GLOBAL equity markets remained relatively quiet last week as northern-hemisphere investors made the most of the last days of summer.
Economic data was largely thought to be supportive of a soft landing and markets responded accordingly.
The Nasdaq gained 3.27% and the S&P 500 lifted 2.55%.
A softer-than-expected US employment report on Friday supported the view that the Fed did not need to hike rates again.
The market is now pricing in a 94% chance that Fed holds rates steady in September and 65% chance of a hold in November.
The consensus view is firmly a soft landing, goldilocks scenario.
Data suggests the US is on track to deliver a very solid quarter of GDP growth, with the Atlanta Fed’s GDPNow measure at 5.6% growth.
The market takes a more nuanced view, however, believing consumer strength won’t be sustained with a wave of headwinds closing in.
Real personal spending growth has continued to run hotter than expected. But headwinds associated with a lower savings rate, resumption of student loan repayments and run-down of pandemic excess savings suggest strong personal consumption growth won’t be sustained into Q4.
This raises concerns that a stronger-than-expected economy may over-ride improving trends in inflation and wages, leading to further uncertainty in rates and the Fed.
This runs counter to the soft-landing scenario now priced into the market (and which recent data supports).
Despite dovish data on Friday, US 10-year bond yields counter-intuitively moved 10bps higher. Some pointed to stronger ISM manufacturing data (and particularly a move up in the price index) as less contractionary.
Though lower market liquidity in a quiet week may have exacerbated the move.
In Australia, July inflation data came in well below expectations at 4.9%, down from 5.4% in June.
Softness was largely driven by more volatile items. Excluding these, inflation picked up in July, mainly driven by higher electricity prices and housing purchase-price inflation.
Meanwhile we wrapped up a volatile reporting season with one in eight stocks moving more than 10 per cent up or down – nearly double the average.
This was despite results that were largely in line with expectations and earnings revisions no bigger than normal.
The S&P/ASX 300 gained 2.6% for the week.
The Reserve Bank is expected to keep rates on hold this Tuesday.
The latest Chinese manufacturing data was mixed. Beijing announced a number of easing measures to support the property sector, consumption and currency. This is a step in the right direction, though more is needed.
The global disinflation story continues.
This is supportive for markets as we come close to the end of the tightening cycle and growth in the world’s largest economies remains largely intact.
At 5.6%, the Atlanta Fed GDPNow – a measure of the growth of the US economy – continues to run well ahead of consensus estimates (which are in the mid-2% range for Q3 GDP).
Who is right? And why the difference?
The Atlanta Fed methodology is model-based and extrapolates the latest economic data for the remainder of a quarter. This compares with human forecasting, which is more likely to mean revert.
The biggest area of differences are:
While GDPNow is a pretty accurate predictive tool, it only has one month of data for the quarter so far.
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This raises a concern that a stronger-than-expected economy may swamp improving trends in inflation and wages.
This could create a dilemma for the Fed, leading to further uncertainty which runs counter to the soft-landing scenario now being priced into the market.
US employment data
August’s employment report had non-farm payroll ahead of expectations at 187k new jobs versus 170k expected, but significant downward revisions (-110k) to the prior two months.
The three-month average is now 150k. This is still above the equilibrium needed to keep pace with labour force growth, but it’s moving in the right direction (and is the lowest since 2021).
The unemployment rate surprised to the upside, rising 30bps to 3.8%. This is now the highest unemployment rate since February 2022.
This reflects higher labour force participation which is now at 62.8% – the highest since February 2020 – as well as a higher number of unemployed.
Average hourly earnings also came in below expectations with the private sector rising 0.2% month-on-month, versus 0.3% expected.
In combination with Tuesday’s JOLTS data, which showed lower job vacancies in June (revised lower) and July, this suggests labour market conditions are continuing to loosen.
This should translate into weaker wage pressure, where we are looking for growth in a range of 3.0-3.5% growth, which is more consistent with inflation at 2%.
The Fed’s preferred read on inflation – Personal Consumption Expenditures – is a measure of the total amount of goods and services purchased by Americans.
