Here are the main factors driving the ASX this week according to Pendal portfolio manager JULIA FORREST. Reported by portfolio specialist Chris Adams.
THE odds of a 50bp US rate hike next week increased markedly after hawkish comments by Fed chair Jay Powell – but that didn’t last long.
Powell last week told US Congress that if the data indicated faster tightening was warranted, “we would be prepared to increase the pace of rate hikes”.
Stronger-than-expected data suggested “the ultimate level of interest rates is likely to be higher than previously anticipated”, he said.
The comments drove two-year US Treasury yields above 5% for the first time since 2007.
The spread between two-year and 10-year bond yields inverted to -107bp – the biggest inversion since 1980 when then Fed chair Paul Volcker was trying to kill inflation.
However, all this was reversed after the collapse of Silicon Valley Bank (SVB) late in the week, which saw yields fall.
Market expectations for next Wednesday’s decision quickly dropped back to a 25bp hike.
Equities continued to sell off. The S&P 500 fell 4.5% and the S&P/ASX 300 shed 1.2%.
US labour markets and SVB
On Friday we saw a strong US payrolls number with 311,000 additional jobs versus 225,000 expected.
This followed a very strong January number.
February average hourly earnings were up 0.2% M/M and +4.6% Y/Y, slightly below consensus (+4.7%).
In normal circumstances the labour numbers would have realised the Fed’s worst fears about labour market resilience – and we would have seen bond yields spike.
But rates collapsed across the curve in response to the failure of SVB, the 16th biggest bank in the US.
The sudden failure does not appear to be a systemic issue.
The failure was tied to the specific and concentrated nature of SVB’s depositors in the venture capital and cryptocurrency sectors. Deposits attributable to digital currency customers account for 82% of the deposit base.
It appears cash drain from the cryptocurrency fallout and cash burn on venture capital starts-ups led to cash withdrawals.
This forced SVB to sell $11.4 billion of its “available for sale” securities, including Treasuries, mortgage-backed securities and municipal bonds.
After the recent sell-off in fixed income markets, this crystalised a $1.8 billion loss.
Bank stocks were sold off on Thursday and Friday with investors concerned about the quality of bank balance sheets and outlook for net interest margins.
It’s difficult to know if this will be an ongoing issue, since most bank investment portfolios are held to maturity and not forced to mark to market.
There appears to be no issue with deposits in the US banking system.
This episode demonstrates that banks need to offer competitive rates to retail and business depositors, since they are now competing with Treasury bills that offer over 5% and money market funds that offer 4.5% to 5%.
This will squeeze net interest margins or possibly impact the amount of credit in the system.
We have seen signs of credit tightening in response to the cycle.
But we don’t know if financial conditions are tight enough to dampen inflation enough to get back towards “normal”.
Rate-tightening cycles normally work their way through the economy via housing, manufacturing orders, corporate profits and then employment – in that order.
The housing market reflects higher rates, as do new orders, which look bleak.
At this point sales have started to retreat but operating margins in the US remain elevated and profits resilient.
Employment remains strong, though history shows that when employment starts to deteriorate, it does so quickly.
Labour markets tend to be tight until they are not – then central banks realise they have over-tightened.
Australia
As expected, the RBA hiked rates 25bps to 3.6% last week.
The tone was less hawkish and markets are pricing a terminal rate of 4.14% in November 2023.
We are yet to see a meaningful slowdown in consumer data, though sentiment remains soft.
This is puzzling given some 17% of households borrowed at trough rates and 35% face higher rents.
Hiking rates is the only policy tool available to the RBA, though this only affects about half of households.
The other half remain cashed-up, while negative “real rates” on savings encourage continued consumption.
It’s no surprise that luxury goods and international travel spending remain strong.
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About Julia Forrest and Pendal Property Securities Fund
Julia Forrest is a portfolio manager with Pendal’s Australian Equities team. Julia has managed Pendal’s property trust portfolios for more than a decade and has 25 years of experience in equities research and advisory, initial public offerings and capital raisings.
Pendal is an Australian investment management business focused on delivering superior investment returns for our clients through active management.
Pendal Property Securities Fund invests mainly in Australian listed property securities including listed property trusts, developers and infrastructure investments.
