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:
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:
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:
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.
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.
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.
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%).
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.
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