Despite some negative surprises among ASX industrials this earnings season, there are still opportunities for stock pickers. Pendal analyst ANTHONY MORAN explains his approach

THERE have been plenty of negative surprises among industrial stocks this ASX earnings season, showing how companies across the economy are changing their behaviour, says Pendal equities analyst Anthony Moran.

It’s an environment that provides opportunity for stock pickers – if you know what to look for.

“Several industrials companies have demonstrated weakness for the December six months and it’s been a surprise,” Moran says.

“There is more weakness than expected and that’s manifesting in corporate results.”

Moran nominates packaging group Amcor where volumes were down 10 per cent for the December quarter, year-on-year.

“That’s quite astounding for a company that sells packaging for centre-of-the-aisle groceries.

“It highlights that there is weak demand in certain sectors, and the de-stocking impact has exceeded expectations,” Anthony says. Pendal holds Amcor.

More broadly, it shows that companies across the economy are trying to manage higher interest costs by reducing working capital and maximising their cash balances, he says.

Pendal Australian equities analyst Anthony Moran
Pendal Australian equities analyst Anthony Moran

“Amcor saw it. Fletcher Building experienced it through the New Zealand construction cycle.

“Treasury Wine Estates saw it in their US wine business and in their Asian premium business. At Treasury there is more destocking then expected along with a weaker consumer.” Pendal holds Treasury Wines.

Where to look for opportunities

The macro shifts hitting individual companies throw up opportunities for investors, Moran argues.

“There are companies that have cyclical weakness, and their valuations can be attractive.

“You want to look for a company that has the ability to grow above its end market and has the potential to accelerate its share, even in a declining market.

James Hardie (held by Pendal) is an example, he says.

“It’s shown strong growth in the last 12 months even as the repair-and-remodel cycle has been down double digits in the US.

“You want companies that are able to do that,” he says.

Another example is Orora (also held by Pendal) which is a major packaging distributor which has spent time implementing a new operating model, that is now showing sustained market gains, Anthony says.

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Delivering good performance from a core business, even if the market is not growing, is attractive to investors, Anthony says.

“Aristocrat Leisure is doing that at the moment. The US casino market is stable, but Aristocrat is delivering good performance.” Pendal holds Aristocrat.

Look for companies emerging from down cycles

He says investors should consider looking for industries that are emerging from down cycles, particularly if they are worried about the economic outlook.

Another theme coming through earnings season, particularly across industrials, is margin disappointment, Anthony says.

“In Fletcher Building’s case, the sensitivity of the margins surprised but that’s what you get in big volume downturns.

“But for someone like Hardie, it did disappoint on its margin outlook, and that’s because some of the cost relief they got during Covid is starting to normalise up.

Transurban is another example where they recorded another year of cost growth above inflation and that’s crimping their margins.

“The headline is that costs are still an issue for a number of companies and for most industries pricing power is coming off. It means investors need to watch margins,” Anthony says.

“The next 12 to 24 months is going to be the great normalisation of the post-Covid super-cycle in margins, at least for the industrials sector.”

About Anthony Moran

Anthony Moran is an analyst with more than 15 years of experience covering a range of Australian and international sectors. His sector coverage has included Australian Industrials and Energy, Building Materials, Capital Goods, Engineering & Construction, Transport, Telcos, REITs, Utilities and Infrastructure.

He has previously worked as an equity analyst for AllianceBernstein and Macquarie Group, spending a further two years as a management consultant at Port Jackson Partners and two years as an institutional research sales executive with Deutsche Bank.

Anthony is a CFA Charterholder and holds bachelor’s degrees in Commerce and Law from the University of Sydney.

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Here are the main factors driving the ASX this week, according to portfolio manager RAJINDER SINGH. Reported by portfolio specialist Chris Adams

GLOBAL equity markets took a breather last week, while bonds continued to sell off as they have so far throughout February.

Stronger-than-expected US inflation numbers weighed on both asset classes. Core CPI — and the services components in particular — stayed stubbornly high.

Other key US data releases were mixed.

Overall, these indicators increase the likelihood that the US Federal Reserve will want to accumulate more evidence of sustained disinflation before making its next change in rates.

