Crispin Murray’s weekly Australian equities outlook
Here’s the latest outlook for Australian equities from Pendal’s head of equities Crispin Murray (pictured above). Reported by portfolio specialist Chris Adams.
EQUITIES continue to surge, driven by optimism over the pace of economic recovery.
The rotation away from defensives and growth to deep cyclicals and value continues. This is providing better breadth to the market as previous laggards start to catch up. It also continues to squeeze a market which has been defensively positioned.
Last week the S&P/ASX 300 gained +4.2%.
Economy and policy
The equity market seems to be disregarding earnings on the basis that everyone knows the current period will be woeful, while one year into the future is impossible to predict.
As a result, the delta on economic news flow is driving returns – and this remains better than expected.
Last week’s US payrolls are a case in point. Non-farm payrolls rose by 2.5 million in May – versus a consensus expectation of a 7.5 million fall. Unemployment fell from 14.7% to 13.3% versus a consensus of 19%. There is debate around the numbers and classifications used. However, the underlying signal is that re-hiring is better than expected.
While fiscal stimulus is driving better outcomes, monetary policy also remains very pro-cyclical as we are effectively at the zero bound.
A strong recovery leads to less fear of deflation, which means lower real rates, which helps further stimulus and higher valuations, creating a virtuous circle. This could of course turn vicious if we start to see economic expectations deteriorate – however for the moment the fiscal backstop appears sufficient.
The combination of these two effects is driving equity markets and squeezing the broadly consensus bearish positioning in terms of sector allocation.
Digging into the US job data, leisure and hospitality saw the best results, with an increase of 1.2 million jobs in May. However this was against 8.3 million lost in the previous two months. While the delta is good, this sector is still well below its high-water mark. There were an additional 400,000 jobs in construction, which has recovered almost half the jobs lost to Covid-19.
While unemployment is a lagging indicator, more real-time indicators are also constructive. PMI numbers are stabilising. While still signalling a contraction, the market is focused on the positive trajectory versus recent results.
Elsewhere US auto production estimates for Q3 are almost back to the pre-Covid levels. This has a positive read-through for supply chain inputs such as steel and components. Mobility data and trends such as AirBNB searches are likewise painting a picture of an economy recovering faster than many predicted.
The US FOMC meeting this week will shed light on their rate of asset-buying going forward and how they are seeing the economy. The next US fiscal package is expected to be announced in July at US$1 trillion to US$1.5 trillion – with a focus on helping the re-start rather than income support. This will be a more contentious process and could represent a risk to the market.
There is a view – backed by data on brokerage account openings – that retail money is driving this rally, supported by various government cheques.
We are mindful this market has shrugged off lot of bad news and uncertainty in the form of tensions with China and US civil unrest. ETF flows have been to defensive assets such as bonds and gold – while equity ETFs remain in material outflow since late March. The market is climbing the proverbial wall of worry, which is a constructive factor.
The reflation trade of the past few weeks continues to dominate price action. In equities, we see it in the continued rotation from growth to value, which is broadening the market’s rally. This can continue while the economic data remains supportive.
In other assets it is seen in US 10-year bond yields rising, credit spreads narrowing, a higher copper/gold price ratio and a stronger AUD.
There are a number of near-term issues to be mindful of:
- Valuation: P/E valuations have surged. Many see P/Es as meaningless given uncertainty over earnings and at this point the market does not seem concerned. However, this could change.
- Technicals: The market’s recent momentum has only been equalled 10 times in the last 30 years and suggests we might see some near-term consolidation.
- Put/call ratio: The case for near-term consolidation is supported by a shift in put/call ratios from super-bearish to a more optimistic stance.
The balance of probabilities suggests we might see consolidation – but not necessarily a material fall. But there are two issues that could potentially de-rail the market and need to be watched closely:
- A second wave of infections: The market’s concern here seems to be diminishing – which does leave it vulnerable to any resurgence. In this vein, it is important to understand the improvement in US case numbers is driven by the hardest-hit States of the north-east. Other States are showing flat-to-rising trends, albeit at low levels. Given we are seeing genuine second waves in places like the Middle East – particularly in Iran and Saudi – this needs to be watched.
- US Presidential Elections: Trump has seen support ebb and Biden is now the favourite for November’s election. The odds that Democrats win five seats to take control of the Senate appear even at this point. This raises the possibility of Democrat control of Washington – with policy implications in areas such as tax which could present a risk to equity markets.
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