THE biggest down day for the S&P 500 since May set the mood last week, triggered in part by credit rating agency Fitch downgrading the US to AA+.
Stronger-than-expected employment data, higher upcoming US debt issuance and further gains in Japanese yields added fuel to the flames.
Treasuries and equities sold off, with stock-bond correlation the highest it’s been since the 1990s.
The US 10-year yield rose 8bps and the yield curve steepened. The S&P 500 ended the week down 2.26% despite 79% of companies beating consensus estimates in the first week of reporting season.
In Australia, the RBA held rates steady. This surprised most economists but was largely in line with the market, which was pricing in a 30 per cent chance of a hike.
In contrast, the Bank of England raised rates another 25bps to 5.25% and signalled rates were likely to stay higher for longer.
Australia equities fell (S&P/ASX 300 -1.17%), but less than most overseas markets.
Overall, data for the week was generally consistent with slowing inflation, despite continued earnings and jobs strength.
Central banks remain concerned around the stickiness of services inflation, but expectations for further hikes continue to fall.
Arguably, the key debate around central banks is how long rates stay elevated.
Oil is also worth watching. Brent crude is now up 15% and West Texas Intermediate (WTI) is ahead 17% for the quarter to date.
This is driven by a record drop in US stockpiles and a decision by Saudi Arabia and Russia to extend production cuts.
Gasoline is the sixth-biggest component of US CPI.
The data last week was generally consistent with slowing inflation and a soft landing. Two Fed members pointed to the labour market coming into better balance.
Despite uncertainty about a potential lagged impact of rate hikes and whether a recession can be avoided, expectations for further hikes continue to come down.
The market is pricing the probability of another Fed hike by November at just 18%, versus 32% in Australia.
Still, at least one Fed member still sees the need for further hikes. Governor Michelle Bowman said “additional rate increases will likely be needed to get inflation on a path down to the FOMC’s 2% target”.
Labour market data remains solid.
Non-farm payrolls came in at 187k new jobs, versus 200k expected, and the prior two months were revised down 49k.
Employment data has shown increasing signs of cooling this year, though 200k jobs per month is still strong by historical standards.
On the other hand, wages rose more than expected with average earnings +4.4% year-on-year versus 4.2% expected.
Along with a low unemployment rate (3.5% vs 3.6% expected), this suggests the labour market remains tight and inconsistent with a 2% inflation target.
We will get two more inflation prints (the first this Thursday) before the next Fed meeting in September.
Pendal Horizon Fund
A concentrated Aussie equities portfolio aligned with the transition to a sustainable, future economy
Consensus is forecasting headline CPI at 3.3% versus 3% prior. Excluding food and energy, the forecast is 4.8%, unchanged from prior.
Assuming no surprise — and the CPI prints confirm the June trend, hike expectations likely remain low.
Soft landing odds rising, bears capitulating
The bears have continued to capitulate, with Bank of America the first of the major US banks to officially reverse its recession call.
Bears now forecast US GDP growth of 0.7% in 2024 — 0.7 percentage points higher than was previously assumed.
However, inflation expectations have been revised to 2.8% in 2024 (+0.4 points) and 2.2% in 2025 (+0.1 points).
Unemployment is seen peaking at 4.3% in Q1 2025 versus the prior expectation of a peak at 4.7% in Q4 2024.
Soft landings are uncommon, with only three in the eleven recessions since World War II.
Concern remains over the lagged impact of rate hikes. While the US yield curve has steepened materially (and Australia is now back in positive territory), it has now been inverted for 13 months.
Ultimately, interest rates are coming down — the important factor will be why.
If it’s in response to a recession, the precedent for equities is not positive based on historical patterns.
Some 422 S&P 500 companies had reported Q2 earnings by the end of last week — with 79% beating analyst expectations.
This is more a function of low expectations rather than stellar corporate performance.
Based on Goldman Sachs data:
A few noteworthy results:
The BoE hiked 25bps, as expected.
Rates are now seen as “restrictive” — though not necessarily “sufficiently restrictive” with markets pricing in another 50bps before the year’s end.
Doing less than that would likely require a big negative surprise in wages, employment and services inflation.
Commentary was perceived as more realistic on inflation than past optimism.
The statement and the press conference both sent a strong signal that the monetary policy committee had a preference for rate smoothing, ie maintaining higher rates for longer rather than pushing for higher peaks.
In Europe, the ECB reported that underlying inflation had probably peaked.
Recent easing has been driven by non-energy industrial goods, while a decline in services also appears to have started.
Incremental policy announcements continue in the wake of the recent Politburo meeting.
There is still scarce detail, but three announcements caught our eye:
Beijing has stopped short of providing major monetary or fiscal stimulus and uncertainty remains whether the measures will be enough.
The challenge was highlighted again last week with data showing continued weakness in manufacturing and property sectors.
Still, the Politburo has acknowledged the problem and Chinese stocks were the best performers last week.
The RBA held rates at 4.1%, in-line with market expectations but contrary to most economists who had forecast a 25bp hike.
The commentary was on the dovish side, omitting a previous statement that “the path to deliver 2-3% target while the economy still grows is a narrow one”.
However growth expectations moderated.
GDP is now seen at a trough of 0.9% this year, down from 1.2% previously. GDP is expected to be 1.6% in 2024.
CPI is forecast to decline to around 3.25% at the end of 2024, returning to the 2-3% target in late 2025, suggesting interest rates may remain elevated for longer.
Further easing in goods inflation is expected to drive the decline.
Key risks include services inflation, which remains strong amid rising labour costs. Rent inflation has also increased.
Energy prices are forecast to add significantly to inflationary pressures in coming years with electricity prices forecast to add 0.25% to headline inflation in FY24.
The RBA continues to see a “high degree of uncertainty around the speed and extent of the decline in inflation expected in the period ahead”.
Four key domestic uncertainties were detailed:
Consensus is pricing one more hike, then a steep drop-off in rates in 2024.
Nearly all sectors ended in the red last week, led by utilities, real estate and financials.
This echoed similar moves in the US. Energy and consumer discretionary were the best sectors.
Energy was comfortably the strongest so far this quarter in Australia and the US on the oil price rebound.
Jack is an investment analyst with Pendal’s Australian equities team. He has more than 14 years of industry experience across European, Canadian and Australian markets.
Prior to joining Pendal, Jack worked at Bank of America Merrill Lynch where he co-led the firm’s research coverage of Australian mining companies.
Pendal’s Focus Australian Share Fund has an 18-year track record across varying market conditions. It features our highest conviction ideas and drives alpha from stock insight over style or thematic exposures.
The fund is led by Pendal’s head of equities, Crispin Murray. Crispin has more than 27 years of investment experience and leads one of the largest equities teams in Australia.
Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management.
In 2023, Pendal became part of Perpetual Limited (ASX:PPT), bringing together two of Australia’s most respected active asset management brands.
This information has been prepared by Pendal Fund Services Limited (PFSL) ABN 13 161 249 332, AFSL No 431426 and is current at Auust 8, 2023. 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