Markets already had moved to a view of a first cut in May or maybe even June, rather than March as hoped earlier in the year.

In other international economic news, two G7 countries – Japan and the UK – dipped into technical recessions.

Commodities have been relatively resilient, with oil holding onto its previous gains, and copper and lithium enjoying some relief after a difficult 2024 so far.

In Australia, the unemployment rate edged up and Australian bonds followed US bond yields higher.

We saw reporting season moving up a gear with numerous important results coming out.

Early indicators suggest that in aggregate, companies are delivering revenue in line with expectations, but with upside on earnings due to better margin management.

The S&P/ASX 300 gained 0.23% while the S&P 500 fell 0.35%.

US macroeconomics

Last week, we saw two important US inflation indicators: the producer price index (PPI) and consumer price index (CPI).

The headline PPI advanced 0.3% in January, which was a stronger than the 0.1% expected.

The acceleration in core PPI was an even bigger surprise, increasing by 0.5% versus consensus of 0.1%.

Another concern is that some components of PPI, especially health care, were strong in January and these are aligned with those used in the Fed’s preferred measure of inflation – the personal consumption expenditures (PCE) core services ex-housing (CSEH) index.

Some economic forecasters increased their predicted PCE inflation as a result.

The CPI report was the most influential of the week’s economic indicators.

Headline CPI for January came in higher than expectations, up 0.3% month-on-month and 3.1% year-on-year versus consensus increases of 0.2% and 2.9%, respectively.

Core CPI advanced 0.4% and 3.9% year-on-year, which also was higher than consensus. 

Strength in housing-related Owners Equivalent Rent (OER) and Core Services ex-Housing drove this result.

This was the highest Core CPI reading in eight months, prompting a sell-off in the S&P 500 and an increase in bond yields.

While CPI is still decelerating, the concern is that the pace of this decline has stalled – requiring the Fed to keep rates up higher for longer.

The case for this is supported by the gap that has opened up between Core CPI and PCE Core Services ex-Housing measure.

There were some noteworthy trends in the CPI components:

  • Services inflation remains consistently higher and stronger, though some forward-looking indicators suggest rent should have a moderating effect.
  • Commodities and food effects have continued to reduce slowly over the last 12-18 months.
  • Energy is having a deflationary effect, though this could easily reverse with base effects and changing prices.

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Following the release of the CPI numbers, the Fed’s Chair, Jerome Powell, held a closed-door meeting with US House members.

Here, he reportedly said words to the effect that the CPI numbers were consistent with the Fed’s expectations and that they would look at the upcoming PCE report to give them some more information.

Elsewhere, January retail sales were also disappointing, down 0.8% month-on-month.

Housing starts were soft, down 14.8% month-on-month in January, but poor weather has been blamed for depressing both indicators.

Initial Jobless Claims remained low at 212,000, indicating that US labour markets still appear resilient.

On Tuesday, we saw the release of the NFIB small business survey, which showed that US business sentiment remains at recessionary levels.

However, the survey also showed small businesses continue to moderate price rises.

In terms of consumer sentiment, the University of Michigan update showed consumers feeling significantly more optimistic than the low levels in 2023.

Historically, this has correlated with S&P 500 market performance.

Global macroeconomics

US goods imports data demonstrates the sharp decline in China’s share of the US market.

As a percentage of total US imports, China has fallen from a peak of more than 20% prior to Covid back to 13.7% in December 2023 – roughly the same level as 2004.

Mexico has overtaken China with 15.3% of US imports, which at least partly reflects the outcome of “near-shoring”.

Elsewhere, the EVRISI survey of company sales in China shows that sales have fallen back to near-record lows and are only just above the Covid trough.

Japan and the UK dipped into technical recessions with a second quarter of economic contraction in Q4 2023. Germany also contracted but had been flat in the previous quarter. 

Japan’s three-decade economic slide continues, with the country slipping from the third to fourth-largest economy in the world after the US, China and Germany.

Australian macroeconomics

The unemployment rate rose to 4.1% (consensus 4.0%), which is the first time above 4% since Jan 2022.