About Pendal Group
Pendal is an Australian investment management business focused on delivering superior investment returns for our clients through active management.
Monetary policy gets the headlines — but investors would be wise to pay more attention to fiscal policy, argues Pendal’s TIM HEXT
- Budget decisions dwarf rate changes
- Fiscal policy to dictate if going into recession.
- Find out about Pendal fixed interest funds
WHILE Australia focused on the RBA’s 10th rate rise in a row this month, Team Albanese was working in the background on the May federal budget.
The March rate rise added about $7.5 billion to repayment schedules across the nation.
By comparison, the May Budget will include hundreds of billions of dollars in spending initiatives and cuts, impacting all parts of the economy.
Why does monetary policy get so much attention?
Which is more important for investors: monetary or fiscal policy?
“We’ve built a whole system around monetary policy and the wisdom of the independent central bank,” says Tim Hext, head of government bond strategies at Pendal.
“But fiscal policy doesn’t get enough attention.
“Fiscal policy is more likely to determine whether or not Australia is going to have a recession,” he adds.
Monetary policy – movements by the Reserve Bank in the official cash rate, which is used as a basis for other lending rates – is conveyed regularly, normally 11 times a year after central bank board meetings.
Fiscal policy – the government’s spending policies – normally has only two spotlight events.
The first is the annual budget on the second Tuesday of May, and the second is the mid-year economic and fiscal outlook (MYEFO) about six months later.
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Pendal’s Income and Fixed Interest funds
The power of monetary policy comes less from the actual movement in interest rates, and more from the secondary round impact on asset prices, Hext says.
“The direct impact of monetary policy might not be that huge, but if it causes a boom in asset prices, such as people’s homes, it’s going to make people feel wealthier,” Hext says.
There is about $3 trillion of debt in the economy, Hext says. About $1.2 trillion is held by foreigners and the rest is local – Australians lending to Australians.
Therefore the net impact of a one per cent rate hike on the economy is only $12 billion. The other $18 billion of payments are between Australians.
“After 3.5 percentage points of hikes we are $42 billion a year worse off,” Hext explains.
Fiscal policy the main game
“The government spent $250 billion during Covid. Fiscal policy remains the main game for people’s pockets and the economy.
“It explains why the Australian economy is proving more resilient to rate hikes, at least for now.”
Hext says in a world of four per cent wage growth, bracket creep means fiscal policy is tightening.
Bracket creep occurs when income growth causes individuals to pay higher average income tax each year.
Stage 3 tax cuts, legislated for the middle of next year, will reverse bracket creep, assuming they go ahead.
“Tight fiscal and monetary policy will be a major headwind through 2023 and the Federal Budget in May should confirm this,” he says.
“In essence, fiscal policy just doesn’t get enough attention.”
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.
The team won Lonsec’s Active Fixed Income Fund of the Year award in 2021 and Zenith’s Australian Fixed Interest award in 2020.
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.
Here are the main factors driving the ASX this week according to our head of equities Crispin Murray. Reported by portfolio specialist Chris Adams.
EQUITIES remain range bound, having absorbed a material rise in bond yields without breaking down through technical support levels.
The S&P 500 gained 1.96% last week, helped by stabilising bond yields and a weaker US dollar.
The S&P/ASX 300 was flat (-0.03%). Gains in the resource and energy sectors offset a decline in REITs and domestic cyclicals.
Weak results in discretionary retail and concern over impending rate hikes weighed on the latter.
There was limited news in the wake of reporting season and the market remains braced for further signals from central banks.
Fed chair Jay Powell provides his semi-annual Monetary Policy Report to Congress this week.
The decline in equity markets this year has helped tighten the “Total Financial Conditions” index – a measure of changes in key indicators such as mortgage rates, credit spreads, equity markets and currency moves – possibly allowing the Fed to be more balanced in its comments.
This suggests the market should be reasonably well supported for now, as long as growth and inflation don’t continue to surprise to the upside.
Elsewhere, resource and commodity prices have been stronger in hope of positive statement from the Chinese National People’s Congress. Though the signals indicate less stimulus for growth than many anticipated.
Economics and policy
China
The National People’s Congress, which officially starts Xi’s third term and introduces many new faces at top posts, announced a target of 5% GDP growth for this year.
