Crispin Murray: What’s driving Aussie equities this week

Here are the main factors driving the ASX this week, according to Pendal’s head of equities CRISPIN MURRAY. Reported by portfolio specialist Chris Adams

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THE remarkable recovery in the US market continues; the S&P 500 (up 4.6% last week), has moved from a 9% drawdown to a new all-time high in 11 days – the quickest time in 75 years.

As of Friday night, the NASDAQ finished up for 13 consecutive days – its longest streak since 1992.

We also saw this translate into lower bond yields and a weaker US dollar last week, which is risk friendly.

The revival reflects a combination of:

– The belief that the US administration will find a solution for the Iran conflict and that the tail risks to global growth are diminished. This is reflected in Brent crude falling 5.1% and West Texas Intermediate dropping 13.2% last week.

– A significant position reversal from systematic strategies and the unwind of market hedges.

– Strong earnings for US financials signalling that the economy was holding up and earnings season should be positive.

– Positive signals in the tech sector, with TSMC and ASML noting robust AI-related demand.

Overseas equity markets have lagged the US recovery as they are more exposed to higher energy prices and supply disruption and had less economic growth momentum to act as a buffer.

Australia is more exposed than most, due to the shortage of fuel inventory, the pre-existing inflation pressures and tightening monetary policy, which leads to greater downside risk to corporate earnings. The S&P/ASX 300 was down 0.1% for the week and is up 5.6% month-to-date.

The outlook for the Gulf crisis remains as opaque as ever.

The market is pricing some form of ceasefire, which translates into a messy peace agreement where key issues such as uranium enrichment are subject to ongoing negotiations, but the Strait of Hormuz is opened and Iran can access capital.

The current ceasefire deadline is Wednesday.

US – Iran conflict

The key issue remains whether the Strait will be reopened to shipping, as had been suggested at the outset of the ceasefire – and the view here continues to oscillate.

There is no clear read on what is happening.

Daily transits had picked up from 11th of April, but only from around 4-5% of pre-crisis levels to 8-10%.

The US blockade of Iranian ports has acted as a constraint (affecting ~2 million barrels per day (bpd) of oil), although it has given the Trump Administration additional bargaining leverage.

Things turned positive last Friday, with the Israel-Lebanon ceasefire seemingly enabling the resumption of negotiations and Iran declaring the Strait was open.

However, things turned more negative over the weekend. An Indian-flagged ship – which thought it had approval to pass through the Strait – was fired upon and forced to turn back, which has led to a drop off in transits.

Overnight there have been reports of the US Navy firing on, then seizing, an Iranian cargo ship.

There are two perspectives on the situation:

1) The bearish take is that the Iranian side is fractured and can’t deliver on a coherent agreement.

2) The more positive interpretation is that this is all part of the negotiating process.

Clearly with the S&P 500 back to highs and the S&P/ASX 300 up 7% from its March lows, the market is assuming the left tail risk is diminished and global growth will hold up.

Again, there are two perspectives on the market’s reaction:

1) We see a replay of the Liberation Day rally where, despite the tariff issue playing out for months, the market continued to rally. Then, the market did a far better job than any economist in gauging the underlying economic situation and concluding that earnings were going to hold up well.

2) The negative perspective is that equity investors do not understand how physical commodity markets work. The risk is product shortages will affect supply chains, crimping global growth (with worse effects in Asia and Europe than in the US) and putting upward pressure on inflation which limits the ability for interest rates to fall, leading to earnings disappointment.

Our view is that we must ensure we manage to these different scenarios in our portfolios.

We can see a lot of heavily discounted stocks which provide good leverage to a normalisation of trade, with more limited downside. We are wary of more domestically exposed stocks, given Australia’s fuel supply issues.

There are three broad scenarios which appear possible at this point.

1) No deal, Strait remains blocked, conflict resumes.

This would clearly be very negative for markets, with further supply disruption having increasingly non-linear effects on the world economy as the buffer of oil and other inventories has been run down.

2) Partial re-opening on an extended ceasefire or initial peace agreement.

This is seen as the most likely option given a lack of regime change in Iran and the fact that the issues requiring negotiation and resolution are extensive, including: enriched uranium, ballistic missiles, Iranian proxies, Lebanon, the Gulf Cooperation Council’s (GCC) relationship with Isreal, and access to capital to help rebuild Iran.

Some of these issues have previously been subject to months of negotiation and so are unlikely to be resolved in a matter of days.

This scenario is likely to lead to a step-up in flows of product from the Gulf, but nowhere near back to pre-conflict levels.

It is estimated there are 170-180 million barrels of oil sitting in floating storage inside the Gulf, so there is material product ready to flow out.

This could usually occur in two weeks; however the expectation is that uncertainty will prompt some reticence from ship owners, seafarers, and insurers to transit the Strait, meaning it could take four to six weeks to clear this backlog.

That still would represent 5 million+ bpd, which would go a long way to reducing the physical shortage given the pipelines would still be operating to supplement supply.

But there would be the two to five weeks it takes to get this crude to refineries, which also delays the resolution of physical shortages.

There is also the matter of how much oil production has been “shut-in” (i.e. the wellhead having been temporarily closed), primarily in Kuwait, Iraq and Qatar. It can take weeks to months to restore this production. 

All up, supply disruptions would probably last six months, and oil could trade in the US$80 to US$90 range.

3) Full re-opening of the Strait.

This is the least likely scenario and would likely require a more material leadership change in Iran, or a large shift in the US/GCC bargaining position. If it did transpire, it could see oil fall back below US$80.

Risk to supply through the Bab al-Mandeb Strait

Concerns that the Houthis would shut the Bab al-Mandeb Strait (which connects the Red Sea to the Gulf of Aden and the Indian Ocean) flared a couple of times in the week.