Employment was flat, the number of unemployed rose 22,000, and the number of hours worked dropped 2.5%, though there may be seasonal effects at play.

It’s only one month of data, but it is in line with other indications that the Australian economy is starting to show signs of slowing.

The trend in employment growth slowed considerably towards the end of 2023.

Also, the shift from full-time to part-time employment as the composition of hours worked indicates a degree of under-utilisation within the Australian labour force, which is important in helping slow inflation.

ASX earnings season

It’s still relatively early days, but it’s been a decent start to ASX half-year reporting season.

Australian companies seem to have navigated relatively subdued revenue growth by increasing margins and delivering decent EPS outcomes.

An analysis of management commentary indicates that companies are, if anything, a bit more optimistic (or at least less pessimistic) about current positioning and the outlook for the year ahead.

About Rajinder Singh and Pendal’s responsible investing strategies

Rajinder is a portfolio manager with Pendal’s Australian equities team and has more than 18 years of experience in Australian equities. Rajinder manages Pendal sustainable and ethical funds, including Pendal Sustainable Australian Share Fund.

Pendal offers a range of other responsible investing strategies, including:

Part of Perpetual Group, Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management. Responsible investing leader Regnan is now also part of Perpetual Group.

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How to conquer the interest rate peak | Goldilocks beware on inflation data | What to watch in a turning-point year | What’s driving the market this week

What’s next for rates and how should fixed-interest investors be positioned? CommBank chief economist STEPHEN HALMARICK and Pendal’s head of government bonds TIM HEXT discuss their views in a new on-demand webinar

Below are the highlights. Watch the webinar here

AS chief economist at Australia’s biggest bank, Stephen Halmarick has better access to real-time consumer data than almost anyone.

The day after the RBA’s February rates decision, Halmarick sat down to share his insights in a webinar with Pendal’s head of government bond strategies Tim Hext.

“The Reserve Bank kept a mildly hawkish tone … at its board meeting,” Halmarick said after the no-change decision.

“Governor Michelle Bullock isn’t yet ready to declare victory against inflation.”  

Official figures, and internal data from the Commonwealth Bank, show the economy is slowing and growth this year is likely to be below trend, he said.

“Household sectors will be under ongoing stress. But business investment intentions are holding up nicely. And state government infrastructure spending is still pretty solid.”

Soft landing

Halmarick believes the Australian economy is heading for a “soft landing”, based on weak consumer spending.

“It’s not till we get the rate cuts through the door that we see consumers start to pick up,” he says.

“We think the unemployment rate by the end of this year will be closer to 4.5 per cent.

“There will be more people employed but there will also be more people joining the labour market.

“It’s important to remember that nobody needs to lose their job for the unemployment rate to go up.”

Halmarick expects inflation to keep falling this year, giving the central bank confidence to cut the official cash rate in September.  

US inflation almost under control

Pendal’s head of government bond strategies Tim Hext says the US economy is close to getting inflation under control.

He believes the first rate cut in the US will happen in May, followed by several more this year.

“The RBA always follows what happens globally,” Hext says in the webinar.

 “This cycle has been all about inflation and that’s what will allow the Reserve Bank to start cutting rates.”

Hext believes there will be three or four cuts within six months of the first reduction in the local cash rate, which he tips will be in September.

Geopolitical factors and other risks

What are the key risks to this scenario?

Halmarick points to geopolitical factors and risks around supply chains, as well as the performance of China.

“Domestically the key risk is the fall in household real income,” he says “The other big issue is the housing market.

“I’m particularly interested in rental markets. Rents are chewing up so much more of people’s money.”

Hext says the list of worries about the economy is getting smaller, not bigger.

One potential concern is the Reserve Bank’s aggressive reduction in its inflation forecast – it expects headline inflation to be 3.2 per cent by the end of 2024.

There’s a risk that won’t be met, says Hext.

And he says oil – via primary and secondary effects – can also have an impact on inflation.

Significantly, the Reserve Bank seems more relaxed about wages.

Both Stephen and Tim agree that the upcoming tax cuts in the middle of the year will not make a significant difference to inflation or growth, relative to the already legislated Stage 3 tax cuts.

What does it mean for fixed income investors?