This is down on last year’s 5.5% target – though up from the 3% that was actually achieved.
There had been hope of a higher target – somewhere near 6% – to reflect the re-opening of China’s economy.
The 5% target – despite an environment of potentially strong “revenge spending” by Chinese consumers – suggests Beijing is not planning material policy changes to stimulate growth, particularly in housing and infrastructure.
This may be prompted by fears around inflation.
This is consistent with local government bond quotas, which are traditionally used to fund investment and are lower than last year.
Beijing is targeting employment stability, with a goal of maintaining unemployment at 5.5%.
US
The latest Institute for Supply Management’s (ISM) Services PMI came in at 55.1 for February, versus 55.2 in January and 54.5 expected.
The new orders component was particularly strong, though the price outlook fell (which is a positive).
This puts paid to theories that the strong reading in January data was an aberration.
It reinforces the issue that the US economy remains too strong to enable inflation to slow sufficiently at the current rate setting.
Service sector resilience is supported by other surveys which note continued strength in restaurant spending.
Anecdotes from home builders suggest the year has got off to a better-than-expected start, despite continued high mortgage rates.
The ISM manufacturing index came in at 47.7 versus 47.4 in January – and below an expected 48.
This suggests manufacturing remains weak but is not deteriorating. New orders are improving and there are no signs yet of significant impending job losses.
US Non-farm business output per hour data – a measure of productivity – continues to decline as we see the pandemic boost unwind.
The economy continues to recover employment without driving additional growth. This potentially signals labour hoarding. It may also indicate job growth in lower-productivity sectors.
Central bank action
The market is locked in on a 25bp from the US Fed.
While economic data has been stronger since last meeting there are emerging signs of easing labour market pressure.
This should encourage the Fed to be patient and stick to the plan of 25bp hikes – while focusing more on the duration of rates at higher levels to deal with lingering inflation pressure.
The European Central Bank is in a greater bind, since inflation data has been materially worse than expected.
European core inflation expectations have risen from 5.2% to 5.6% with the release of regional data, leading to a step-up in inflation and rate expectations.
A 50bp hike is the likely outcome and the tone of comments will probably be quite hawkish given the fear of inflationary pressure on wage negotiations.
The market expects another 50bp in May.
The Reserve Bank of Australia is expected to hike 25bps on Tuesday.
We are watching to see whether it eases back on recent hawkish rhetoric. The RBA may be able to point to some early anecdotal signs of a softening economy, though these are limited and not yet sufficient to offset an apparent strong economic momentum.
While we’re seeing a significant rise in household interest payments, the total as a share of household income is still well below that seen in the GFC, given the growth in income in recent years.
This suggests a soft landing is possible.
But it may also signal the need for rates to rise beyond market expectations.
Markets
The S&P 500 bounced off its 200-day moving average last week, which is a significant support level.
The sell-off this year has not been marked by higher volatility and breadth has been narrower, which is constructive.
The Australian market continues to be resilient.
The domestic and rate-sensitive part of the market was down last week after a signal of inventory building in the Harvey Norman (ASX:HVN) result.
This was offset by a bounce-back in resource stocks after a weak February.
Overall, resources were weakest during reporting season, as sentiment on China faded and results showed an increase in costs.
Discretionary retail was weaker as market concerns around domestic interest rates rose.
This led to underperformance in the banks, which were also affected by fears of margins rolling over due to strong competition.
Earnings season winners tended to be companies where fears had built but did not eventuate in the result. Examples include:
- Medibank Private (MPL)– where the cyber-attack had minimal impact on customers
- Orora (ORA) – where no evidence of a US slowdown was evident
- QBE (QBE) – which delivered an in-line result with no new surprises and a clever reinsuring of the highest-risk part of its back-book
- Ampol (ALD) – which is seeing margins recover in its convenience retail business
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 an independent, global investment management business focused on delivering superior investment returns for our clients through active management.
Fixed interest investors should get their portfolio settings right now, before US inflation tops out and starts falling in the second half, says Pendal’s TIM HEXT
- Markets set to trade in narrow range
- Inflation to move quickly lower in second half
- Find out about Pendal fixed interest funds
FEELING moody? It’s understandable says our head of government bond strategies Tim Hext.
Right now, US inflation reports are resetting the mood of investment markets every month, says Hext.