There is no evidence yet of this occurring, but it is another bargaining chip for Iran in the discussions.

It could still happen, but there are several factors which can counter the more bearish views:

1) The Houthi strike capability has been degraded in the last 12 months.

2) Their leadership has seen how Tehran has not been able to support Hezbollah in Lebanon – and will therefore be wary of being left exposed should the US/GCC attack them.

3) A lack of ability to communicate with Iran, which limits coordination and supplies.

4) The Saudis have begun to organise a more coherent internal opposition to them.

5) The Houthis are not as ideologically aligned to Iran as Hezbollah and the Iraqi militias are.

Oil demand

So the outlook for oil prices is tied to the supply issues discussed above, however we also need to consider demand.

The announcement of the Strait’s re-opening drove a big move lower in the financial oil markets – but it also coincided with a fall in “dated Brent” (the price for North Sea crude oil for physical delivery in the next 10-30 days) which dropped $28 to $116.

This price should not be affected by future-looking sentiment. Instead, it reflects the first signs of demand destruction, with European hydroskimming refiners cutting purchases.

These are more basic operations, with higher yields of lower value products (i.e. not diesel or jet fuel) and their margins have been squeezed as they cannot pass on the physical premium in product prices.

This is how commodity markets work, with higher prices choking demand.

It is disproportionately felt by poorer end markets (e.g. some emerging markets) and in lower value products.

Again, this demand destruction may help in the middle scenario described above – but would be materially greater in the case that the Strait remains closed, which could possibly lead to rationing.

Australia

Understanding the impact of the fuel crisis on Australia’s economy is critical for our portfolios.

As a starting point it is important to note that the economy has been strong.

This is evident in last week’s March employment data.

– The 12-month employment growth rate is 1.8% and three-month annualised is 2.6%.

– Full-time jobs growth was strong at 53,000 and year on year is also accelerating to +1.9%. 

– The labour market is clearly tight, with unemployment at 4.3% and the total underutilisation level remaining at 40+ year lows and around 3.5% below the pre-pandemic level.

– Hours worked is growing at a six-month annualised rate at 3.0%. This compares to a 1.8% rise in the population.

– We also note that job losses are at record low levels, despite AI fears.

This means the economy is enjoying good income growth, supporting consumer spending. Australian credit growth was also strong and above trend.

There has also been higher saving in recent quarters which provides a buffer to spending patterns.

All this signals that the economy was running above capacity, driving inflation and rates hikes from the RBA.

But the point is the economy has gone into this shock in a good position.

The headwind from fuel is estimated at about $15-17 billion per quarter in terms of additional spending.

The savings buffer is $7 billion per quarter, so the remainder will eat into other consumption.

However, if wages growth remains solid (likely helped by the upcoming Fair Work Commission ruling) spending should slow but stay positive.

For the overall economy, with population growth of 1.8% we should avoid recession, with GDP rising around 1%.

This scenario is reasonably benign for earnings and equities. Under it we may get rates hiked one-to-two more times and then held stable.

However, there is a more bearish scenario – which is what happens should we need fuel rationing.

Our discussions with companies indicate that this is a scenario they are planning contingencies for, in the possible context that the government chooses to preserve fuel for critical parts of the economy and begins to allocate it by directing rationing amounts.

Barrenjoey estimated the potential impact of this. Assuming 15% rationing over a three-month period, its modelling suggests a 1.5 percentage point drag on GDP, taking the economy negative for a quarter before a big bounce back once fuel is available.

The impact comes mainly from industrial production (0.7-percentage-point impact), then the flow on effect of consumer confidence on spending (0.5-percentage-point impact).

The scenario does highlight this is a short, sharp effect – and also that it could lead to a 50-basis-point (bp) shift down in the interest rate curve, to help lessen the confidence shock.

For equities this would likely lead to a material market decline, although relatively short-lived and very much skewed to domestic focused companies.

Markets

The rally in US equities has been remarkable in a historic context. The 11 days to regain a new high after an at least 8% drawdown is the fastest going back to 1950.

In contrast, it took the market 55 days to regain its high after the 12.3% drawdown in response to Liberation Day last year.

The NASDAQ’s run of 13 consecutive “up” days is its best run going back to 1992.

Flows have been a big driver of the recovery: Goldman Sachs reported it had seen the largest ever five-day buying of global equities by Commodity Trading Advisers (CTAs – professional managers buying and selling futures contracts).

Market macro signals in the US are supportive of the economy, with consumer staples hitting a low relative to the S&P 500.

Copper also pushed back to highs, helped by concerns supply may be disrupted by sulphuric acid and diesel shortages.

Aluminium is close to all-time highs with supply disruption of 2 million tonnes creating a deficit of 2.6% – the highest since 2000.

The Australian dollar is also breaking out to cycle highs versus the US dollar, despite the challenged outlook for the domestic economy.

Australian equities

The ASX was held back last week by underperformance from the banks on the back of a Westpac (WBC) update indicating higher collective provisions, serving as a reminder that if there is an economic slowdown, bank earnings may be perceived to come under some pressure.

Industrials were also down, reflecting domestic growth concerns with downgrades from Qantas and Cleanaway relating to fuel, although those stocks did not underperform materially. Tech had a very strong bounce, triggered more by risk reversal than any shift in perception on AI risks.e month, which suggests returns were impacted by transition flows as more money went to index-trackers.

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About Crispin Murray and the Pendal Focus Australian Share Fund

Crispin Murray is Pendal’s Head of Equities. He 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 a global investment management business focused on delivering superior investment returns for our clients through active management. 

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