Jim Taylor: What’s driving the ASX this week?

Here are the main factors driving the ASX this week according to portfolio manager JIM TAYLOR. Reported by investment specialist Chris Adams

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THERE was not enough in Australian economic data last week to bring forward expectations of rate cuts.

US economic data remains on the soft-landing trajectory, with a slowing labour market and still-resilient consumption. The market is locked on for a 25bps cut at the Fed meeting this week.

We are seeing the highest dispersion in outcomes in a while from both US quarterly reporting season and the trading updates from Australian annual general meetings (AGMs). There are plenty of anecdotes about consumers “trading down” to cheaper products and services.

There are perhaps a couple of new trends emerging.

– First, weak EU data is prompting speculation about where rates go to – and do they settle below the “neutral” level.

– Second, some are starting to question the return-on-investment expectations around the swathes of corporate investment in AI.

Elsewhere, there is further chatter about a potential stimulus out of China’s NPC meeting this week. If forthcoming, it would see a confluence of China, the EU and the US all on a path of monetary easing and/or stimulus into 2025.

The US Presidential election remains a coin-toss – as does the time frame that it will take to determine a winner.

Increased volatility seems the only sure bet at the moment.

Macro and policy Australia

The headline consumer price index (CPI) for Q3 2024 rose 0.2% quarter-on-quarter, while the year-on-year rate eased 100bps to 2.8%. This is the first time inflation has been within the RBA’s 2-3% inflation target band since the first quarter of 2021.

That said, new subsidies drove electricity prices down 17.3% over the quarter, taking about 40bps off headline CPI.

The trimmed-mean CPI – a seasonally-adjusted measure closely watched by the RBA – rose 0.78% for the quarter and 3.54% for the year.

This has decelerated sequentially over the year; the quarterly growth was +1.01% in Q1 and +0.87% in Q2.

Year-on-year growth for the month of September was 3.2%, only just ahead of the RBAs 2-3% band.

Overall, inflation is tracking in the right direction, but not quickly enough to change expectations around rate cuts.

Breaking CPI into components:

– Goods prices fell 0.6% quarter-on-quarter, driven by the drop in electricity mentioned above as well as -6.7% in fuel prices. This offset a 0.6% gain in food prices.

– Services prices rose 1.1% quarter-on-quarter and the year-on-year figure rose 10bps to 4.6%. The volatile holiday travel and accommodation segment rose 1.4% for the quarter. There was moderating growth in rents (1.6%), other financial services (0.9%) and medical and hospital services (0.1%).

Retail sales

September retail sales rose 0.1%, versus 0.3% expected and 0.7% the previous month.

Weakness in clothing, footwear and accessories (-0.1%) and department stores (-0.5%) offset growth in household goods (+0.5%) and restaurant and takeaway food services (+0.4%).

Retail volumes rose 0.5% for the third quarter, having fallen 0.4% in the previous two quarters. This is only the second time in the past two years that quarterly volumes have increased.

The long-term average trend is 5% annual growth in retail sales. We are currently tracking a little below half this rate.

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Macro and policy US

JOLTS

The September Job Openings and Labor Turnover Survey (JOLTS) saw job openings decrease by 418k to 7,443k.

This was lower than a (downwardly revised) 7,816k in August, well under consensus expectations of 8,000k and is the lowest level of job opening since January 2021.

Openings fell furthest in; 1) private education and health services (-175k), 2) trade, transportation and utilities (-132k), and 3) government (-132k). They increased in financial activities (+93k) and professional and business services (+77k).

The job openings rate fell 0.2%, to 4.5%, and the quits rate was down 0.1%, to 1.9%. The hiring rate rose 0.1% to 3.5% and the layoff rate was also up, by 0.2% to 1.2%.

Labour turnover now appears lower than pre-pandemic levels – for example, the quits rate averaged 2.3% in the two years before 2020.

Inflation

The 0.8% quarter-on-quarter rise in the employment cost index (ECI) was good news for the Fed, as the yearly rate dropped from 4.1% in Q2 to 3.9% in Q3. This is the first reading under 4% in three years.

Recent solid growth in productivity (averaging ~1.7% p.a. for the last 5 years) means that unit labour costs already are rising slowly enough (2.3%) for core personal consumption expenditures (PCE) inflation to fully return to the Fed’s 2% target during 2025.

The PCE price index rose +0.18% month-on-month for September, in line with the median forecast and up from 0.11% in August. It is up 2.09% year-on-year, again in line with the median forecast and down from 2.27% in August.

The Core PCE price index rose 0.25% month-on-month, which was the largest gain since April and is up from 0.16% in August. It is up 2.65% year-on-year, versus +2.72% in August.

The Q3 data appears to have been slightly worse than the Fed expected, as it would now require month-to-month increases to average 0.10% over the next three months for the median participant’s forecast of a 2.6% year-over-year increase in Q4 to be realised.
Nonetheless, the low level of food and energy prices, frictionless supply chains, cooling new rent inflation and the ongoing loosening of the labour market suggest that the outlook for core PCE inflation is fundamentally benign.

GDP

US GDP rose 2.8% in Q3 2024, driven mainly by strong consumption.

Consumer spending rose 3.7% – the largest gains since Q1 2023 – which accounted for 90% of the increase in activity.

This in turn is driven by the top 40% of US households by income, reflecting strong balance sheets and still-favourable wage and employment prospects.
In contrast, the bottom 40% of households are feeling the pinch from higher prices and higher mortgage costs.

Meanwhile, the middle 20% of households are still spending but trading down in the search for value.

