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

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THE domestic market seems to be awakening to the realisation that Australia and the US are at appreciably different stages of this rate-raising cycle.

It will be interesting to observe the extent to which domestic equity sectors begin to de-sync from global momentum trends, reflecting the heavy lifting still required to tame inflation domestically.

Last week the S&P/ASX 300 shed 0.33%.

On a brighter note, the S&P 500’s +0.41% weekly gain meant it technically entered a bull market; up 20% from the 52-week low (Oct 22).

The NASDAQ gained 0.15% — it’s seventh consecutive weekly rise.

US small caps are rebounding and market leadership is broadening from the “mega-tech” names to autos, airlines, energy, machinery, building products and banks.

RBA hikes rates

The RBA increased the cash rate +25bp to 4.1% at June’s board meeting.

The outcome was a hawkish surprise relative to consensus expectations.

Two-thirds of 30 economists surveyed by Bloomberg were expecting a pause, while financial markets had only around +8bp priced ahead of the meeting.

The RBA noted they were looking “to provide greater confidence that inflation will return to target within a reasonable timeframe”.

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They also referenced rising house prices and accelerating public sector and administered wages.

Some key observations of the RBA’s release:

• The RBA retains a bias towards further tightening, noting “some further tightening of monetary policy may be required to ensure that inflation returns to target in a reasonable timeframe, but that will depend upon how the economy and inflation evolve”.
• Inflation: “While goods price inflation is slowing, services price inflation is still very high and is proving to be very persistent overseas.”
• Wages: “Growth in public sector wages is expected to pick up further and the annual increase in award wages was higher than it was last year”. The RBA reiterated that “unit labour costs were also rising briskly, with productivity growth remaining subdued”. The latter point was confirmed by subsequent data.
• Labour: “Conditions in the labour market have eased” but “remain very tight”. The unemployment rate, which has “increased slightly” to 3.7% in April, is “still very low”.
• Housing: “Housing prices are rising again”. While “some households have substantial savings buffers, others are experiencing a painful squeeze on their finances”.

Governor Lowe reiterated these points at a subsequent conference.

Now that house prices were rising again, they had shifted from a headwind to a tailwind for consumer spending, he emphasised.

He also noted that labour productivity remained poor, public sector wages were going up and services inflation remained sticky elsewhere in the world.

Lowe wanted to “make it clear … that the desire to preserve the gains in the labour market does not mean that the board will tolerate higher inflation persisting”.

The board couldn’t just “sit idle” given these risks and there was a limit to their patience on inflation.

The “unevenness” of the effect of higher rates across the community was “not a reason to avoid using the tool that we have”. 

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The sum effect was that the three-month interest rate implied by bank bill futures had shifted from a peak of about 4.1% in September to a touch under 4.5% by December.

There have also been nearly three more hikes priced into the outlook in the past month.

Australian Q1 GDP and other data

The punchline is that the GDP data release painted a picture of an economy slowing materially.

GDP grew 0.2% sequentially in the first quarter — a touch softer than the +0.3% consensus forecast.

This was the third quarter in a row in which growth slowed. Annual growth now sits at 2.3%.

There were a couple of bright points. Business investment (3.4%) and public investment (4%) accelerated in the quarter, reflecting eased supply constraints to a degree.

On the negative side:

• Consumer spending increased only 0.2% for the quarter (3.5% annual). Spending on essentials rose 1.1% for the quarter, but discretionary spending fell 1.0%. This is an important trend to monitor.
• The savings rate fell to 3.7%, below its pre-Covid average.
• Disposable income fell 4% year-on-year in real terms, the biggest annual decline since 1983. While wage income has been strong, the effect of higher taxes (+15% yearly) and interest costs (+107% yearly) are providing a material drag.
• Labour costs are still accelerating. Total Compensation of Employees (COE) has risen 10.8% for the year – the strongest rate since 2007 – given the still tight labour market and rising wages. Productivity continued to decline. GDP per hour worked fell 0.2% quarterly and -4.5% over the past year. This meant that unit labour costs (wages adjusted for output) accelerated in Q1, up 2% for the quarter and 7.9% for the year.

On the housing market, data from CoreLogic showed 11.7% annual rent growth in Australian capital cities in May — a record high. The national vacancy rate is near a record low at 1.2%. New listings are a third below the long-term average.

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This suggests little relief for Australian renters through to the end of the year.

US economy

Headline initial jobless claims rose to a cycle high of 261k, ahead of 235k consensus expectations.

The next few data points are likely to be a little messy given auto makers re-tool over summer. 

The May ISM services index from 51.9 to 50.3. There is a clear shift down following a period in which services remained resilient compared to manufacturing.

At a sub-sector level, declines in the employment and prices indicate slower growth in payrolls and wages. This is good news for the Fed.

Other snippets to note:

• The NY Federal reserve Global Supply Chain Pressure index has hit a record low point extending back to 1998.
• The prime age workforce participation rate moved up to 83.4% in May. This represents 65% of the total workforce. Participation among workers aged 55+ was unchanged at 38.4%.
• The RealPage rent measure came in at 2.3% year-on-year in May, down from 15.6% a year earlier. This is a lead indicator of the rent component of the PCE, which was still at 8.4% for April and is likely to see a substantial fall. This highlights an aspect of the difference between Australia and the US at the moment.
• The three-month moving average Service PMI for prices has fallen sharply this year. It leads the core PCE for services, which is likely to slow significantly for the rest of 2023 and into 2024.

Rest of the World

The Bank of Canada raised rates 25bps to 4.75%. This followed a pause, and was contrary to most expectations.

China’s exports declined 7.5% yearly in May, versus consensus expectations of -1.8%. Exports to the US (-18.2% yearly) and the European Union (-7%) and ASEAN (-15.9%) declined sharply.

The EU slid into technical recession with GDP for the three months to March 23 at -0.4%. The

ECB remains on track for its eighth consecutive rate rise.

Markets

Markets remained gripped by AI mania.

Last week was the biggest weekly inflow in listed technology companies in history at about $9 billion, according to market analysts EPFR. That’s about 40% more than the next biggest inflow in 2021.

The Bureau of Meteorology has announced that the El Niño-Southern Oscillation (ENSO) had shifted from “watch” to “alert.”

This means about a 70% chance of El Niño forming in 2023 — roughly three times the normal chance of an El Niño in any given year. After three years of high rainfall, the “weather ate my homework” excuse may be taken off the table for many companies. 

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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