What’s driving ASX stocks this week

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

CONCERNS about the Middle East and Ukraine, ongoing tight money conditions and an opaque inflation outlook are weighing on equity markets.

On a positive note, we’ve seen an improvement in US domestic politics with the appointment of a House speaker after a three-week hiatus. Though the underlying US political backdrop remains deeply partisan.  

Oil prices remain elevated but have not spiked despite Middle East mayhem. Crack spreads — the pricing difference between a barrel of crude and all the petroleum products refined from it — are actually pointing to lower oil prices.

Gold and natural gas prices also remain high.

Iron ore prices are up on expectations of a China stimulus package and lower Chinese domestic iron ore production.

In Australia, a September quarter consumer price index (CPI) of 1.2% pointed to a re-acceleration of inflation, with stickiness in rents and services.  

Aussie two-year and 10-year government bond yields were up 10bps and 7bps respectively last week.

The S&P/ASX 300 shed 1.05% for the week, led down by interest-sensitive sectors such as real estate (-4.33%) and technology (-3.60%)

Simply put, higher rates are likely to reduce an already muted earnings growth outlook. 

US macro and policy

Overall, the economic consensus in the US is now the Goldilocks scenario of inflation on a glide-path to 2%, with GDP slowing and a soft landing.

This is what’s currently in the price.

US GDP growth remains strong and US consumers are still spending.

However there are straws in the wind that suggest growth might be slowing — including a plunge in the recent EVRISI homebuilder survey and some softer manufacturing indices.

Labour costs and services inflation remain thorny issues for inflation. However Covid-inspired quit rates are slowing, helping the outlook for slowing labour price gains.

It’s interesting to note the US has a real (inflation-adjusted) cash interest rate of 1%, versus zero for Europe, about -1% for Australia and -3.5% for Japan.

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Higher real cash rates help lower inflation. Jamming the Fed funds rate above the inflation rate worked in 1979 for Fed governor Paul Volcker, who broke the back of inflation.

The US yield curve is now much less inverted than it was mid-year. The spread between 10-year and two-year nominal yields has fallen from about -100bps to -20bps.

We continue to watch a number of factors which have driven 10-year yields to 20-year highs. These include:

• Strong Q3 GDP growth of 4.9%
• Increased supply of Treasuries as the fiscal deficit expands
• Reduced demand for US government bonds from global investors. There is also competition from rising yields on offer in Japan
• Reduced demand from the Fed

Looking at the past eight Fed tightening cycles, bond yields fell post the final hike each time by 90bps on average over the following six months — irrespective of whether a recession or soft-landing followed.

However history also shows that sharp rises in 10-year bond yields often culminate in a financial “accident” such as the 2018 global sell-off or the 2013 “taper tantrum”.

We did see the US banking crisis earlier in the year and we remain on watch for other signs of stress.

Australian macro and policy

September’s CPI came in at +1.2% for the quarter, up from a +0.8% rise in the previous quarter.

It was 5.4% year-on-year, down from 6% in the June quarter.

The trimmed means were 1.2% for the quarter and 5.2% for the year.

The devil was in the detail. Food grew only 0.6%, helped by deflation in the fresh food category. Meanwhile subsidies helped rein in growth in the childcare and electricity components.

Services inflation remains elevated, driven by rents and insurance. It’s likely that growth in the rental component is understating the actual state of rents.

An RBA rate hike is now more likely in November.

We do note that accounting software company Xero’s data suggests wages rose just 1.9% in the year to September and averaged 2.7% in the prior three months for Australian small businesses. This is a positive trend for inflation.

Labour cost growth is starting to trend down, according to the latest NAB business survey.

About Pete Davidson and Pendal Focus Australian Share Fund

Pete is Pendal’s head of listed property and a portfolio manager in our Aussie equities team. For more than 35 years, he has held financial markets roles spanning portfolio management, advisory and treasury markets.

Pendal Focus Australian Share Fund is Crispin Murray’s . 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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