With a soft landing the most likely outcome, the current bond rally should be sustained, argues Hext.

Last year investors could buy “real yields” on 10-year bonds above 2 per cent – meaning the investor gets 2 per cent above the inflation rate on a government bond.

“That’s very generous for taking very little risk,” Hext says. “It’s not sustainable unless you have a massive productivity boom.

“If inflation heads towards 3 per cent and real yields start to head back towards where productivity is at the moment – somewhere between zero and 1 per cent – then 10-year bonds  should land around 3.5 per cent and the cash rate around 3 per cent.

“Right now we are a bit above 4 per cent so there’s a fair bit of juice left in 10-year bonds,” he says.

“The rally should be sustained. Bonds still represent some value though they’re not as cheap as a year ago.

“Under a soft-landing scenario, it is quite risk friendly. “

Which asset classes should investors consider?

“You should have more duration than normal in bonds, you should be comfortable about owning credit, and it’s not a bad environment for equities,” argues Hext.

Watch the one-hour webinar here. CPD points apply

About Tim Hext and Pendal’s Income & Fixed Interest boutique

Tim Hext is a Pendal portfolio manager and head of government bond strategies in our Income and Fixed Interest team.

Tim has extensive experience in banking, financial markets and funding including senior positions with NSW Treasury Corporation (TCorp), Westpac Treasury, Commonwealth Bank of Australia, Deutsche Bank, Bain & Co and Swiss Bank Corporation.

Pendal’s Income and Fixed Interest boutique is one of the most experienced and well-regarded fixed income teams in Australia.

Find out more about Pendal’s fixed interest strategies here

About Pendal

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

In 2023, Pendal became part of Perpetual Limited (ASX:PPT), bringing together two of Australia’s most respected active asset management brands to create a global leader in multi-boutique asset management with autonomous, world-class investment capabilities and a growing leadership position in ESG.

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The latest US CPI data surprised to the upside. Pendal’s head of government bond strategies, TIM HEXT, explains what it means for investors

THE inflation numbers were released this week and surprised to the upside.

Headline for January was up 0.3% (3.1% year over year) and core up 0.4% (3.9% year over year).

This meant that CPI has, for now, failed to follow the PCE (the Fed’s preferred inflation measure) below 3%.

This was only a small miss, 0.1% higher than expected, but was still against the narrative of falling inflation.

After all, the US needs monthly inflation numbers hitting 0.2% before the Fed can relax.

In the US, CPI is heavily influenced by what is called Owner’s Equivalent Rent.

Unlike most countries which only measure rents for those actually renting (in Australia this is 6% of the CPI), the US CPI tries to capture the idea that owners are ‘consuming’ their residence by putting an equivalent rent on it.

This is almost 25% of the CPI basket, on top of the 7.5% for actual rent. Together, they make up housing inflation.

Analysts use Zillow private sector rent numbers as a good lead indicator, but the downward trend there was not matched in this CPI.

Maybe next time.

There was other noise in the numbers, but the market was focused on core services.

The narrative of core goods falling (down 0.3% in this number) contrasts with core services (ex-shelter), which were up 0.7% on the month.

It’s hardly time for the Fed to declare victory.

The focus will now turn to whether core PCE can stay down around 2% annualised or drift higher towards CPI at 3%.

The PCE has a smaller weight to shelter of only 15%. This will help keep it lower than CPI for now.

Historically, core CPI has been around 0.3-0.5% above core PCE as housing has increased at a faster pace than other services.

The following graph, courtesy of Citigroup, shows that these gaps between CPI and PCE do open up quite often, especially when house prices are on the move.

Source: Citigroup, 2024

For now, the markets will grant inflation a bit of leeway.

Yes, cuts from The Fed are being pushed out and bond yields are drifting higher.

Inflation break-evens (long-term expectations) only moved 0.05% higher (from 2.25% to 2.3% for 10 years).

But the market is on notice.

If this becomes a trend in the months ahead, then risk markets will start to take notice, as rates will stay higher for longer and the chances of a recession also increase.

Goldilocks beware.

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Our view is that the overall trend to lower inflation is still intact, but the sugar hit from lower oil prices and improved supply chains we saw late last year is now entering a period of more balanced risks.

