THE sharp equity market rally last week was fuelled by very bearish positioning and ignited by weak job opening and manufacturing data. There were also hopes that emerging financial strain would prompt a Fed pivot.
But the “good is bad” phase proved short-lived. Solid US employment data emphasised a tight labour market, while OPEC+ quota cuts sent the price of oil higher.
The S&P 500 ended the week up 1.56% and sitting at a key technical support level of 3500-3600.
There is scope for the bear market bounce to continue back to the next technical level of 3900-4000, but data trends are not supportive.
The US economy remains resilient with insufficient signs of weakness. Meanwhile inflation remains stubbornly high – with the additional risk that fuel prices are rising again.
The S&P/ASX 300 was up 4.5% last week and continues to outperform. It’s down 6% for 2022, while the S&P 500 has lost 22.7%.
This is due to currency moves, the index sector mix and a defiant RBA.
Our central bank raised rates only 25bps. It’s crossing fingers and toes that the rest of the world fixes the inflation problem and it won’t have to induce a recession here.
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US job openings were a lot weaker than expected, which is good for markets. The ratio of openings to unemployed remains very high, but the quarterly downward trend is encouraging.
There was also a fall in job “quits” which is a signal people see less opportunity to move.
Job layoffs remain low, which is also constructive. The best scenario is one where the job market loosens via less hiring (ie less labour demand) but layoffs remain limited (ie more supply). A big increase in layoffs is more likely to trigger a recession.
The US is now 50% of the way to reducing the gap between jobs and workers to a level where wages should slow sufficiently, according to a Goldman Sachs indicator.
Wage growth appears to be running over 5% annualised on most measures and needs to drop below 4%.
However the relief on this data was short-lived. Payroll and employment data reinforced the tight labour market.
This is the Fed’s key policy problem, since they risk recession in bringing this down.
There is much focus on the lessons of the 1970s, where the Fed heeded political pressure and loosened too soon. This meant it had to go through three phases of tightening to finally solve the problem.
US payroll data was in line with expectations (+263k jobs). The household survey was a bit stronger than consensus, with the unemployment rate falling to 3.5% due to a 0.1% drop in the participation rate.
The market did not like this because:
Payrolls need to get down to 50-75k per month to be at a level where wages may slow to the target level.
The household survey of wage growth among production and non-supervisory workers is seen as a better proxy of underlying wage growth. It was stable month-on-month, landing at 5.8% year-on-year. This is consistent with inflation running between 4 and 4.5%.
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Mixed signs on the state of the economy are another challenge for markets.
The bears can point to measures such as housing and trucking as signs the economy is slowing sharply. But consumers continue to hold up – as do hiring intentions.
One of the signals from the employment report is that nominal incomes continue to grow – and in fact are picking up in real terms as inflation slows. This makes the Fed’s job harder.
Underlying resilience in the US economy is also evident in a pick-up in the Atlanta Fed GDP Now tracker. It’s re-accelerated in the last couple of weeks, driven by net exports and the consumer.
The Cleveland Fed inflation tracker is another real-time indicator not helping the case for a pivot. It continues to indicate inflation running at 0.4-0.5% month-on-month.
We will see the CPI print released on Wednesday. This will be a key determinate of market direction.
OPEC+ surprised the market with a bigger-than-expected quota cut of 2 million barrels per day.
It is worth bearing in mind that many members are already producing below their quotas. By a rough estimate the real production impact would be about half of that announced. The market is expect 0.8 to 1.2m barrels to be taken out of the market.
There will be another meeting in early December to review the impact, so this will be in place for at least two more months.
This was not designed as a direct attack on the US, despite the latter’s reaction.
Instead, OPEC is concerned about the impact of recession on demand – and also that the oil price appears to have disconnected from fundamentals.
When you compare the oil price to inventory levels there is probably a US$20 gap.
OPEC also believes the inability to reach production quotas shows a lot of countries are not investing in capacity – which will make the oil supply-and-demand balance more precarious in the future.
This requires higher prices to incentivise investment. In response to rhetoric from the US, OPEC is also pointing to factors such as levies, carbon taxes and fuel standards as reasons why petrol prices are so high in the west. These, they say, are in the hands of western governments to resolve – if they want to.
There is now upside risk to the oil price because:
1. Chinese refinery production is ramping up (counter to OPEC’s concern over recession)
2. Another round of sanctions on Russian oil will start in the next few months, creating more friction in oil markets
3. SPR releases will slow from 1m barrels per day to about 500k through to the year’s end.
In combination, these could have an impact of 1.5m to 2m barrels a day on oil supply-and-demand balance, more than offsetting any slowdown.
The Reserve Bank got global attention last week as people thought the lower-than-expected 25bp hike might signal the beginning of a small pivot from central banks.
We find it hard to draw any broader global conclusions from the RBA’s move.
It could be slowing rate rises to gather more information and gauge the effect of tightening to avoid a policy mistake and recession. The likely rationale includes the notions that:
1. Australian wages have not risen as quickly as other nations, so the RBA has less to do at the moment in loosening the labour market
2. Australia has more short-rate sensitivity due to floating-rate mortgages
3. The RBA has more meetings than the Fed, so they will get the opportunity to re-appraise in early November with more data.
4. They are probably anticipating a reasonably tight federal budget, ie no fiscal stimulus, unlike the UK
5. They will be expecting the tightening in the ROW to help contain inflationary pressures
Also, the RBA has already tightened more than other regions in Europe and Canada, though not as much as the US.
There is some risk to the RBA stance.
While wages growth is slower than the US, surveys indicate it is still rising, unlike the US.
Should this continue – and the Australian dollar weakens – we could see inflationary pressures build, forcing the RBA to go harder again.
For now the ASX can take comfort from the more benign approach from the RBA, with strength across all sectors and resources and domestic cyclicals running. Consumer staples was the laggard.
The trifecta of higher bond yields, oil prices and the USD is a challenge for equities.
Friday’s sell-off leaves the US market in a finely balanced position in the near term.
The bounce earlier in the week had all the hallmarks of the start of at least a bear market rally, with some extremes in terms of buying / selling ratios.
On average, these rallies are 15% over 32 days, so the 6% in 4 days looked like it should have had legs.
Wednesday’s CPI print is likely to have a large bearing on whether the S&P 500 gets back to 3900 in the near term.
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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