Anthony Moran: what’s driving Aussie equities this week?

Here are the main factors driving the ASX this week according to Pendal investment analyst ANTHONY MORAN. Reported by portfolio specialist Chris Adams

• The small-cap Russell 2000 gained 3.47% while the NASDAQ fell
• Microsoft, Meta, Apple and Amazon all report this week
• We remain constructive on the medium-term market outlook
• Find out about Pendal Focus Australian Share fund

A CONTINING reversal in global asset markets was the main story last week as hedge fund “de-grossing” of equity exposure led to a broader risk reduction among investors.

This prompted underperformance among large caps and ongoing sector rotations.

The S&P 500 fell 0.82% and the S&P/ASX 300 was down 0.65%. The NASDAQ retreated 2.08%, while the small-cap Russell 2000 gained 3.47%.

Limited economic data tended to maintain support for the soft-landing thesis.

It was a busy week for offshore quarterly results, which reinforced the sell-off in Mag7 stocks and reflected an overall challenging top-line environment for many industries.

We remain constructive on the medium-term market outlook given resilient economic growth and easing inflationary pressures.

But the reversal in market momentum may persist given the stretched positioning and the low likelihood of a positive circuit breaker, with a rate cut from the US Federal Reserve not expected until September.

Market reversal and rotation continues into its second week

Market action was dominated by continued de-grossing and the reversal of previously winning crowded trades originally triggered by June’s softer inflation print.

The Mag7 have had an outsized impact on these trends, with Alphabet down 6% and Tesla down 8% for the week.

The rotation into small caps continued in the US but not in Australia, where weakness in commodities has had an influence.

The sell-off appears to be entering a self-fulfilling phase, with investor sentiment becoming much less bullish and VIX (an index of equity market volatility) picking up.

What was initially a rapid resetting of positions by hedge funds has led to a broader number of investors reducing their risk in response to the pullback.

This has also spread beyond equity markets with reversals seen elsewhere, including the JPY/USD cross, metals and commodities, and even gold.

The pullback and rotation may persist, given that a Fed rate cut is unlikely in August (giving us two months until the policy catalyst of a September cut) and quarterly earnings results seem to be reinforcing some of the dynamics – in particular, Mag7 disappointment.

In addition, positioning still has room to unwind and liquidity conditions are tougher. We note:

• commodity trading adviser (CTA) accounts – which are systematic strategies – still have a very long positioning in equities
• equity markets have pulled back but are still a long way from oversold
• the VIX has increased but remains well below the level of recent selloffs. The second half of calendar years have historically had more volatility and greater drawdown risk.

Given the likelihood that current trends persist, we have slightly reduced our exposures to some of our year-to-date winners.

However, this episode is also offering an opportunity to lighten up in companies where stock-specific fundamentals are deteriorating but are benefiting from the macro-driven rotation.

US macro: a soft landing with some downside risk

June’s US Personal Consumption Expenditures (PCE) Deflator was the week’s most important data point, given its role as an input for the Fed’s decision making.

The PCE deflator was up 0.2% month-on-month, which was in line with consensus. This saw the three-month annualised rate at 2.3% and the year-on-year rate at 2.6%. It further de-risks the prospect of a rate cut in September and also triggered a US share market rally on Friday.

The in-line PCE deflator offset a hotter Core PCE release (up 2.9% versus the 2.0% expected) from earlier in the week, which was released along with better-than-expected US Q2 GDP figures (up 2.8% versus the 2.0% expected).

The GDP data supported the view that the US economy remains resilient overall, which is constructive for the market.

Key drivers of the GDP beat were government spending (up 3.6%) and a build in inventories.

Non-residential fixed investment was also a little stronger, driven by an 11.6% rise in spending on equipment. Weakness in durable goods orders and capex intentions surveys suggests this boost is unlikely to be sustained.

Elsewhere, we saw weaker-than-expected new and existing home sales.

The University of Michigan consumer sentiment survey was in line with expectations but also the weakest reading since November 23.