This is also helped at the margin by the small improvement in the US budget deficit, which is taking some of the steam out of the economy.

We expect the fallout from today’s numbers to persist very near term, as momentum funds lean against a vulnerable market.

This will open up opportunities to once again build exposure into long-duration positions.

The US now has less than four cuts this year (1%) and Australia less than two (0.5%), from almost six and three respectively at the end of 2023.

About Tim Hext and Pendal’s Income & Fixed Interest boutique

Tim Hext is a Pendal portfolio manager and head of government bond strategies in our Income and Fixed Interest team.

Tim has extensive experience in banking, financial markets and funding including senior positions with NSW Treasury Corporation (TCorp), Westpac Treasury, Commonwealth Bank of Australia, Deutsche Bank, Bain & Co and Swiss Bank Corporation.

Pendal’s Income and Fixed Interest boutique is one of the most experienced and well-regarded fixed income teams in Australia.

Find out more about Pendal’s fixed interest strategies here

About Pendal

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

In 2023, Pendal became part of Perpetual Limited (ASX:PPT), bringing together two of Australia’s most respected active asset management brands to create a global leader in multi-boutique asset management with autonomous, world-class investment capabilities and a growing leadership position in ESG.

Contact a Pendal key account manager

Here are the main factors driving the ASX this week, according to Pendal’s head of equities CRISPIN MURRAY. Reported by investment specialist Chris Adams

GLOBAL equity markets continued to rise last week despite another sell-off in bonds.

The market continues to see stronger economic data — and is now pushing out the expected timing of rate cuts in the US to May or June, rather than March.

Equities were supported by a good US earnings season and the prospect of higher growth to underpin positive earnings revisions. The S&P 500 gained 1.4% for the week.

There was little new insight on the US economy, though a Federal Reserve survey of US bank lending showed early signs that credit tightening was coming to an end. In addition, annual US CPI revisions produced no surprises.

Oil bounced on rising concerns about geopolitical risk but remained in its recent trading range. Brent crude gained 5.6%.

In Australia the Reserve Bank held rates steady and gave a mixed signal on the outlook, effectively conceding they do not really know which way things will break. The S&P/ASX 300 fell 0.65%.

Early half-yearly results were mixed among ASX-listed companies, but largely reflected stock-specific issues.

Sentiment on China continued to deteriorate ahead of the Lunar New Year with base metals lower, which in turn dragged on the resource sector (-3.36%).

US growth outlook

The latest Fed Reserve bank-lending survey pointed to a significant reduction in the number of banks tightening financial conditions.

Credit tightening has been an area of concern for recession bears. Easing here would support the soft-landing case.

Lending standards may be a lead on improving US manufacturing data.

Anecdotally, we are hearing of companies that have reached inventory target levels — and are now waiting on consumer signals before dialling up production.

Jobless claims continued to stay low in the US, averaging 212k per week. This indicates February payrolls will be more than 200k.

The Atlanta Fed GDPNow — a monthly forecasting model created by the Federal Reserve Bank of Atlanta —continues to signal good growth of just under 3.5% for the first quarter of 2024.

Fiscal policy — which has not tightened in the US despite low unemployment — is one factor which explains the resilience of growth.

US Inflation

Inflation news remains supportive, despite better-than-expected economic growth.

This is good for equities, since we’re still seeing the economy holding up with rates able to come down.

The Atlanta Fed’s wage-tracker continues to improve, with 12-month wage growth falling to 5%.

The US Employment Cost Index is back near pre-pandemic levels. Unlike Australia, productivity is strong in the US, which is supportive of the disinflation thesis.

The annual revision of US CPI was also helpful since it contained no surprises (unlike last year). Some feared the progress on disinflation may have been overstated. This has not been the case.

Overall, three-month annualised core CPI stayed at 3.3% with goods a bit higher (-1.2% from -1.6%) and services lower (4.8% vs 5.1%). 

There are some signs to be mindful of on inflation.

The service prices component of the ISM Manufacturing Index rose materially and we continue to have freight disruption due to the Red Sea.

