Elise McKay: What’s driving ASX stocks this week

Here are the main factors driving the ASX this week according to Aussie equities analyst and PM ELISE MCKAY. Reported by portfolio specialist Chris Adams

• Nvidia delivers blow-out 1Q result
• Pendal Australian equities portfolios positioned to benefit
• Find out about Pendal Focus Australian Share fund

THE global economy appears to have left last decade’s monetary policy era well behind and embraced a far more exciting fiscal policy era.

Kicked off by Covid spending, and quickly bolstered by the energy transition and defence focus, we now see further momentum in a sovereign artificial intelligence race and the generative AI build-out.

This was highlighted by last week’s blow-out Nvidia first-quarter result.

The stock gained 15% over the week, suggesting that investors continue to underestimate the speed, scale and scope of the AI revolution.

Nvidia is perhaps more than just another stock. At present it appears to be a key driver of markets – touching almost every aspect of the global economy.

Its influence is felt everywhere – from the geopolitical need for sovereign AI and the productivity and capex boom affecting economic growth, to increased demand for commodities to help power data centres, and the wealth effect of rising stock markets, which helps consumption.

Our portfolios are positioned to benefit.

In the large-cap portfolios, we have NextDC (NXT) and Goodman Group (GMG), which benefit from increased demand for data centres.

In our midcap fund, we hold NXT and Megaport (MP1), which is exposed to networking, as well as newly listed copper stock Capstone (CSC).

The small-caps team own another data centre play Macquarie Technology Group (MAQ), along with copper miners Sandfire (SFR) and CSC.

In this week’s note we check the pulse of the global consumer – with the European consumer strengthening, the Australian consumer under pressure, and a bifurcation occurring between US consumers who own shares (like higher-income households) and those at the lower end.

On the inflation front, a bounce in May’s Flash S&P Global Composite Purchasing Manager’s Index (PMI) plus more hawkish Federal Reserve speak and minutes resulted in US 10-year Treasury bond yields moving up five basis points (bps) to 4.47%.

Goldman Sachs was prompted to push out its first rate-cut assumption from July to September 2024.

But the PMI sub-components data, plus unemployment claims, were consistent with the narrative that employment and inflation measures are on track to weaken over the coming months.

Confidence remains high that the next move will be down.

The market is now only pricing a 10% chance of the Fed cutting rates in July, while this rises to 50% by the September meeting.

Though last week was very busy in Australia, with a mini-reporting season seeing the likes of Xero (XRO), Technology One (TNE), James Hardie (JHX) and ALS (ALQ) all delivering results, this week looks a little quieter.

The S&P/ASX 300 fell 1.11%, while the S&P 500 returned 0.05% last week.

The US market is closed Monday for the Memorial Day long weekend and then we get personal income and spending data on Friday.

Economics and policy

The Fed

The May FOMC meeting minutes were released and were relatively hawkish. In addition, we had almost 20 statements from various Fed members.

The broad takeaway is that there is no sense of urgency to cut, and it looks as if like the fastest route to a cut would come through an unexpected deterioration in the labour market, rather than inflation alone.

Unemployment claims

The four-week average weekly unemployment claims inched up to 220k, off the lows of 201k earlier this year.

While we haven’t seen a meaningful increase in claims, the slowing rate of hiring (the first step taken by businesses in response to rising borrowing costs and reduced demand) would suggest claims will eventually follow.

S&P Global PMIs

The flash S&P Global Composite PMI survey rose to 54.4 in May – up from 51.3 in April and well above consensus expectations of 51.2.

The market responded negatively, with US 2-year bond yields rising 7bps on the day.

It is worth noting that this index has been a poor indicator of growth in GDP since the COVID pandemic.

More importantly, the sub-components data was consistent with the narrative that employment and inflation data are on track to weaken over the coming months, supporting potential US rate cuts later this year.

Expectations of the first cut have now been pushed back to September.

On the negative side, the composite employment index recovered half of the unexpectedly soft April decline.

However, it remains soft at 49.9 – suggesting equally as many firms are reducing employment as there are those increasing it.

This is consistent with materially weaker jobs growth and signals that businesses expect demand growth to soften.

The output prices indices for both Services and Manufacturing supported the global disinflation story:

• While the services output price index ticked up from 53.7 to 54.0, it suggests that CPI services ex. rents will soon be rising at a 2.5% three-month annualised rate, down from 7.1% in April.
• The manufacturing output price index moderated from 54.9 to 54.5 and also suggested manufacturers built up inventories of finished goods in May, which may prompt price cuts to free up cash flow and be positive for disinflation.

The Nvidia (NVDA) result

Another “beat and raise” print for Nvidia, which reported 1Q24 revenue of $26 billion – beating consensus expectations by 6%.

Earnings per share (EPS) of $5.59 were in line with expectations.

Guidance for 2Q24 is revenue of $28 billion and EPS of $6.30, which are 8% and 3% ahead of consensus expectations, respectively.

A 10:1 stock split was also music to the ears of retail investors.