The latest data released on Thursday showed core PCE prices rising 0.22% in June, slightly ahead of consensus (0.20%). The annualised three-month rate is 3.3% and is up 4.2% year-on-year.
Core goods inflation declined further (-0.45% month-on-month) – the second negative read in a row.
This should provide some comfort to the Fed, since Chair Jay Powell said sustained progress was “needed” at Jackson Hole.
Disappointingly, core services (excluding rent) rose 0.5%, breaking the downward trend evident since January. More than half of the increase was due to a volatile financial services component.
US consumer spending
Personal income grew 0.2% in July, slightly weaker than expected. There was a deceleration from +0.6% to +0.4% in wages and salaries.
Consumer spending rose 0.8% in July with all categories stronger, driven by strong retail sales (assisted by Amazon’s Prime Day sale) and discretionary services.
The “Barbenheimer” effect of the popular Barbie and Oppenheimer films showed in the data. Recreational services spending (such as movie tickets) were particularly strong at +10.7% for the month.
Stronger spending and higher taxes contributed to a decline in the savings rate to 3.5%.
Restarting student loan payments should cause a significant headwind to consumption in Q4.
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Meanwhile, about 75% of pandemic excess savings have now been spent. The remaining 25% are held by higher income households, which are less likely to spend it.
August US manufacturing data sent a mixed message to the market on Friday.
While remaining in contractionary territory at 47.6 (marginally above consensus at 47) there was a focus on the Institute for Supply Management “prices paid” data.
A surprise jump from 42.6 to 48.4 (versus consensus at 44) raised some concern about how this might roll into core goods inflation, which is now in deflationary territory.
Inflation data for July came in well below expectations, moderating to 4.9% (consensus at 5.2%) from 5.4% in June.
Softness was largely driven volatile items such as fuel, fruit and veg, as well as travel.
Excluding volatile items and travel, inflation picked up in July, mainly driven by higher electricity prices and housing purchase price inflation.
Manufacturing PMI increased to 49.7 in August, the highest reading since March. This was broadly consistent with anecdotal information that the pace of inventory destocking was slowing.
However, non-manufacturing PMI declined to 51, the lowest reading of 2023, as the “reopening boost” from covid faded and construction activity weakened.
We are seeing a drip-feed of policies and support for markets, with concerns around housing, leverage, shadow-banking and capital flight still in focus.
Last week, Beijing delivered a number of easing measures to support the property sector, consumption and currency. It is a positive step in the right direction but more is needed.
Summarising the key announcements:
In an example of how China could restimulate the birth rate, South Korea plans to cut mortgage rates for new parents to 1-3% below loans offered by commercial banks.
August was one of the most volatile Australian earnings seasons in the past 15 years with one in eight stocks moving more than 10% up or down.
This is nearly double the average move and comes despite results being largely in-line with expectations and earnings revisions no larger than normal.
For stocks up more than 10%, 85% of the move was explained by valuation re-rating. For those that moved down more than 10%, 65% of the move was from earnings downgrades.
This possibly implies an overly-bearish outlook going into reporting season.
Cyclical sectors were better than expected, whilst defensives were more likely to disappoint.
Operating margins contracted slightly, resulting in a 2% average hit to EPS.
The bigger impact was increased financing costs, with average interest expense up ~50% year-on-year, which dragged EPS down 6% on average.
Should interest rates stay at current levels, this implies a further 7-14% headwind to EPS in the next couple of years as fixed-rate debt rolls off. The other recurrent theme was upwards revisions to capex budgets, with a median +17% increase in capex for the half and +6% increase in consensus forecast for capex spending over FY24 / 25, largely driven by resources sector. This is driven by cost overruns and inflation rather than growth.
Elise is an investment analyst with Pendal’s Australian equities team. Elise previously worked as an investment analyst for US fund manager Cartica where she covered a variety of emerging market companies.
She has also worked in investment banking and corporate finance at JP Morgan and Ernst & Young.
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