Jim Taylor: What’s driving ASX stocks this week

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

THE US CPI print, which dominated headlines last week, reminded markets to expect the unexpected.

The highly anticipated data point came in hotter than expected and even the most dovish will now expect 75bps moves in November and December.

The federal funds rate predictions also shifted to just a tick under 5% in Q1 2023, resuming the debate on the likelihood of a recession.

Inexplicably, on the day of the print the market went bottom-left to top-right – which no one foresaw but plenty rationalised.

These theories were swiftly discarded as markets reversed back into the red on Friday.

The situation in the UK highlighted that material policy errors need to be near of mind when forming expectations in this highly unpredictable environment.

Australian markets fared quite well despite a down week for commodities.

The flat performance was mainly attributed to the positive earnings outcomes in the financials sector.

Economics and policy

The Fed’s stance was split in two last week.

At the start, the commentary was somewhat conciliatory and balanced, indicating that past short-and-sharp rate rises will need time to work through the economy.

Current moderation in demand was due to economic tightening being “only partly realised so far”, added Fed vice-chairwoman Lael Brainard.

Chicago’s Fed president Evans warned of the cost of “overshooting” rate rises.

But after the CPI print, the Fed took a more hawkish tone. Key members flagged the prospect of a 5% fed fund rate at the end of 2023.

These latest Fed minute show a greater degree of differing opinions than usual. This is evident in opinions on goods and services, noting relief in key pressure points such as shipping costs, delivery, and rising inventories. This suggests supply bottlenecks have passed their peak.

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The hawks, however, claim this small improvement does not offset continued elevated rates in core goods prices.

Labour markets appear to be moving towards a better balance, with a lower rate of job turnover, moderation in employment growth and increase in labour force participation rate.

Concerns of a wage-price spiral weighed on sentiment since some expect this may occur sooner rather than later.

Meanwhile it was a tumultuous week in the UK.

The Truss administration backflipped on several key economic policies it defended weeks prior – most notably scrapping plans to freeze UK tax next year.

This was an attempt to settle the markets and allow pension funds to extricate themselves from the recent liquidity crisis.

Attempting to salvage the situation, the PM sacked the treasury chief and back-peddled on her vision for a low-tax environment.

This fanned the political flames, stressing an already nervous market. 

US CPI Print

The US CPI rose +0.4% MoM and 8.2% YoY, which was above the consensus of 0.2% and 8.1%.

Core CPI (ex food & energy) surged another 0.6% to 6.6% versus 0.4% and 6.5% consensus.

Shelter and medical care prices also saw big increases.

US inflation is still elevated, though longer-term expectations are fortunately still anchored.

For the first time in two years we saw core services inflation (6.7% YoY) exceed the core goods inflation (6.6%).

This indicates that goods inflation is passing the baton to services. This is alarming for markets, since inflation in services tends to be far more persistent than goods.

Services make up about 75% of the core index, meaning it triples the influence of core goods.

Overall, core goods inflation was relatively flat, with a 1.1% drop in used car prices offsetting a 0.7% increase in new cars. There were smaller gains in tools, tobacco and other recreational goods.

In contrast, core services inflation was up 0.8% MoM – the highest reading of the cycle and the biggest increase in 40 years.

This was largely due to prices (ex-energy) increasing by 0.8%, acceleration in rents and hefty increases in health and vehicle insurance components.

Shelter continued to anchor core inflation, rising 0.75%/6.6% MoM/YoY – accelerating from the July and August run rates.

Owners Equivalent Rent rose 0.8% which was the highest rise since 1990. When looking at current climate however, data suggests rents are beginning to roll over.

Excluding shelter, services still were up 0.9% Additionally, transportation services inflation was up 1.9%, medical care up 1% and airline fares rose 0.84% MoM.

The PPI also rose above consensus (+0.4%), with a 1.2% jump in food prices and 0.7% increase in energy prices.

Similarly with the CPI, the core increase was primarily in services, up 0.6%, while goods remained flat. One positive note is we are not seeing a continued escalation of margins.

Additional non-CPI data was also released last week. Notably, the Michigan consumer sentiment index rose to 59.8 from 58.6 which was slightly above consensus. This suggests the covid-induced savings bubble has continued to support spending, despite it being depressed overall.

Five-to-ten-year inflation expectations rose to 2.9% from 2.7%, reversing the August drop. The one-year expectations rose more materially by 0.4% MoM to 5.1% YoY, the first rise since March.

These increased expectations could pose troublesome for those wanting the Fed to start putting their foot on the breaks, given how closely the policy makers watch this number.

Australia

Similar to the rest of the world, consumer sentiment in Australia remains firmly in a recessionary environment.

Despite this, consumer behaviour continues to contradict with business conditions remaining very robust throughout Q3.

Importantly, low consumer confidence is not driven by labour as Australians remain highly active in the jobs market. Unemployment expectations are reaching all-time lows with no real slowdown in sight for the hiring movement.

Selling price inflation and wage costs dipped slightly but remain strong overall. Measures of price pressures eased somewhat in September but remained elevated in levels terms.

Labour costs eased 30bps to 3.1% QoQ after peaking in July. Purchase costs eased 60bp to 3.8% QoQ while final product prices eased 40bps to +2.1% QoQ.

These data points all point towards robust economic conditions despite inflation remaining elevated.

Markets

Volatility was the name of the game last week. The day of the CPI print was only the fifth time in history the S&P500 has opened down 2% and finished up 2%. It was also the first time the Dow has fallen 5% and risen 8% in a single session.

The gains were short lived as a sharp reversal occurred on Friday.

Bond yields were choppy, ending up for the week. Brent oil was up 2.4% alongside copper which bounced down and up 1%. The AUD traded down to 61.7c, was swept in the CPI euphoria and ended back at 63c.

It is predicted that inflation concerns will not be conclusively taken off the Fed agenda until corporate margins/earnings start coming down. As of now, there is not much evidence of broad-based margin/earnings issues yet.

The Australian market was supported last week by the performance of the major banks (Financials +3%) and Consumer Staples (0.4%). Large-cap miners were flat for the week with the brunt of the pain in resources felt in the mid and small-cap space.

The REITs (-2.2%) sector struggled due to big discounts to book value and too much gearing. It is becoming increasingly hard to identify the circuit breaker to this valuation down spiral.

Information Technology (-3%), Health Care (-2.9%) and metals had another tough week.

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.

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

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