There are some concerns the January CPI due this week may be higher than expected. There has been a seasonal effect recently as certain industries load price increases in that month.

There are offsets to these concerns. Chinese deflation remains material, providing a very different context to the situation during Covid. At this point the market has all but given up on a March cut in US rates.

Pointing to the horizon at sunset

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A May cut is regarded as lineball. June is priced as a near-certainty.

China

Chinese deflation continues.

Its consumer price index (CPI) dropped 0.8% in January (year-on-year) versus -0.5% expected.

Core CPI rose 0.4%. This was the lowest since June 2022 when the economy was in the midst of its zero-covid policy.

The producer price index (PPI) was down 2.5%, in-line with forecasts.

The Lunar New Year holiday may provide some respite from bad news on the Chinese economy.

There remains a lot of speculation about whether its weak stock market will trigger a more aggressive policy response.

Last week Beijing replaced the head of its China Securities Regulatory Commission with a banking veteran who was serving as deputy party secretary for Shanghai.

This is a signal that China president Xi Jinping was not pleased with how the sell-off has been managed. Though the issues are more to do with the economy than anything the regulator is able to control.

We doubt this is a sufficient catalyst for China to become more aggressive on stimulus, since the equity market is still not widely owned and the issues are more structural (related to consumer and private business confidence).

Credit data in terms of total new loans was stronger than expected. Though this was also the case last January and did not follow through then. So we do not place too much faith in this signal.

We note that Chinese fiscal policy was not as supportive in 2023 as it could have been.

This provides room for expansion. Any announcements are likely to come out ahead of the National People’s Congress starting March 5.

Australia

The RBA stayed on hold last week.

The message from the press conference was “each way.”

On one hand Governor Michele Bullock noted inflation was too high and needed to fall. This was important because it was tied to cost-of-living pressures.

On the other, she said recent developments were encouraging. The first cut would not require inflation to be in the 2-3% range if confidence was high that’s where it was heading.

Bullock’s testimony to the parliamentary committee was a little less hawkish but with no forward guidance.

There is an expectation that the economy is slowing and there are some anecdotal signs of this, notably with talk of job cuts.

However, retailers have seen decent sales, the housing market fired last weekend and the US is holding up better than expected.

We also note New Zealand inflation data has been worse than expected, prompting expectations of another hike.

On balance, we suspect the market’s current expectation of an August rate cut may be optimistic.

Markets

Three-quarters of the way through US earnings season we are seeing positive earnings revisions.

The market was expecting 3% EPS growth for CY24 and Q1 is currently signalling around 7%. Stripping out the “Magnificent Seven” tech stocks this is still coming in around 6%.

This strength is supported by resilient margins, as input and labour costs are coming in less than expected.

On the negative side, we’ve seen a step-up in layoff announcements.

This may be a seasonal factor — we saw similar announcements in January 2023. It also has not flowed through yet into claims data.

We are seeing cash deployed. Stock buy-backs were down in the first three quarters of 2023, but began to rise from Q4 and now stand at about US$150 billion.

We have also seen a strong start to investment-grade credit issuance, which is also supportive for funding requirements.

The US market is up 5.52% so far this year. But similar to last year, much of the gains are driven by the Magnificent Seven (which are up 15% while the rest of the market is flat).

We note that gains in the “Mag 7” stocks are supported by earnings growth.

In Australia, resources were weak last week due to concerns over China.

Meanwhile a collapsed deal between Santos and Woodside weighed on the energy sector (-3.53%). 

Healthcare (+1.36%) and technology (+1.01%) were the best sectors.

That reflects a benign environment for quality growth stocks with rates likely to fall while the economy holds up.

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 a 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  

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RBA interest rate outlook | An alternative to bank hybrids | Is DEI good for investors? | Why it’s time to focus on value

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

LAST week was a big one for economic data and US company reporting, amped up by the Federal Open Market Committee’s (FOMC) meeting and Chairman Powell’s press conference. 

US reporting season is tracking in-line with historical trends, and the results from five of the “Magnificent Seven” which reported were generally well received – with a strong showing from Meta crowning the week of results. 

US economic data was all largely as expected and supportive of the soft-landing scenario, until the monster Non-Farm Payroll print on Friday night potentially put paid to the notion of a March rate cut.  