“The mood runs for about a month or so until the next set of numbers.
“Central bank officials in the US and Australia come out and express concern if the numbers are too high. Then they warn they’ll have to do a lot more.”
On the other hand, when inflation data is lower – like late last year in the United States – investors start thinking the rising interest rate cycle is nearer the end.
“We’re going to be in this environment for the first half of this year and we are going to be range-trading as the narrative goes backwards and forwards,” Hext explains.
But the uncertainty won’t last – and investors should be ready, says Hext.
“By the second half of the year, we are going to get a much clearer picture and we are going to see that inflation hasn’t just topped out but is coming down.
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Pendal’s Income and Fixed Interest funds
“Inflation could head back towards central bank target ranges faster than they think.”
Inflation to fall this year
Pendal’s income and fixed interest team estimates inflation will fall towards 4 per cent by the end of 2023. That compares to the Reserve Bank’s forecast of 4.75 per cent.
“The Reserve Bank is going to be pleasantly surprised by inflation,” Hext says.
“In this current March quarter, the number will still be higher because of utility charges, but then in the second, third and fourth quarters, there’s a chance we get readings below one per cent.”
Goods inflation is weakening, in large part because supply chain disruptions during COVID is broadly over. Services inflation continues – about two-thirds of the way through, Hext says. That’s why the inflation data remains elevated, and choppy.
“Investors will start believing the soft landing story,” Hext says, whereby the economy slows bringing inflation down, but doesn’t go into a recession.
“There is a risk though. Central banks might feel they haven’t done enough, particularly the US Federal Reserve.”
Hext believes there will be a couple more interest rate hikes in Australia in coming months, starting next week at the Reserve Bank board meeting.
As to how far the official cash rate set by the Reserve Bank goes, Hext says ten-year bond rates normally top out around the same level as the cash rates peaks.
“That’s where we are now. We are around about 385 basis points for ten-year bonds.
“The big message is that investors have a bit of time on their hands now, but things will start to move quite quickly by the middle of the year.
“So investors should be getting their duration sorted.”
That means checking the duration of your fixed income investments and their sensitivity to interest rate changes.
“Investors should be getting back to at least where their model portfolios tells them they need to be in the medium-to-long term.”
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.
The team won Lonsec’s Active Fixed Income Fund of the Year award in 2021 and Zenith’s Australian Fixed Interest award in 2020.
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.
As markets absorb the impact of central bank tightening, it’s important to maintain a high-quality, balanced portfolio, says Pendal’s ANNA HONG
INVESTORS need two things in 2023 – protection and patience.
Today’s Australian monthly CPI shows the Reserve Bank’s tightening – which started in the second quarter of 2022 – is starting to have an impact.
The monthly CPI indicator rose 7.4% for the year to January – an easing from 8.4% in December.
Monetary policy works with a lag – but it does work.
This can be observed through the two key components of the CPI number: new dwelling prices and rents.
Compared to December, there is moderation in the growth of new dwelling prices and rents – which accounts for almost a fifth of the basket.
The January data also shows price increases have slowed more broadly.
We may have passed peak inflation.
This will be welcome news for the RBA.
But their job is not done.
While price rises are moderating, inflation can be sticky. That’s something the Reserve Bank is alert to.
Globally, we are still in a tightening cycle as central banks race to contain inflation by unwinding the easy money of the last couple of decades.
As the markets absorb the impact of coordinated central bank tightening, it’s important to maintain a high-quality, balanced portfolio.
Defensive assets can play an important role as a shock absorber when risk assets wobble.
The effects of central bank tightening will continue to flow into economies and markets in 2023.
Investors should add protection to their portfolio, but may need patience to reap rewards.
About Anna Hong and Pendal’s Income and Fixed Interest team
Anna Hong is an assistant portfolio manager with Pendal’s Income and Fixed Interest team.
Pendal’s Income and Fixed Interest boutique is one of the most experienced and well-regarded fixed income teams in Australia.
With the goal of building the most defensive line of funds in Australia, the team oversees some $20 billion invested across income, composite, pure alpha, global and Australian government strategies.
Find out more about Pendal’s fixed interest strategies here
About Pendal Group
Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management.
