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

• The call on how big the Fed’s September cut will be is “finely balanced”
• Need to look elsewhere for data, which will shift markets and guide the Fed
• Find out about Pendal Focus Australian Share Fund
• On demand: Crispin Murray’s Beyond the Numbers webinar

SOME elements of the current investment landscape are finely balanced right now.

For example, the US election is anyone’s call at this juncture.

That’s pretty handy, because the market can ignore policies from both sides at the moment – it’s a bridge too far to price anything in.

The call on whether the Fed cuts by 25 or 50 basis point (bps) in September is also finely balanced.

Pricing has been seesawing between a 30% and 60% chance of a 50bps cut. The much-anticipated employment data out of the US last week wasn’t non-consensus enough to move the dial materially outside of these bands.

Comments from the Fed late in the week saw the market finish at the lower end of the 50bps cut probability band.

On the other hand, the toe-to-toe in Australia last week between RBA Governor Michele Bullock and Federal Treasurer Jim Chalmers wasn’t “finely balanced”.

The treasurer pointed fingers at the RBA, which retorted with comments that may not sit very well with the government this close to a federal election.

The S&P/ASX 300 fell 0.66%, while the S&P 500 was off 4.2%.

Resources were trounced (down 6.27%), with red ink across the commodity and equity screens. The outperformance of banks versus resources nearly added another 10% to an already incredibly lop-sided ~50% for the year to date.

Australian reporting season wrapped, with overall downgrades to FY24 earnings-per-share (EPS) of about 3%. Reporting season market volatility was in line with what we have experienced since Covid.

Margin pressure was probably the key call-out from reporting season. A more subdued sales environment means that continued cost pressures are manifesting in negative operating leverage, which is flowing through to pressure on earnings and dividends.

There is some CPI and PPI due this week but the infatuation with inflation has largely run its course, and without any real data on growth, the market may be a bit skittish as we head toward Fed decision time.

US macro and policy

The Fed

Emphasis on the focus shift from inflation to the labour market was evident in several comments from the Fed – probably the last as it moves into black-out mode before the next meeting:

San Francisco Fed President Mary Daly noted the need to cut rates to keep the labour market healthy, highlighting the risk from “a real rate of interest that’s rising into a slowing economy”.


FOMC Board member Christopher Waller said that Friday’s job report showed that the labour market has cooled, but that evidence doesn’t suggest that the economy is in recession or “necessarily headed for one”. He noted that front-loading rate cuts, or cutting in 0.50% increments, could be appropriate if determined “by new data”, suggesting he would need to see subsequent evidence of significant deterioration.


New York Fed President John Williams noted that balance in the labour market and good data on inflation “are telling us it’s time to dial down that restrictiveness” of monetary policy.


Atlanta Fed President Raphael Bostic sounded more cautious, saying that the Fed’s goals of stable prices and full employment are in balance but that he is “not quite prepared” to claim victory on inflation.

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Economic data

The Institute for Supply Management (ISM) US manufacturing index shrank in August for the fifth consecutive month. At 47.2, it was higher than July’s 46.8 but lower than the 47.5 expected.

New orders – which are watched as an indicator for growth – fell from 47.4 to 44.6, which is an 18-month low. Production, at 44.8, is at a four-year low.

The bottom line is that the manufacturing sector is just not large enough to weigh too heavily on overall GDP, and so remains a small headwind to production and employment as it has been for a few years now. 

We need to look elsewhere for economic data, which will shift markets and guide the Fed. 

The ISM Services index rose from 57.0 in July to 57.3 in August and continues to suggest moderating inflation in underlying services over the next few months.

Employment

There was a raft of datapoints which generally underpinned the notion of a softer labour market:

