Elise McKay: What’s driving equities this week?

Here are the main factors driving the ASX this week, according to analyst and portfolio manager ELISE McKAY. Reported by investment specialist JONATHAN CHOONG

• Labour market data “noisier than usual”
• Geopolitical risks surge on Middle East tensions
• One demand: tune into Crispin Murray’s Beyond the Numbers webinar
• Find out about Pendal Focus Australian Share fund

DESPITE the relatively flat index performance belying underlying trends, it was a volatile period last week.

In Australia, the ASX 300 experienced a modest decline of 0.75%, which masked significant sectoral movements. The energy sector surged by 6.75%, driven by geopolitical tensions and rising oil prices, while consumer discretionary fell by 2.5%.

Globally, the resolution of the East Coast Ports strike was swift, yet geopolitical risks remain heightened – particularly with the Israel-Iran conflict.

Energy markets swiftly adjusted to geopolitical risks, though sustained higher oil prices are uncertain due to excess supply and global players’ preference for stable pricing.

Anticipation is also building around China’s imminent announcement of additional fiscal stimulus.

Macro data was relatively quiet, with the standout being a stronger-than-expected jobs report on Friday. This bolstered US markets, which rallied on optimism that the Federal Reserve will achieve a soft landing.

Jobs data supports a likely 25 basis point (bp) cut rather than a 50bp cut in November, with the possibility of a larger cut in December if necessary.

Bond markets quickly priced in these expectations.

Economic data

Jobs

Friday’s robust jobs report challenges the prevailing narrative of a gradually softening labour market and contradicts other indicators, such as hiring and quits rates, which point to upcoming weakness.

Markets traded up strongly on bets that the Fed will achieve a soft landing.

September payrolls surged by 254k, significantly exceeding the consensus estimate of 150k growth, with an additional upward revision to previous months.

Consequently, the three-month average for private sector job creation has risen to a mild 145k, which further indicates a soft landing.

After peaking at 4.25% in July, the unemployment rate has fallen to 4.05% over the past two months – defying expectations for it to remain flat.

Labour market data is noisier than usual, with October expected to be another mixed month due to the impact of strikes and Hurricane Helene.

Business response rates for the first estimate haven fallen to 62%, down from September 2023 and below the 77% average of the 2010s. Typically, compliance reaches 90-95% by the third estimate.

Given the breadth of other indicators pointing to a softening labour market, it is worth questioning whether the strength seen in the September 2024 jobs report is an outlier, rather than a true read of a goldilocks-type scenario.

Other data:

• JOLTs data for August 2024 shows the hiring rate slowing to 3.3% and the quits rate falling to just 1.9%.
• The employment subcomponent of Services ISM is in contraction territory. 
• The NFIB small business survey has net 15% of firms with plans to hire, which is indicative of a softer labour market.
• A modest increase in initial jobless claims, albeit still at generally low levels. 

Wages

Average hourly earnings accelerated to an annualised 4% year-on-year (YoY) in September 2024, up from a low of 3.4% in July 2024. 

Again, this data can be lumpy so it remains to be seen whether this is an uptrend that can be sustained. The JOLTS quits rate suggests the trend should move lower.  

ISM survey data

The Services ISM data surprisingly jumped to 54.9 in September 2024, driven by strength in new orders and business activity. At the same time, however, the employment index was weaker and fell into contractionary territory. 

This has now joined the employment data for Manufacturing, which is in recessionary territory at 43.9. Note that the Manufacturing ISM data remained flat at 47.2 in September this year. 

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Oil

Geopolitical risks have surged following an escalation in the Middle East, pushing Brent crude oil prices up by 8% last week to $78 per barrel (/bbl). Discussions between the Biden administration and Israel regarding potential strikes on Iranian oil facilities have heightened these concerns.

Putting Iran’s oil market into perspective, the country produces approximately 3.5 million barrels per day (mb/d), with around 50% exported primarily to China despite US and EU sanctions.

The remaining production is consumed domestically, with Iran being self-sufficient in refined products such as gasoline, diesel, and jet fuel.

Iran also controls the strategic Strait of Hormuz, a vital shipping route where about 17% of global oil production and 19% of global LNG supply pass through.

