Crispin Murray: What’s driving ASX stocks this week

Here are the main factors driving the ASX this week according to our head of equities Crispin Murray. Reported by portfolio specialist Chris Adams

WE SEE constructive signs emerging in recent market action after a period of consolidation.

Concerns over inflation and China remain heightened and persistent. Inflation, in particular, is likely to remain a key issue for markets for some time. But there are indications of small improvements at the margin for sentiment on these issues.

Further indication that concerns on these issues have peaked — combined with continued economic recovery and a period of seasonal strength in markets — could set up equities well into the year’s end.

It is far too early to declare victory in this regard. But equities moving higher despite ostensibly bad news, as we saw last week, can be a strong positive signal. The S&P/ASX 300 was up 0.65% and the S&P 500 1.84%.

Whether or not this continues in coming weeks is likely to rely heavily on US earnings season and Chinese data and policy signals.

Economics, policy and markets

The market has 3 broad concerns at the moment;

1. Inflation and its implications for policy tightening: The risk is that we start to see stagflation, where price rises choke off demand and economic growth, or that we see the Fed forced to tighten earlier, also weighing on growth.
2. Chinese growth: People are concerned that a slowing property market and power constraints will drive a sharper-than-expected slowdown in growth.
3. US debt ceiling: The fear is that political discord disrupts the government’s ability to function.

At this point there are signs that each of these issues may have reached a near-term crescendo, which is helping markets rally. 

In the US, Congress and the Biden administration have been able to delay the debt ceiling issue to December. It hasn’t disappeared, but they’ve bought time.

Outlook on China

There are signs that China is addressing power shortages. Beijing is looking to source coal and gas from all available sources – including Australia, despite previous embargoes.

This will not flow through immediately, but the signal is that China is looking to solve the problem and not stubbornly stick to old policies.

Pendal Focus Australian Share Fund

Now rated at the highest level by Lonsec, Morningstar and Zenith

Read more

Property remains more complex in China. The Evergrande issue has seen credit spreads blow out in the property sector. So far this looks contained within that sector and has not spread to other parts of the market.

There are indications in the data that monetary policy is too tight in China. There are various committee meetings this week which may result in some indication of easing.

Outlook on inflation

Inflation is the greatest long-term threat to markets.

In the past few weeks there has been a shift in expectations including a realisation that inflation is likely to be higher and more durable than previously thought.

At his Jackson Hole speech on 27 August, Fed Chair Powell was able to calm inflation concerns with the idea that it was transitory. His key reasons were:

1. It is not broad based
2. The largest surges are already receding
3. No threat yet from wages
4. Inflation expectations are anchored
5. Globally, pressure on inflation is downward

Since then inflationary pressures have strengthened, due to:

1. Expanding supply chain bottlenecks: Lockdowns in some countries and Chinese power issues have constrained production.
2. Labour availability: This continues to disappoint in the US, where it’s increasingly apparent there has been a reduction in supply, driving real wage increases and rising friction between employees and employers.
3. Commodity prices: Key inputs such as gasoline and power prices have continued to rise.
4. House prices: Continue to rise and are flowing through into rents.
5. Strong demand: Bolstered by re-opening and reducing delta concerns.

What was “transitory” is now being described as “transitory for longer”.

This is because the “transitory” argument is now falling foul of its own rationale outlined in the Jackson Hole speech:

1. It is not broad based: Inflation is showing up in a broader range of sectors as new supply chain problems occur and fuel prices rise. Last week’s CPI data shows prices in longer-duration areas are rising. Rents, for example, are increasing at their highest monthly rate since the housing bubble in 2006.
2. The biggest surges are already receding: This is true in some categories. In others, such as timber and autos, there have been recent rebounds. New auto prices were up 1.3% in the month.
3. No threat yet from wages: Average hourly earnings have not surged, but are steadily picking up.
   – We are also seeing greater friction in labour markets. For example workers at machinery maker Deere and Co knocked back a front-loaded 11-12% wage increase over six years and called a strike for the first time in 35 years. This kind of action reflects the recognition that supply chains need to be shortened and the threat of off-shoring has diminished.
   – There are further indications that early retirements and career changes are having a negative impact on labour supply.
4. Inflation expectations are anchored: This is still the case, but they are rising. The risk is this starts bringing forward consumption and drives higher wage demands.
5. Globally, pressure on inflation is downward: It’s true that inflation is less of an issue outside the US. But rising fuel prices are having an impact. The move in global bond yields indicates some concern on inflation.

The market realises the Fed is in something of a bind. It wants to promote growth while being mindful of the need to keep inflation expectations anchored.

The balance in recent weeks has been a shift in expectations to the Fed having to move sooner on tapering and rate hikes.

As a result we saw a “bear flattening” in bond markets, with two-year yields rising while 10-year yields remain flat. Despite this, equities and commodities made gains.

Pendal Focus Australian Share Fund

A high-conviction equity fund with 16 years of strong performance in a range of market conditions

Read more

One factor could be that supply chain fears have perhaps reached their nadir. Freight rates from China to the US east and west coasts have rolled over recently.

Surveys suggest the proportion of US firms reporting inventories as “too low” has also rolled over.

The Biden administration has recognised the importance of this issue. It’s been working with stakeholders to keep the Port of Los Angeles open 24/7.

This alone won’t solve the problem. But combined with factories re-opening in Asia and private companies adapting their sourcing, it can help calm fears on the issue.

We see inflation as a key issue for markets going forward. But signs of alleviation in supply chain pressure, coupled with marginally better news on China and the US debt ceiling — plus expectations of good US corporate earnings — may continue to support markets in the near term.

US economic outlook

While the big risk issues are marginally improving, the outlook for US growth is also encouraging.

US retail sales were better than expected at +0.7% m/m, with positive revisions for the previous month. This means it’s holding up despite a surge in the past year. There is strength in discretionary spending (clothing, sporting, e-commerce) which was up 13.9% year-on-year (and 15.6% ex-autos).

Fiscal stimulus has played an important role in this. It also goes some way to explaining some of the supply chain issues we are seeing.

Consumer spending is expected to shift from retail to the service sector as restrictions are rolled back. It remains supported by $US2 trillion in excess savings as a result of stimulus. Income growth also remains greater than expenditure.

Markets

We are seeing some important and positive signs, such as:

1. Commodity prices appear to be breaking higher, having consolidated for six months. This reinforces the notion that concerns over supply chain issues may be peaking.
2. The sectors most affected by supply chain issues are beginning to perform. This suggests the market is looking through near-term issues and expecting a strong catch-up in demand next year.
3. Chinese bond yields have begun to move higher. They had previously been falling since the start of the year and were a decent signal on the impending Chinese slowdown.
4. The Australian dollar is rallying against the Yen — another positive cyclical indicator.
5. There are signs the equity market is broadening, with the small cap index stabilising versus the overall market.

In conclusion the market signals are more positive than the media headlines. This is often the right signal to watch for.

About Crispin Murray and 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 an independent, global investment management business focused on delivering superior investment returns for our clients through active management. 

Find out more about Pendal Focus Australian Share Fund here.  

Contact a Pendal key account manager here.