Incredibly, data centre revenue growth accelerated again from 409% year-on-year in 4Q23 to 427% year-on-year in 1Q24.

The velocity of demand for graphics processing units (GPUs) continues to grow, with demand expected to outstrip supply until at least 2025.

This is not just from the larger cloud service providers (the “hyperscalers”) – individual corporates (“enterprise”) are now the largest incremental buyers in aggregate.

In addition, sovereigns are now coming in and buying to build their own secure infrastructure stacks.

For example, Japan is making a US$740 million investment in a project led by telco KKDI, Skura Internet and Softbank to build up Japan’s AI infrastructure.

NVDA also talked about supplying 100 “AI Factories” – data centres operated independently of the hyperscalers, which may also provide opportunities for companies such as NextDC (NXT).

Amazingly, NVDA now has 81% share of wallet for data centre processors and continues to gain on its peers (Intel and Advanced Micro Devices, or AMD).

It is estimated that there are 15-20k generative AI-related start-up companies.

We are still in the experimental phase of what this new ecosystem will mean for the economy.

Long-term, the AI revolution is expected to drive significant productivity gains, however, the more immediate concern is the inflationary impact the boom in share prices may have on consumer spending.

This was reflected in the FOMC meeting minutes, with at least two participants hawkishly noting that “financial conditions appeared favourable for wealthier households, which account for a large portion of aggregate consumption, with hefty wealth gains resulting from recent equity and house price increases”.

NVDA stock closed up 9% on the day and added about US$275 billion in market cap (equivalent in size to Salesforce, Netflix, and AMD).

To put this in perspective, NVDA made a cyclical low in October 2022 – trading at 25x next-12-month (NTM) price/earnings (P/E) with a US$280 billion market cap.

Since then, earnings have grown roughly ten times and the stock is now trading at 31x NTM P/E with a US$2.5 trillion market cap.

This is supportive for shareholders more broadly; the boom in the US tech sector alone has added about 10% of GDP to US household net worth this year.

According to Fidelity, the number of millionaires in the 401(k)-retirement savings scheme has hit a new record, with 485k in 1Q24 – up 15% for the quarter and 43% for the year.

Fidelity has more than 23 million plan participants with an average balance $126k, which is up 16% year-on-year.

So the rich are getting richer and that’s supportive for the companies skewed at the higher end of the consumer market, as the beneficiaries of such gains are likely to spend a bit more.

We note that households own 39% of the $73 trillion US market in cash equities – that rises to 65% inclusive of mutual funds and ETFs.

The UK

Core CPI inflation came in at 3.9% year-on-year in April, which was down from 4.2% in March but above consensus expectations of 3.6%.

Disappointingly, services inflation only declined by 10bps from 6% to 5.9%, which was well ahead of consensus and Bank of England (BOE) expectations of 5.4%-5.5%.

This has pushed out expectations for a cut from June (with a 10% probability now) to August.

Further, the BOE will not being updating on policy or giving any speeches until after the UK election on 4 July.

Wage pressures remain firm in the UK, with the three-month average private sector regular pay growing at 5.9% year-on-year.

Several leading indicators, such as the Indeed wage tracker and HMRC pay data, are pointing to a potential increase from here.

Europe

The flash S&P Eurozone Composite PMI rose from 51.7 in April to 52.3 in May – its highest reading for twelve months.

This suggests that output across the combined manufacturing and services sector has continued to grow.

This is supportive for Eurozone GDP growth, which should be bolstered further by the expectation that the European Central Bank (ECB) will cut rates in June.

Further optimism came from output prices, which rose at the slowest rate in six months and are rising at a level that is consistent with inflation meeting the ECB’s 2% target.

The data was particularly constructive for Germany, where output rose for a second month running and the pace of growth strengthened and hit a twelve-month high.

Germany has been under pressure for some time, suffering from a range of cyclical problems (like the gas crisis, higher rates, weaker Chinese demand) and structural issues (like its reliance on China imports, the auto industry shift to EVs, and unfavourable demographics).

Real GDP has been flat since 2019, compared with 5% growth for the rest of the Euro area and 9% growth in the US.

A cyclical upswing is underway – with lower inflation boosting real household incomes, which should support consumption growth in coming months.

Combined with lower inflation dynamics allowing the ECB to ease, growth in Germany should pick up over the next twelve months, leaving behind two years of stagnation.

Europe, and Germany in particular, should benefit from the huge wave of liquid natural gas (LNG) supply coming online over the next couple of years. This should result in lower energy prices and act as a tailwind for consumers and the energy-intensive manufacturing industry.

Global consumer pulse-check

This change in Europe is starting to come through in consumption measures.

The Euro area Goldman Sachs Consumer Health Indicator has improved, from the 30th percentile in early 2023 to the 60th percentile more recently.

The US is also around the 60th percentile on the same measure.

It is downbeat in the UK, where it has ranged between the 30th and 40th percentile for 2023 and into 2024.

Australia is also around the 40th percentile.

More broadly, Australian consumer sentiment has continued to decline despite a supportive budget, according to the Westpac Monthly Survey.