Powell had strongly indicated at the FOMC press conference that a March cut had not been the Fed’s base case.  

Commodities were generally weaker and oil gave back all of the gains from the previous week. 

The week’s upshot is that expectations around the extent of rate cuts in CY2024 now look more appropriately centred. 

The S&P/ASX 300 rose 1.82% while the S&P 500 gained 1.34%.

Interest rates

The Fed removed the previous reference to “any additional policy firming that may be appropriate” from its statement. 

Instead, it noted that it will “carefully assess incoming data, the evolving outlook, and the balance of risks” in determining adjustments to the interest rate. 

In addition, Powell noted that he didn’t think it likely that the Fed could reach a required level of confidence by March to cut rates at that time.   

The market is now focused on the May 24 meeting for a potential first cut.  

This gives the Fed the opportunity to see three additional PCE, CPI, PPI and employment data, as well as the first quarter employment cost index (ECI).   

Elsewhere, the Bank of England voted 6-3 to keep rates steady as expected; there were two votes for a hike and one for a cut. 

US economic data

It was a big week for labour-market data.  

JOLTS 

The JOLTS job opening data rose to 9,026k in December.  

This was above the upwardly revised 8,925k openings in November and ahead of the 8,750k expected by consensus. 

Importantly, the JOLTS quit rate held steady at 2.2%.  

This is regarded as a key lead on the employment cost index (ECI), which is the Fed’s preferred measure of wage growth and suggested moderation here. 

ADP employment 

The ADP employment report delivered 107k increase in private payrolls, which was well below the 150k expected by consensus. 

ECI 

The ECI rose 0.9% quarter-on-quarter for Q4 2023, down from 1.1% in Q3 and versus consensus expectations of 1.0%. This is the smallest increase since December 2019. 

Wage gains slowed to 0.9% from 1.2% in Q3, while the year-on-year rate fell to 4.3% down from 4.6% in Q3 and from the high point of 5.2% in Q2 2022.   

While hawks on the FOMC are possibly looking for a reading below 4%, the annualised increase in Q4 came in at 3.8% while a drop in the quits rate over recent months bodes well for further slowing ahead.  

Initial jobless claims 

Initial jobless claims rose to 224k from 215k, and ahead of the 212k expected by consensus. 

Data around layoffs suggests that jobless claims could head toward 250k in the next few months.  

This is still low by historical standards during an employment slowdown, but is something that the Fed may have their eye on.  

During the week, we also had UPS and PayPal – among others – announcing up to 10% in workforce reductions. 

Non-farm payrolls 

The market had been generally happy with the jobs data through the week.  

Then came the hammer blow from non-farm payrolls, which rose 353k in January – almost twice the consensus expectation of 185k.  

Net previous revisions were also up 126k. 

The headline payroll gain comprises 317K private and 36K government jobs, and gains were broadly spread across the economy. 

The unemployment rate was unchanged at 3.7%, which was just below consensus.  

The available work force has been growing because of migration. 

Average hourly earnings rose 0.6%, versus 0.3% expected, however, this data series is not as reliable as the ECI which is favoured by the Fed.  

The market’s reaction was initially negative on concerns that a firm labour market could push out expected rate cuts.  

However, several analysts noted that Powell had stressed in his press conference that the Fed was not looking for a fall in employment as a pre-condition for rate cuts. 

Pointing to the horizon at sunset

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Australia

Consumer price index (CPI) 

The December quarter CPI came in weaker than expected. 

Headline CPI rose 0.59% for the quarter (versus 0.80% expected) and 4.05% year-on-year.  

This is 45 basis points below the RBA’s forecast made in November. 

The trimmed mean inflation rose 0.78% for the quarter, also weaker than the 0.9% consensus expectation.  

This measure was 4.18% year-on-year and 3.12% at an annualised quarterly rate. 

The result was explained by strong pressure on electricity prices from ongoing subsidies, as well as greater disinflation from tradable goods. 

Strong disinflationary pressure on core goods is increasingly offsetting relative resilience in core services pricing. 

