What’s driving Aussie equities this week

Here are the main factors driving the ASX this week, according to Pendal investment analyst JACK GABB. Reported by portfolio specialist Chris Adams

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IT WAS a Thanksgiving feast for the bulls in the US last week, with the S&P 500 up 1% (and 8.9% month-to-date) following the latest CPI print.  

A combination of factors — dovish minutes from the US Fed, seasonality, rampant “big tech”, and systematic investors (like commodity trading advisers) being underweight equities — all pushed the market to one of its strongest-ever Novembers. The week closed out near year-to-date highs.  

While higher-than-expected consumer inflation expectations provided a small note of caution, expectations remain high that the Fed is done hiking rates and will cut by mid-2024. 

Unfortunately, the same can’t be said of Australia, with the ASX falling 0.1% last week.  

If it’s “job done” for the Fed, it’s clearly not for the RBA – with comments from Governor Michelle Bullock underscoring a gulf in inflation and interest rate outlooks between Australia and the US.   

US treasuries were little changed given the Thanksgiving public holiday.  

The yield curve did push further into inverted territory, though it has been there for some time (and just how reliable this is as an increased indicator for a recession remains open to debate).  

The Fed and US rates

The implied probability of a Fed rate cut by mid-2024 has risen 15 percentage points over November and is now sitting above 60%. 

Central bank minutes published during the week provided little new information but were generally viewed as slightly dovish, given united caution on further rate hikes.  

There was a 50-basis point reduction in forecast headline PCE inflation to 3% by year end (with the core PCE forecast at 3.5%). 

By 2026, core and headline inflation rates are expected to be close to 2%. Officials also noted credit standards tightening in many sectors and some concern over rising consumer loan delinquencies.  

US economy

Most US data continues to support a dovish Fed outlook.  

For example, durable goods orders were down 5.4% in October – mostly on softer aircraft orders. Excluding aircraft, orders for non-defence capital goods still fell 0.1% and September’s order growth was revised to a decline.  

The outlier was the University of Michigan inflation expectations survey, where median year-ahead inflation expectations rose to 4.5% – the highest since April. Long-term expectations rose to a 12-year high of just above 3%. 

Where to for the US?

It’s clearly been a positive November for global equities and momentum suggests the rally has further room to run.  

Amid declining core inflation and rising rate cut expectations, US markets appear well supported, particularly as data continues to point to a mild slowdown rather than a recession.  

The Conference Board Leading Indicators index is a case in point. It is now showing signs of a possible bottom.  

Historically, this has occurred at a median of 61 days before the end of every recession since the 1969-70 downturn, with stocks gaining a median 23.4% in the year following a trough. 

Initial signs from Black Friday sales were also positive.  

Expectations heading into the traditional start of the holiday shopping period were relatively muted, with the first three weeks of November essentially flat year-on-year.  

However, Adobe Analytics estimated that Black Friday sales were up 7.5% year-on-year, while Salesforce estimated that spending in the US and across Australia and New Zealand was up 9% and 5%, respectively.  

Finally, S&P earnings expectations also continue to be revised higher, having bottomed in Q1 and Q2.  

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It can be helpful to also remember that 2024 is an election year, which has historically tended to be positive for equity markets. An average annual return of 10.2% dates back to Roosevelt’s win in 1932. 

So, what could go wrong?

1. Possibility of recession: The current 7.6% fall on the Leading Indicators index would be the largest ever year-on-year decline without a recession. The yield curve remains inverted and the economy is slowing, with data for inputs like durable goods showing meaningful declines. If inflation expectations are correct, rates could stay higher for longer and risk more significantly lagging effects. We note that if the Fed cuts because of a recession, the equity outlook will be very different.  
   
2. Seasonality: This factor is undeniably less supportive in the near term. December, February and March have been softer for the S&P 500 over the past few years. 
   
3. Positioning is no longer as supportive. November has seen a shift in underweight equity positions. Commodity trading advisers have reduced 80% of their shorts in global equities in the past two weeks, buying $60-70 billion worth of shares. The pace of purchases is now expected to slow, though there is still potentially $30-40 billion to buy over the next fortnight. The S&P is also technically overbought (RSI >70). Over the past 12 months, the S&P 500 ETF has crossed this level six times and then, on average, fallen 1% in the following 20 days. Finally, measures of options pricing suggest that demand for downside and tail risk hedging have fallen materially.  