Durable goods orders and the Richmond Fed manufacturing index were also weak, which comes at a time when investment in new factories in the US is at a record high in response to onshoring.

The upshot is that a slowing, but not concerning economic outlook and easing inflation provides support for rate cuts without requiring a material cut to earnings expectations.

When looking beyond the short-term momentum reversal, this should be supportive to equity markets.

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US quarterly reporting: exacerbating negative momentum for market leaders

As we reach one third of the way through US reporting season, earnings have so far beat expectations by 4% in aggregate, driven by margin.

Mag7 share price weakness was boosted by disappointing results.Tesla was down heavily after missing earnings due to price cuts hurting margins.

Alphabetalso sold off despite beating on earnings, as the market decided it was time to start questioning the return on investment on AI spending. Alphabet’s top-line growth in YouTube and Google is slowing sequentially but its capex is up dramatically (up 91% year-over-year).

Microsoft, Meta, Apple and Amazon all report this week.

Staples are showing that the reversal of post-Covid price increases is playing out as hoped, with Unilever and Nestle showing slowing prices but volume growth accelerating in Q224 (after a year of volume declines).

This is supportive of deflationary dynamics globally, taking pressure off the consumer, and is relevant for stocks like Brambles, Amcor, and Orora in our market.

We are also seeing the trade-off of lower prices for higher volume play out in other sectors, including automakers, packaging and homebuilders.

Consumer-exposed stocks are generally seeing softer demand, but in many cases at a slower rate than in Q1. Luxury stocks (e.g. Kering, LVMH) were sold off as a China recovery failed to materialise and the global recovery in luxury spending was pushed out.

Visa also highlighted some weakness in lower income cohorts.

This all suggests that stocks that are more positioned for volume growth, rather than price/revenue, are likely to be relative outperformers.

Any stock that has benefitted quite a lot from higher prices over the past few years probably has margin risk because the slower consumer environment makes it hard to hold price.

Commodities

Slowing macro conditions and no real positive news for China from the Plenum saw another week of declines for commodities, which dragged on the Australian market.

With the Chinese property market continuing to weaken despite policy measures, dragging consumer sentiment and consumption down, the market was hoping for some material policy moves from the Plenum.

These did not eventuate, barring a tiny cut in interest rates, and saw commodity prices continue to slide during the week.

A weak property sector, a soft consumer and declining infrastructure spend means Beijing is increasingly relying on exports and “green” investment to drive economic growth.

This is driving deflation in many global categories, including steel, solar cells, batteries and EVs.

Resources have generally been poor performers this month, but the lack of a catalyst for change in China demand leaves them with poor fundamentals.

The sector may see short-term rallies if the sector/commodity is oversold, but it seems there is a low likelihood of sustained outperformance.

This is arguably a positive for the banks as a “last man standing” among the ASX big-cap sectors.

Commodities

Few sectors were spared declines last week.

Energy (down 5.57%) did the worst after Woodside’s (WDS) poorly received acquisition.

Defensives such as Healthcare (up 0.08%) and Financials (up 0.32%) were the only places to hide.

In contrast to the US, Australian small caps continued to underperform large caps.

At a stock level, the largest underperformers tended to be resources stocks given declining commodity prices and some poor quarterlies, as well as weakness in growth year-to-date winners including Goodman (GMG), Block (SQ2) and NextDC (NXT).

Financials had a good week outside of the big four banks, as did a range of defensives.

About Anthony Moran

Anthony Moran is an analyst with over 15 years of experience covering a range of Australian and international sectors. His sector coverage has included Australian Industrials and Energy, Building Materials, Capital Goods, Engineering & Construction, Transport, Telcos, REITs, Utilities and Infrastructure.

He has previously worked as an equity analyst for AllianceBernstein and Macquarie Group, spending a further two years as a management consultant at Port Jackson Partners and two years as an institutional research sales executive with Deutsche Bank.

Anthony is a CFA Charterholder and holds bachelor’s degrees in Commerce and Law from the University of Sydney.

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