WE SAW some relief for equity markets last week following a tough period. The S&P 500 gained 6.5%, the NASDAQ added 7.5% and the S&P/ASX 300 put on 1.6%.
There was a notable rotation in performance on the ASX. The year’s bottom-three sectors — information technology, real estate and consumer discretionary — were the best performers for the week, up 7.9%, 6.9% and 5.5% respectively.
Resources — which had been a lone bright spot in the market — fell 5.6%.
US Fed rhetoric continues to emphasise commitment to the fight against inflation. Increasingly, investors are trying to work out what this means for commodity demand. This helps explain market moves over the week.
We also saw this in volatility among commodity markets. Brent crude fell 2.6%, iron ore was down 5.4% and copper lost 6.4%.
Fed sound bites indicate it will raise hard and fast, with seemingly very little prospect for a soft landing.
Several members of the Fed’s Open Market Committee signaled that another 75bps move was very much on the cards next month. Fed governor Christopher Waller noted “the central bank is ‘all in’ on re-establishing price stability”.
Chair Jay Powell noted the Fed was “acutely focused” on returning inflation to 2 per cent and commitment to reining in inflation was “unconditional.” He warned a recession was “certainly a possibility” and it would be “very challenging” to achieve a soft landing.
In this vein, Philadelphia Fed president Patrick Harker noted the US could very well see a couple of quarters of negative growth.
Pendal Focus Australian Share Fund
Now rated at the highest level by Lonsec, Morningstar and Zenith
The rate trajectory is well understood, but the market is still grappling with the possible implications. This is driving much of the volatility in markets.
President Xi noted last week that Beijing would “strengthen macro-policy adjustment and adopt more effective measures to strive to meet the social and economic development targets for 2022 and minimise the impacts of Covid-19”.
China should be a net positive contributor to the global economy in the second half of 2022, compared to the first half. That said, there is skepticism over the strength of the outlook given competing policy constraints.
RBA governor Phil Lowe noted the path of rate hikes currently implied by market pricing was too aggressive and not likely. But here, too, markets remain sceptical and are looking for evidence that the RBA has a handle on inflation.
There is a lot of bearishness priced into current markets. At this point the S&P 500 is sitting at the third-worst, first-half return since 1928 (after 1932 and 1940).
Historically, the worst first halves have resulted in a positive second half — though usually not enough to return a positive full year. It remains to be seen if we follow that historical path this time around.
We are also mindful of bear market bounces.
Selling the rally has been a consensus trade in recent times. For example the ARK Innovation ETF — a proxy for the long-duration growth names — has undergone more than 15 rallies of 10 per cent or more over the past 15 months, but it’s still down some 70% from its highs.
Similarly, the NASDAQ had 19 rallies of more than 10% in the three years of the tech crash from 2000 to 2003.
Nevertheless this market has had a lot thrown at it in a historical context. So, too, in bonds, where the total return of a 10-year US treasury bond over the past year has been among the worst ever — albeit with a strong base effect.
We have also seen a large and sharp drawdown in high-yield bonds in a historical context.
At this point the relative forward P/E of defensives is at a historically extreme premium to cyclicals.
That said, current operating conditions remain fine. When we start to see earnings downgrades come through this may shift the “E” in the cyclical P/E — so they no longer look as cheap versus defensives.
Pessimism is showing up all over the place.
There is a lot of chatter about private equity activity in the current environment.
With this backdrop and in this type of market it can be dangerous to get too bearish on certain stocks and sectors. Private equity has lots of liquidity and public market valuations are relatively cheap.
For example, we have seen a recent bid for Ramsay Health Care (RHC). The infrastructure space has also been very active.
Fund Manager of the Year
Finally, it is worth noting Covid is not going away.
Combined with this season’s flu, Covid is leading to ongoing societal disruption. This is showing up as a real cost to businesses where working from home is not an option — such as supermarkets, hospitals and airlines.
The duration of this impost remains to be seen.
Energy came under pressure last week.
With the Fed talking tough, people are questioning how oil can escape the maelstrom. Energy is a key component of inflation, which needs to be brought under control.
From a fundamental point of view demand remains stubbornly inelastic, while supply constraints remain an issue.
It is also worth remembering the oil price is not particularly extended from a historical point of view. This is all mitigation against the risk of a material fall in the oil price.
We also remember how strangely oil traded during the GFC. It literally peaked 12 months after the market peaked.
Oil, though, is also very macro-driven and is part of a broader trade expressing concern over the pace of US tightening. Thematic trades can prove to go way deeper and last way longer than the fundamentals justify.
All that said, it would probably take a recession to materially affect oil demand and prices enough to start helping tame inflation.
It is also important to note that refined oil product prices locally continue to rise even as crude has fallen, due to high regional refining margins.
This, in turn, could be driven by China which has spare capacity but may be holding it back.
Russian production remains stronger than many expected and is finding a home in China and India.
Sanctions are about to get tighter, but it seems people find ways of working around these impediments. The upshot is that the effect of trying to remove Russian volumes is not contributing as much to the price as some think.
Oil and refining is becoming very political in the US. There is not much the Biden administration can do about refining because the additional capacity doesn’t exist and has a long lead time. Meanwhile utilisation of existing capacity is already very high. If the US government sought to ban exports then regional refining spreads would go higher again.
The rotation back to growth saw Block (SQ2, +21.6%), REA (REA, +19.7%), Xero (XRO, +11.7%) and Next DC (NXT, +10.6%) among last week’s market leaders.
Resources fared worst, led by Whitehaven (WHC, -9.6%), Evolution (EVN, -8.4%) and Santos (STO, -7.3%)
Elsewhere an update from Qantas (QAN, +2.1%) reiterated guidance but flagged some one-off costs, which equates to an upgrade for the underlying operations. Demand remains strong. Capacity has been trimmed to 110% of pre-Covid levels in response to higher fuel costs. Importantly net debt continues to improve, down $500 million since April to $4 billion.
Pendal’s head of equities Crispin Murray 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.
This information has been prepared by Pendal Fund Services Limited (PFSL) ABN 13 161 249 332, AFSL No 431426 and is current as at June 27, 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