The RBA and Australian rates

In contrast to the US, expectations for a February rate hike in Australia have nearly doubled since its last meeting.  

Governor Bullock’s speech was interpreted as laying down hawkish credentials, arguing that the inflation problem facing Australia is largely domestically driven – not the global problem that many have believed.  

As such, we are arguably not on the same path as others.   

Inflation is seen as broad-based, with 66% of the CPI basket running at greater than 3%. It is only lower than average for a few items, such as fresh food and holiday travel.  

More generally, services demand is continuing to exceed supply, and with limited labour market spare capacity, inflation is expected to take longer to come back down to target.  

We note that the next CPI print is Wednesday, with consensus expecting a 5.2% annualised increase versus 5.6% in the last reading.   

It is also worth noting the impact of rent. According to SQM (a residential property research group), rental inflation is set to grow 7-10% in 2024, down from 15.5% in the year to mid-November but still at high levels.  

Eurozone

Inflation data due on Thursday is expected to show CPI dropping to 2.7%, which is the lowest since July 2021. However, officials have cautioned that it may pick up again in the short term due to statistical effects. 

According to European Central Bank President Christine Lagarde, rates are at a level that will help bring inflation back to the 2% target if maintained for long enough. That target is expected to be hit in 2H 2025.  

However, the economy is already showing stress, with GDP down 0.1% in Q3. Data on PPI during the week also showed a contraction to 47.1 – the sixth consecutive month below 50.   European bonds also slid on concerns of higher supply, with Germany announcing the suspension of its constitutional limit on net new borrowing for a fourth consecutive year.                          

China

Over the past few months, there has been a renewed focus by authorities on growth, with a range of measures announced to support construction in China.  

Last week, it was revealed that authorities would allow Chinese banks to offer unsecured short-term loans to qualified developers for the first time – a major push to ease the property crisis.  

The previous funding shortfall has been estimated at US$446 billion.  

Time will tell whether this latest measure is sufficient to turn the tide when previous efforts have failed. But over the short term, the impact has been positive for developer shares and bonds, as well as iron ore.    

Commodities wrap

Iron ore: The lack of material Chinese steel production curbs this half – on contrast to previous years – have seen demand remain strong. Coupled with inventories, which are at a five-year low for this season, prices have been driven up 6.4% month-to-date. With further regulatory moves to boost the property sector and strong seasonality ahead of Chinese New Year, our view is that demand and pricing will remain well supported into early next year.  

Oil: It was a quieter week for oil, which remains 7.8% lower month-to-date. Uncertainty continues to cloud the upcoming OPEC+ meeting, which has been delayed until 30 November while US stockpiles continue to grow.  

Lithium: Prices continue to decline on weak demand and rising inventories, with the latter now accruing more at upstream producers rather than at converters and battery manufacturers. Chinese carbonate futures are down 37% over three months to 125,000 RMB/t, but they remain above marginal cost at about 80,000 RMB/t. Given the ongoing inventory build and that we’re heading into a typically weaker period for demand, there remains a high risk that prices continue to decline unless, or until, we see production or project curtailments.   

About Jack Gabb and Pendal Focus Australian Share Fund

Jack is an investment analyst with Pendal’s Australian equities team. He has more than 14 years of industry experience across European, Canadian and Australian markets.

Prior to joining Pendal, Jack worked at Bank of America Merrill Lynch where he co-led the firm’s research coverage of Australian mining companies.

Pendal’s Focus Australian Share Fund has an 18-year track record across varying market conditions. It features our highest conviction ideas and drives alpha from stock insight over style or thematic exposures.

The fund is led by Pendal’s head of equities, Crispin Murray. Crispin has more than 27 years of investment experience and leads one of the largest equities teams in Australia.

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

In 2023, Pendal became part of Perpetual Limited (ASX:PPT), bringing together two of Australia’s most respected active asset management brands.

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