Strong consumption offset weakness in other areas such as private investment, which rose just 1.3%, and in inventories, which went backwards.
The Atlanta Fed’s real-time GDP estimate GDPNow is forecasting 2.7% growth in Q4.

Other data

• October US consumer confidence rose 9.5pts to 108.7 which is the largest one month increase since March 2021. Are we drawing a line through the “vibecession” we have been experiencing for a couple of years?

• Pending home sales rose 7.4% in September, the strongest number since June 2020 and well ahead of expectations. Mortgage rates have however spiked since the end of September, so this could be short-lived joy.

• October non-farm payrolls rose 12K, versus 100k consensus expectations. Manufacturing strikes and hurricane impacts rendered the number somewhat meaningless. However there was a significant net revision of -112K across Aug/Sept. The 6-month average in September is ~150k, versus nearly 250k 6-month average in January 2024. The net revisions probably lock in a 25bp cut from the Fed in November.

• The unemployment rate was unchanged at 4.1% in October, matching the consensus.
Average hourly earnings rose by 0.37%, slightly stronger than the consensus, 0.33%. Net revisions were -0.09%.
- The ISM manufacturing index dipped to 46.5 in October, from 47.2, below the consensus, 47.6.

Macro and policy EU

There is some chatter that ECB policymakers have begun debating whether interest rates need to be taken below neutral to stimulate the economy.

While nascent, this is a significant shift in the policy debate.

Europe’s economic backdrop is deteriorating rapidly, while inflation is well below earlier predictions.

This raises the risk that price growth undershoots the ECB’s target, as it did in the decade before Covid.

Germany’s finance ministry flagged that the economy would probably contract in 2024, as it did in 2023, as the country continues to deindustrialise as a result of the EU’s energy policies.

German Chancellor Olaf Scholz noted the need for new a new approach – especially for industry – in the face of high renewable energy costs, weak global demand, and growing competition from China. One key question is how to ensure cheap energy.

Volkswagen asked its workers to take a 10% pay cut, arguing it was the only way it could save jobs and remain competitive.

Whilst only one company at the moment, we are starting to see the wave of deflation that Europe faces.

China

Vice finance minister Liao Min noted that Beijing’s stimulus is focused on lifting domestic demand and reaching the 2024 growth target, while coordinating with monetary policy to target economic restructuring.

There is an expectation that China will unveil fiscal stimulus following the National People’s Congress (NPC) Standing Committee meeting, schedule to conclude on 8th November.

Liao said fiscal policies will be of “quite large scale”, reiterating an earlier message from finance minister Lan Fo’an.

US earnings

The blended Q3 earnings growth rate for S&P 500 EPS currently stands at 5.1%, versus 4.3% expected at the end of the quarter.

The blended revenue growth rate is 5.2%.

70% of S&P 500 companies have reported, with 75% beating consensus EPS expectations. This is below the 78% one-year average and the five-year average of 77%.

60% have surpassed consensus sales expectations, below the 62% one-year average and the five-year average of 69%.

In aggregate, companies are reporting earnings that are 4.6% above expectations, below the 5.5% one-year average positive surprise rate and the five-year average of 8.5%.

In aggregate, companies are reporting sales that are 1.1% above expectations, better than the 0.8% one-year positive surprise rate but below the five-year average of 2.0%.

• Alphabet delivered a well-received set of numbers. Overall Group sales were up 15% versus 14% in Q2. Net income of $26.3bn was up 34% on the same period last year. The Cloud business was the highlight, with revenue up 35% versus 29% in Q2. Advertising growth slowed to 10.4%, versus 11.1% in Q2, with Search advertising of $49.4bn up 12.2% versus 13.8% in Q2. YouTube advertising sales of $8.9bn were up 12.2%, versus 13% in Q2. Investment in AI is “paying off,” according to management
• Microsoft beat consensus expectations for revenue and EPS. Azure, its cloud business, grew revenue 33% versus 29.5% expected, with generative AI contribution 12 percentage points of that. Capex as a percentage of revenue is running at 28%, versus a historical average of 12%.
• Meta grew revenue 19% in Q3, down from 22% in Q2. Q3 profits grew 35% to US$15.7bn. The capex budget for infrastructure is high and going higher. Capex to sales running at 24%, versus 19% historically. Zuckerberg said the company’s AI-driven feed and video recommendations have led to an 8% increase in time spent on Facebook and a 6% increase on Instagram. He added that more than one million advertisers used Meta’s generative AI tools to create more than 15 million ads in the past month, and the company estimates that businesses using image generation are seeing a 7% increase in conversions.
• Amazon expects to spend about US$75 billion capex in 2024 and more than that in 2025, with the majority driven by cloud-based Amazon Web Services (AWS). CEO Andy said “the increased bumps here are really driven by generative AI” which “is a really unusually large, maybe once in a lifetime type of opportunity,” but “customers, the business and our shareholders will feel good about this long term.” He noted that Amazon has “proven over time, that we can drive enough operating income and free cash flow to make this a very successful return on invested capital business…and we expect the same thing will happen here with generative AI.”

About Jim Taylor and Pendal Focus Australian Share Fund

Drawing on more than 25 years of experience investing in top-performing Australian companies and a background in accounting, Jim manages our Long/Short Fund and co-manages our Imputation Fund. He is a Chartered Accountant with membership of the Australian Institute of Chartered Accountants.

Pendal Focus Australian Share Fund is managed by Crispin Murray. The fund has beaten its benchmark in 14 years of its 18-year history (after fees), across a range of market conditions. Find out more about Pendal Focus Australian Share Fund here.

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