China is another key player and the world’s largest crude oil importer. Not only is it Iran’s main client, but 40-50% of its imports originate in the Persian Gulf and must pass through the Strait of Hormuz to get to China. 

The market is focused on three hypothetical scenarios:

1. Damage to Iranian oil infrastructure could affect downstream assets (such as refineries), midstream assets (like pipelines and terminals) and upstream assets (including production fields). An attack on refinery assets would be less impactful than on midstream or upstream assets.
2. Tightening enforcement of sanctions.
3. Broader disruption of regional oil supplies via (a) regional trade routes, (b) attacks on oil infrastructure outside Iran, or (c) interruption of trade through the strait of Hormuz. 

On the first scenario, it seems politically unlikely that President Biden would support a strike on Iranian oil facilities given the potential for higher oil prices and the impact on the upcoming election.

However, even if such a strike were to occur – with or without US support – the medium-term impact on oil prices might be muted due to excess capacity in the market.

The third scenario, particularly the closure of the Strait of Hormuz, would be the most disruptive, though it is considered unlikely due to its importance to Iranian exports and global trade.

Globally, this excess capacity is estimated at approximately 6 mb/d against a global market size of around 100 mb/d. For instance, Saudi Arabia is currently producing 9 mb/d versus a capacity of 12 mb/d, while other OPEC members such as the UAE also have excess capacity (estimated at around 1 mb/d).

Even if there was an attack targeting Iran’s oil production, OPEC has historically acted quickly to mitigate disruptions – typically offsetting 80% of lost production within two quarters. 

Goldman Sachs (GS) has estimated the impact of two hypothetical scenarios relative to a baseline forecast for $77/bbl on average in Q424 and $76/bbl average in 2025.

Scenario 1: A 2 mb/d disruption for six months could see Brent crude temporarily peak at $90 per barrel if OPEC quickly offsets the shortfall and reach the mid-$90s in 2025 without OPEC intervention.

Scenario 2: A persistent 1 mb/d disruption, possibly due to tighter sanctions, could push Brent to the mid-$80s if OPEC gradually offsets the shortfall, and to the mid-$90s in 2025 without an OPEC offset.

Given the current oil price of $78/bbl, the impact on inflation and economic growth appears limited at this stage.

Oil prices would need to exceed $100/bbl to have a meaningful impact on inflation. Academic research finds that a 10% shock to oil prices translates to an increase of about 7bps to core inflation. 

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Australia

Retail sales for August 2024 surpassed expectations, rising by 0.7% month-on-month (MoM) and 3.1% YoY – the fastest since May 2023 and ahead of expectations. 

The strength was broad-based except for household goods spending, which has declined for the past two months. 

This stronger trend should continue over the coming months as tax cuts come through and are eventually spent. 

Eurozone inflation

In Europe, inflation has dipped below the target for the first time in three years, reaching 1.8% compared to the 2% target.

Inflation is cooling all around the world, maintaining the momentum of the worldwide rate-cutting cycle.

The European Central Bank (ECB) is expected to cut later this month.

The US Federal Reserve’s decisive 50bp cut last month provided global thought leadership and created room for other countries to ease more without further depreciating their currencies. 

China

China took a break for Golden Week, which is a week-long break in celebration of the National Day. This holiday was first introduced in 2000 as a way of stimulating China’s economy by encouraging domestic tourism, travel to visit family, and general consumption. 

As the nation returns from this break, the government is expected to announce further fiscal stimulus at a press conference to further boost the consumer and support economic growth. 

Morgan Stanley anticipates a RMB2 trillion package, with potential announcements as early as today. The support could span local government financing, infrastructure capex, bank capitalisation, and consumption/social benefits.

As highlighted by Jack Gabb in last week’s equities note, while more substantial support (up to RMB10 trillion) is needed, this move is a step in the right direction.

Australian markets

Despite the market declining by 0.75% for the week, sector dispersion was notable.

The energy sector surged by 6.75% due to geopolitical risks driving oil prices higher, while consumer discretionary fell by 2.5%.

Santos (STO) and Woodside (WDS) were the top performers, moving in lockstep with the 8% rise in oil prices.

Reflecting on September, the ASX 200 achieved a 3% total return, highlighted by the rotation of resources into banks reversing. 

Small-cap stocks also recovered some of their year-to-date underperformance relative to large and mid-cap stocks.

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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