Crispin Murray: What’s driving the ASX 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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MARKETS have started off the year on a weaker note, with the “US exceptionalism” theme seeing an increase in bond yields.

US two-year yields are up 14 basis points (bps) and 10-year yields up 19bps year to date. The move in bonds has been driven by some combination of:

• Signs of inflation basing out and turning higher
• Perceptions that US economic growth is stronger than expected, exemplified in US payroll data
• Building concerns that Trump’s policies will reinforce growth and inflation issues
• Some circumspect comments from the Fed on the rate cycle
• Structural fiscal deficit concerns affecting term premiums

We have also seen an impact on currencies, with the US trade-weighted dollar index up 0.6% year to date.

Equity markets have struggled when US 10-year bond yields move over 4.7%. They are currently 4.8%, which explains the small recent sell-off.

The S&P 500 was down -1.9% last week and -0.9% for the year to date.

Australian equities have held up better, with the S&P/ASX 300 up 0.5% last week and 1.6% year to date.

There is a perception that the US Federal Reserve (the Fed) declared victory over inflation too early, with bond yields up 115bps since the 50bp interest rate cut in September.

There are, however, some self-correcting mechanisms as the rise in yields potentially slows the economy, with some data points indicating this may already be beginning to play out.

Equities have also been affected by strength in the US dollar, which is back to three-year highs on a trade-weighted basis.

This partly reflects the divergence in the economic and rate outlook for the US versus the rest of the world and is reinforced by US funding needs tightening the market for dollars.

The final macro factor to watch is oil, which has risen 3.1% year to date, breaking through technical resistance levels. 

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Potential macro outlook scenarios

We see four broad potential scenarios developing from here, with an aggregate 70% bullish/30% chance bearish conclusion for equity markets:

1. Recession. There is still a cohort of economists that believe the economy is softer than current perceptions and the risk of recession cannot be dismissed (~10% chance).

2. The economy slows, disinflation reasserts, leading to falling bond yields and equity markets continuing to rally (~35% chance).

3. US economic growth continues to hold up better than expected, prompting the Fed to pause rate cuts, meaning bond yields stay higher but equity markets are supported by better earnings (~35% chance).

4. Inflation goes higher, prompting the Fed to shift monetary policy stance to slow the economy. This is negative for equities, as we get higher yields without the higher earnings (~20% chance).

US economic data holding up OK

Recent US employment has been better than expected – see data below:

1. December payrolls added 256k jobs versus 156k expected – the strongest gains since March 2023. The unemployment rate fell from 4.2% to 4.1%. The three-month average is 170k jobs, which is running slightly above the threshold needed to hold unemployment constant. Unlike previous months, private payrolls were stronger than expected at 223k versus 140k expected. Economic bears believe this is overstating labour market strength as it is a catch-up post the hurricane and strike-affected September/October period. Still, the underlying unemployment rate has reversed its recent upward trend and therefore gives the Fed cause to pause.
2. JOLTS (the Job Openings and Labor Turnover Survey) saw an upside surprise in job openings, which still sit above the pre-Covid levels. This was mitigated to an extent by the quits rate falling to new low levels for the cycle, which is a positive signal for wage inflation.
3. Weekly jobless claims have fallen back and most recently came in at 201k versus consensus at 215k.

A stronger ISM Services Index gave the market a jolt.

The December Services Purchasing Managers’ Index (PMI) rose to 54.1 from 52.1, driven by the current business activity component and the price diffusion index. The latter increased to 64.4 from 58.2 – the highest since February 2023 – highlighting that services inflation will potentially prove more resilient.

More positively, December average hourly earnings rose 0.28%, which was in line with consensus and indicates that the likely trend is 3.5% annual wage growth.

US economic outlook

The upshot is that the market is now pricing in 25bps of rate cuts in 2025, with no rate cut in January and a roughly 35% chance in March.

Not until July will we see an implied chance above 50%.

The interesting issue is that by deferring a March cut, it would mean that the Fed would be cutting in May or June at a time when prospective tariff increases would be potentially impacting inflation.

There are several reasons why the Fed retains scope to cut rates in 2025:

• While there is more risk on inflation than three months ago, underlying drivers such as wages are relatively benign as demonstrated by average hourly earnings and the quits rate.
• Trump’s policies may represent a one-off price shock rather than a money supply or demand-driven impulse and are, therefore, not necessarily as negative for inflation – or as large an impediment to Fed easing – as perceived.
• Real rates do remain high and the move in bonds and currencies are tightening financial conditions.

The monetary policy environment is not negative but has shifted to a more neutral factor than was the case last year. This emphasises the need for vigilance on markets given current valuations.

Australian inflation – slightly better data raising hopes for rate cuts

November’s monthly Consumer Price Index (CPI) data was seen as aiding the case for the RBA cutting rates in February, rather than waiting for April or later.

While headline CPI rose to 2.3% from 2.1%, this was as expected, and the composition proved a bit better.

Electricity prices rose more than expected for the month, however, these are being distorted by the government subsidies.

Travel prices fell both for international and domestic travel.

Construction costs (new dwelling purchases – the largest component of the CPI) are falling quicker than expected. This segment was down 0.6% in November, taking annual inflation to 2.8% versus 4.2% in October.

The underlying trimmed mean measure of monthly inflation has improved to 3.2% from 3.5%.

Does this mean rates will be cut sooner? We do not think so.

Given a lower likelihood of US rate cuts, a weaker Australian dollar, uncertainty on services inflation and a healthy labour market, it would be a bold move that could very quickly look a mistake.

This would represent a significant gamble for a newly formed monetary policy board.

Markets

We continue to believe markets are consolidating, rather than starting a more material sell-off – but that is conditional on the above view that growth and inflation remain as expected.

The market consolidation has taken us back from an extreme in sentiment, looking at a variety of criteria such as S&P futures positioning, various bull/bear ratios, and sentiment surveys.

Equity ETF flows remain the biggest support for this market.

These are at an extreme for US equities, with a four-week average of US$9.6bn/week versus a $5.7bn/week average for the year. However, flows into other equity markets are subdued.

S&P 500 market breadth has deteriorated to the lowest level in a year in terms of percentage of stocks above their 200-day moving average. That is a warning sign we need to watch.

Bonds remain a key issue.

There appears to be some disconnection in yields from fundamentals, in that 10-year yields have risen from early December even as the overall economic surprise index has fallen.

This probably highlights the anticipation – or fear – of what Trump will do post-inauguration.

But this may prove overstated. Fiscal policy measures are likely to run into issues in the House and may be diluted. At the same time, tariffs may be designed to avoid giving the Fed a reason not to cut rates, nor to drive the US dollar any higher.

Australian equities

The S&P/ASX 300 has performed better than other equity markets, which reflects optimism that rates may fall sooner than expected, in addition to being helped by thin volumes.

Sentiment on Resources is very low. While iron ore prices have been subdued, copper and oil prices are bouncing off their recent lows and, given positioning is skewed against the sector, there has been better price action. The Resource sector is up 1.6% year to date.

Real Estate Investment Trusts have so far defied the negative lead from offshore, up 2.8% year to date.

Banks were the sector that caught much of the market out last year and have continued to perform well, up 1.8% year to date. Valuation multiples remain at historical highs for the Big Four except ANZ, where the market has been cautious on changes in strategy and management.

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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