Retail sales  

Retail trade fell 2.7% for the month-on-month in December, worse than the expected -1.7% and reversing the 1.6% gain in November.  

There were material seasonal adjustments to the December figure, without which this figure would have been a 5.3% month-on-month decline. 

Weakness was broad-based across states and led by non-food spending.  

Clothing and soft goods fell 5.7%, household goods was down 8.5%, and department stores were 8.1% lower.  Eating out fell 1.1% month-on-month, while spending on food rose 0.1%.

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. 

Contact a Pendal key account manager here

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The latest quarterly CPI data shows inflation is on the right path. But there’s still more work to do, writes Pendal’s head of government bond strategies, TIM HEXT

Inflation on track towards 3%

THE market was not disappointed with today’s December-quarter CPI inflation data.

The theme since early November has been inflation moderating globally — and today’s Australian numbers back that up.

The headline Consumer Price Index was 0.6% and underlying 0.8% for the quarter. Annual numbers were 4.1% and 4.2% respectively.

These numbers were slightly lower than expected due to electricity subsidies and international travel.

We also got a comparison of December 2023 with December 2022. Weak fuel prices saw that number at 3.4%.

The Reserve Bank is entering 2024 with inflation somewhere around 4% annually but with the three-month annualised number nearer 3%.

Next week’s RBA statement will urge caution

The RBA will be encouraged by these inflation numbers.

Their panic rate hike in November looks like a mistake — but they will claim some credit for the easing pace.

Their caution will come from non-tradable inflation. Non-tradables are prices largely driven by domestic factors — predominately services.

The RBA can have more impact in this area than in tradables, where we are a global price taker.

Non-tradable inflation has eased from 6% to 5.4% but this is still inconsistent with the RBA inflation band.

The RBA would need to see non-tradable inflation nearer 4% if inflation was to fall closer to the 2-3% target band. Non-tradables are around two-thirds of the CPI.

The biggest driver of non-tradable inflation is wages, which are now around 4%.

Therefore there should be some optimism that over 2024 non-tradable inflation can ease further — though recent hikes in areas like education will continue to put pressure on this.

The path of inflation this year

The key battleground for inflation remains housing, which makes up 22 per cent of the CPI.

New dwelling cost growth is easing, but at a slower rate than hoped.

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Rents are still growing, though closer to 5% than 10%. Utilities are held down by subsidies that will be reviewed later this year.

The RBA won’t gain confidence in the medium-term inflation path for inflation until they see housing moderate nearer to 4% in the CPI. (Housing CPI includes the cost of a new dwelling, rents and utilities but not house prices).

The RBA is expecting CPI at 3.9% by June and 3.5% by December.

They may tweak the June number lower but are unlikely to change the December number for now.

Implications for monetary policy

The market still has cash priced for 3.85% — or two cuts — by the end of 2024, with the first around September.

This is driven more by the fact the US is priced for 4% Fed Funds or 1.5% lower by year’s end.

The US is likely to deliver these cuts since their inflation is near target (unlike the RBA).

But the RBA should eventually deliver lower rates — and we think pricing is fair for now.

Hurdles include oil prices (which have sneaked higher in the past week) and resilient employment markets.

Yes, the long-and-variable lags of monetary policy could see last year’s hikes further weigh on the economy, accelerating the need for cuts.

But we think risks lie more to the latter than the former — which makes us still positive on duration.

About Tim Hext and Pendal’s Income & Fixed Interest boutique

Tim Hext is a Pendal portfolio manager and head of government bond strategies in our Income and Fixed Interest team.

Tim has extensive experience in banking, financial markets and funding including senior positions with NSW Treasury Corporation (TCorp), Westpac Treasury, Commonwealth Bank of Australia, Deutsche Bank, Bain & Co and Swiss Bank Corporation.

Pendal’s Income and Fixed Interest boutique is one of the most experienced and well-regarded fixed income teams in Australia.

Find out more about Pendal’s fixed interest strategies here

About Pendal

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

In 2023, Pendal became part of Perpetual Limited (ASX:PPT), bringing together two of Australia’s most respected active asset management brands to create a global leader in multi-boutique asset management with autonomous, world-class investment capabilities and a growing leadership position in ESG.

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