The decline was driven by softer perception of personal financials and an increase in unemployment expectations – signalling a softer outlook for the labour market.

Within Australia, those under 40 years old are facing the greatest pressure.

Analysis from CBA on consumer card transactions in 1Q24 showed that cuts to real discretionary and essential spending are skewed to younger cohorts – particularly the average 25–29-year category.

On the other hand, those at or heading into retirement seem well-placed to enjoy it – with a strong propensity to spend.

This is particularly favourable for those consumer companies most exposed to older age cohorts, such as Flight Centre (FLT).

Meanwhile in the US, overall spending remains healthy but bifurcated, with companies increasingly calling out a weaker lower-end consumer.

These consumers are also most exposed to a weakening labour market, with each 1% increase in the overall unemployment rate lowering spending by 1.2% for households in the bottom income quintile but only 0.4% in the top-income quintile.

Of Australian-listed companies, Block (SQ2) is exposed to the lower-end US consumer through its Cash App offering.

Markets

While the NASDAQ had a decent week (up 1.4%) off the back of an exceptional NVDA quarterly, the rest of the market was pretty soggy.

Looking at US large caps, winners are taking more of the spoils – with the largest ten companies now accounting for 26% of S&P 500 earnings, yet 35% of market cap.

While large caps are reporting positive earnings, this is not the case for small caps.

It was interesting to note that the number of companies mentioning AI during quarterly earnings calls has jumped from about 10% in 2022 to 41% in the most recent quarter.

The breadth of sectors that are considered AI beneficiaries has expanded from semiconductors into AI infrastructure plays, such as copper and power.

In particular, utilities have been in focus as a potential AI beneficiary given the substantial energy requirements to power data centres.

Global data centre power demand is expected to more than double by 2030.

This has been reflected in mutual fund positioning, with the smallest underweight to utilities in ten years.

More broadly, hedge and mutual fund positioning has rotated towards cyclicals – with increases across consumer discretionary, financials and energy as investor confidence about economic growth has strengthened.

Copper

Copper dropped 5.5%, giving back some of its 23% year-to-date gains and coming off all-time highs of $5.12/lb reached during the week.

This has been an interesting market, with differences emerging between the two most liquid markets for the metal: the Chicago Metal Exchange (CME) which is largely investor driven, and the London Metal Exchange (LME) which is largely a physically based market.

Pricing between the two is usually within a 2%-3% range, but huge demand from investors has overwhelmed the physical market – pushing the spread by more than 10%.

This huge dislocation has led to risk mitigation as the medium-term speculative positioning is at odds with a lack of physical tightness in the market today.

In fact, the physical market is trading in contango, with spot demand less than current supply.

However, traders are widely expecting that a supply deficit will start building from 2H24 and that long-term structural drivers, such as decarbonisation and AI-related demand, are very supportive for a tight market.

Previously, the ASX had only one sizeable copper player – Sandfire (SFR) – but that has recently been joined by the Australian listing of Capstone (CSC).

Gold

Gold also fell on the week, down 3.3% (but still up 13% in 2024) despite real yields going higher.

Usually, they would trade inversely, reflecting lower demand for inflation-proof assets.

However, this relationship hasn’t held with new buyers emerging from central banks and the Chinese retail market.

Global central bank purchases have increased three times since Russia invaded Ukraine.

Emerging market central banks (like China, Poland, Turkey, India and Qatar) have been big net buyers.

There is further room for this momentum to continue, with only 6% of emerging market official reserves being held in gold versus 12% in developed markets.

About 20% of all gold mined throughout history is sitting in central bank reserves.

Incremental retail demand out of Japan (reflecting the devaluation of the yen) and China (showing movement of wealth out of property) has also been supportive.

While the Chinese government’s recent moves to support the property market are helpful, we don’t think they are yet at a level to disrupt this trend.

Despite the bullishness in gold, the miners have lagged.

This reflects a combination of positioning – and the possibility that western investors are trained to sell gold miners on the move higher in real rates – as well as hiccups in operational performance.

Australia

Within Australia, Tech (+2.45%) performed off the back of some strong results from Xero (XRO, +8.41%) and Technology One (TNE, +12.18%) while Utilities (+2.35%), Energy (+1.19%) and Industrials (+0.80%) were also in the green. Consumer Discretionary (-4.24%) and Communication Services (-3.73%) were the worst sectors, with Wesfarmers (WES, -6.68%) and Telstra (TLS, -5.99%) weighing on the market.

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About Elise McKay and Pendal Australian share funds

Elise is an investment analyst and portfolio manager 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.

Pendal Horizon Sustainable Australian Share Fund is a concentrated portfolio aligned with the transition to a more sustainable, future economy.

Pendal Focus Australian Share Fund is a high-conviction equity fund with a 16-year track record of strong performance in a range of market conditions. The Fund is rated at the highest level by Lonsec, Morningstar and Zenith.

Pendal is an independent, global investment management business focused on delivering superior investment returns for our clients through active management. 

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