pre-Covid levels. We will need to see goods and trade sectors employment free up more to offset this.
  3. The ratio of job openings to the number of unemployed remains at a record high. This needs to move materially lower to return to levels consistent with a looser labour market.
  4. Underlying income growth in the economy remains high once you combine employment growth with wages and hours. Nominal income is rising about 7% on three and six-month basis, supporting consumer ability to spend and absorb inflation. This needs to head towards 3-4% to be consistent with the inflation target.
  5. Wage growth remains too high. Just staying where we are is not enough for policy makers. We need to see significant loosening in the labour market.

We also saw the US ISM Manufacturing Survey index at 52.8 — stronger than an expected 51.9. It implies a 1.4% rate of GDP growth.

This suggests the economy is not slowing as precipitously as some believe.

Europe

Moscow suspended natural gas flows into Germany for three days on the premise of maintenance work. Russia then announced an indefinite suspension due to a technical fault, following the G7’s announcement of a price cap on Russian oil.

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This will further curtail manufacturing. ArcelorMittal, for example, announced it would close two plants.

European policy-makers are in a far more difficult position than the US.

Gas and power issues combined with a weaker currency are exacerbating inflation. German two-year bond yields have moved from 0.5% to 1.1% since the middle of August.

Markets

We continue to note the total financial conditions index feedback loop — where too big a rise in equities starts to work counter to the Fed’s goals and leads to a hawkish shift in their messaging.

This emphasises that the Fed will need to see inflation and the economy much softer before it is comfortable with a sustained rise in equities.

The S&P500 is sitting at a key support level at 3900. A fall through it would likely set up a test of the June lows around 3600.

Germany is already testing these previous lows and may provide a lead on other markets.

The more benign view is that we are forming a trading range of 3600-4300 for the S&P 500. The more bearish path would come with earnings declining and the market forming new lows.

In this context and given greater resilience in Australia, we are retaining a more defensive tilt, skewing to larger stocks and those delivering capital return to shareholders.

We are also mindful that the market retains scope for speculative episodes as seen in the IPO of China’s Addentax Group in the US. The Shenzhen-based garment manufacturer rose more than 20-fold on its first day of trading, only to collapse below issue price the following day. This is another reason to remain wary.

Issues in the bond market have relevance for sector performance in equities. On the positive side US bonds look oversold. The one-month move is now in the 91st decile, indicating we have seen the worst of the decline.

But looking forward there are two negatives to note.

The first is that September marks the step up in quantitative tightening for the Fed to $US90 billion per month, which means more available supply of bonds.

Second is the decline in US banking deposits. These rose substantially through the pandemic. But the cost of holding cash is greater today and corporates are using cash to pay down debt.

Should banks funding become tighter there will be fewer surplus deposits to invest into bonds, also acting as an overhang on yields.

Australia

The S&P/ASX 300 got caught up in last week’s global sell-off.

Resources (-7.2%) led the market lower on the back of the new lockdowns in China.

Energy (-4.6%) also declined as the oil price continues to fall despite lower inventory levels. Technology (-3.9%) fell as bond yields continued to rise and the market rotated to defensive sectors such as staples (+1.5%) and healthcare (-0.7%).

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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. 

Find out more about Pendal Focus Australian Share Fund  

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This information has been prepared by Pendal Fund Services Limited (PFSL) ABN 13 161 249 332, AFSL No 431426 and is current as at September 5, 2022. PFSL is the responsible entity and issuer of units in the Pendal Focus Australian Share Fund (Fund) ARSN: 113 232 812. A product disclosure statement (PDS) is available for the Fund and can be obtained by calling 1300 346 821 or visiting www.pendalgroup.com. The Target Market Determination (TMD) for the Fund is available at www.pendalgroup.com/ddo. You should obtain and consider the PDS and the TMD before deciding whether to acquire, continue to hold or dispose of units in the Fund. An investment in the Fund or any of the funds referred to in this web page is subject to investment risk, including possible delays in repayment of withdrawal proceeds and loss of income and principal invested. This information is for general purposes only, should not be considered as a comprehensive statement on any matter and should not be relied upon as such. It has been prepared without taking into account any recipient’s personal objectives, financial situation or needs. Because of this, recipients should, before acting on this information, consider its appropriateness having regard to their individual objectives, financial situation and needs. This information is not to be regarded as a securities recommendation. The information may contain material provided by third parties, is given in good faith and has been derived from sources believed to be accurate as at its issue date. While such material is published with necessary permission, and while all reasonable care has been taken to ensure that the information is complete and correct, to the maximum extent permitted by law neither PFSL nor any company in the Pendal group accepts any responsibility or liability for the accuracy or completeness of this information. Performance figures are calculated in accordance with the Financial Services Council (FSC) standards. Performance data (post-fee) assumes reinvestment of distributions and is calculated using exit prices, net of management costs. Performance data (pre-fee) is calculated by adding back management costs to the post-fee performance. Past performance is not a reliable indicator of future performance. Any projections are predictive only and should not be relied upon when making an investment decision or recommendation. Whilst we have used every effort to ensure that the assumptions on which the projections are based are reasonable, the projections may be based on incorrect assumptions or may not take into account known or unknown risks and uncertainties. The actual results may differ materially from these projections. For more information, please call Customer Relations on 1300 346 821 8am to 6pm (Sydney time) or visit our website www.pendalgroup.com

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