• Friday’s August non-farm payrolls were keenly anticipated and rose 142k versus a consensus expectation of 165k. Net revisions to previous readings were down 86k.
• The unemployment rate fell from 4.3% in July to 4.2% in August, which was in line with expectations. The three-month average is now 0.54% above the trailing 12-month average, rising from 0.49% in July and leaving the Sahm Rule of recession still triggered.
• Average hourly earnings rose 0.4%, the biggest gain in seven months and ahead of 0.3% expectations, driven by the service sector. It is now running at 3.8% year-on-year, up from 3.6% in July, and while the Fed focuses more on the employment cost index (ECI) than average hourly earnings, this bears watching.
• Earlier in the week we saw the ADP Employment Report, which rose 99k in August versus 141k expected. July was revised down from 122k to 111k. Private job creation slowed for the fifth consecutive month and was the lowest since January 2021.
• The bulk of new jobs were in construction, education and health services, and financial activities. There were declines in manufacturing, information and professional/business services.
  • July job openings, measured by JOLTS, came in at 7.67m versus 8.10m expected, falling to the lowest level since January 2021. The number of vacancies per unemployed worker is now at 1.1x, the lowest level in three years and almost half the peak of 2.0x in early 2022.
• Finally, initial jobless claims came in at 227k versus the 230k expected and the previous week was revised up from 231k to 232k. Continuing claims were 1,838k versus the 1,868k expected and the previous week was revised down from 1,868k to 1,860k.

Australia macro and policy

Federal Treasurer Chalmers noted that while he and the RBA Governor have different responsibilities, they are both focused on getting “on top of this inflation challenge in our economy without making life harder for people or smashing an economy, which is already weak enough”.

In contrast, Governor Bullock observed that “if the economy evolves broadly as anticipated, the Board does not expect that it will be in a position to cut rates in the near term” and that “full employment is not served by letting inflation stay above target indefinitely”.

She noted that younger and lower-income households have been particularly affected by cost-of-living pressures given tighter budgets.

On the data front, GDP increased by 0.22% in Q2 2024, which was largely as expected, and decelerated by 0.30% to 0.97% year-on-year, which was the weakest in 32 years barring the pandemic. Furthermore:

• Domestic demand rose 0.20% for the quarter and 1.5% for the year. Private demand remained constant at 0.8% year-on-year while public demand rose 0.8% for the quarter to 3.5% for the year. Public demand as a proportion of the economy is now 28%, which is the highest ever level (again, barring the pandemic).
• Net exports (up 0.20%) and inventories (down 0.30%) largely offset each other.
• Household consumption fell 0.20% in the quarter and rose 0.50% for the year. This was the largest quarterly decline (ex-Covid) since the GFC, with the Australian Bureau of Statistics suggesting that the “Taylor Swift” effect of the March quarter may have contributed to the decline. The RBA was expecting 1.1% year-on-year growth. Transport fell 4.4% for the quarter, while hospitality (down 1.5%) and clothing (down 2.6%) were also weak. Gains came in household goods (4.0%), utilities (2.4%) and education (1.2%).

Elsewhere, CoreLogic noted that its rent index was unchanged in August for the second straight month.

• The national annual growth trend was 7.2%, the lowest rate since May 2021.
• Rent values in Sydney declined for a second consecutive month.

Australian reporting season wrap-up

Earnings misses (38% of the market) outnumbered beats (32%), with the ratio of 0.8x ratio of beats to misses well below the long-term average of 1.4x.

Disappointments were driven more by margin, as revenues were largely in line with expectations.

At an aggregate level, ASX 200 FY24 EPS Growth was down 4.6%, which was in line with consensus and a second straight year of falling profits for the index.

Sales growth for the average firm slowed to 6.4% from 8.9% in the prior comparable period, but stickier costs (particularly wages) continued to put pressure on profitability – with margins now back in line with long-run averages.

Dividends fell 1.9% but, at 3.6%, were notably higher than forecast thanks to rising payout ratios and a number of special dividends from retailers such as Woolworths, JB Hi-Fi and Super Retail Group.

At an index level, small caps fared worse – 45% of small caps missed expectations versus 31% of large caps, and earnings revision trends have been twice as negative.

• Outlook commentary was generally cautious, with earnings revision trends weaker than normal:
• ASX 200 FY25 EPS growth has been cut from 3.7% to 0.4%, putting in play a third-straight year of negative growth for the index.
• Across Industrial firms, FY25 EPS was cut by 3%, nearly twice the long-run average and now standing at 4.4% (7.0% ex-banks). While revenue forecasts were trimmed, the bigger driver of downgrades was margins given companies are continuing to struggle to pass on higher costs.
• Downgrades were broad-based, but larger in cyclical sectors such as steel, gold, media, energy and mining. Of the more defensive sectors, healthcare continued its recent run of negative earnings momentum.
• Banks was the only sector to see net upgrades, driven by better net interest margins, albeit to only flat earnings for FY25 and despite highlighting some concerns around deteriorating asset quality.
  Stock volatility in response to earnings was lower than the past two reporting seasons but remained elevated versus the pre-Covid era.

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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