Corporate Australia is looking robust as macro forces work their way through, says Pendal’s OLIVER RENTON
- Earnings season surprisingly conventional
- Five big themes in reporting season
- Find out about Pendal Focus Australian Share fund
ASX earnings season — which wound up at the end of February — delivered a more robust-than-expected picture of the economic backdrop.
Earnings upgrades and downgrades were broadly in line with historical averages despite higher inflation and a tight labour market.
But a closer look at the half-year results shows signs that increasing prices, higher rates and energy prices are at different stages of working their way through corporate Australia.
Investors should be a little wiser as to how this all plays out — without yet having the full picture.
As always there are opportunities and risks over the remainder of 2023, says Oliver Renton, an analyst and co-portfolio manager with Pendal’s Australian equities team.
“If you look top-down at how the reporting season played out, it was pretty normal in terms of the mix of revisions, upgrades and downgrades,” says Renton.
“That’s illustrative, because it wasn’t expected to be a normal reporting season with all the fears around the consumer, home-owners, interest rates and macro-economic forces more broadly.
“So, to come out of the reporting season relatively unscathed in terms of earnings shows the economy is probably holding up better than was feared.”
Here are Renton’s five big themes from this reporting season:
Interest Rates
The effect of higher interest rates is generally well understood. There is a lag, however, as companies adjust decision making to reflect higher costs of capital, says Renton.
Also, with some companies locked in to fixed rates or hedging, the impacts are yet to fully flow through company P&Ls.
“A few companies hit expectations at an operating level but missed at a net profit level.
Alot of that can be attributed to interest costs.”.
Labour cost pressures
Early signs of higher wages are starting to show in company results.
But the full effect could take to two-to-three years to flow through in countries like Australia, he says.
“Even as some of the heat comes out of the headline employment and wages statistics, we continue to be cautious on labour pressures coming through and pressuring margins.
“Labour pressures come through with a lag and we see that persisting for some companies over the forecast horizon.”
Inflation
“In an inflationary environment, we favour companies with a degree of pricing power, strong margins and control of their cost base.
“The online classifieds companies, CSL and COH have these attributes, for example, and they held up relatively robustly.”
Consumer confidence
The earnings season has not resolved concerns about the outlook for household spending and consumer confidence, says Renton.
“This was not the sort of reporting season that washed those concerns out.
“Ultimately, the economy does need to cool, rates probably need to go up or stay higher for longer and the outlook is for a more cautious consumer.”
Energy
This reporting season, energy stocks had exceptional periods for revenue off the back of high commodity prices.
That largely flowed through to bottom-line results and strong dividend outcomes.
“Ampol had revenue up 78 per cent, Viva was up 66 per cent, Santos was up 65 per cent and Woodside up 142 per cent boosted by the BHP transaction,” said Renton.
“Of course, if they’re making those sort of revenues, then that’s inflation which is coming through the rest of the economy.”
Share price performance
ASX-listed stocks dropped about 3 per cent over February through the company reporting season, giving back some of the strong gains in January.
“At a headline level reporting season appeared quite normal, but there is a lot going on under the surface and much-discussed macro drivers are only just starting to come through in actual company earnings,” says Renton.
“This reporting season was not a widespread cleansing event.
The same pressures we’ve been speaking about for the past 12 months are not in the rear-view mirror yet.
“The good thing is that the intersection of those macro forces with company specifics continues to create opportunities to add value.”
About Oliver Renton and Pendal Focus Australian Share Fund
Oliver is an analyst and co-portfolio manager with Pendal’s Australian equities team. He has more than 15 years of industry experience.
Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management.
Here are the main factors driving the ASX this week according to our head of equities Crispin Murray. Reported by portfolio specialist Chris Adams.
GLOBAL markets remain weak as the US and European economies continue to show greater strength than expected.
Last week’s US personal consumption expenditures (PCE) data – a measure of inflation – also came in higher than expected.
Bond yields continue to climb in response. US two-year yields broke to new cycle highs of 4.8% while 10-year yields are at 3.95% – 30 bps off their cycle highs.
The same is true in Europe, with German two-year yields at new cycle highs of 3% versus -0.5% this time last year.
Australian bonds yields haven’t quite broken to new highs. But we suspect it’s a matter of time until we test 4%.
Higher yields are a headwind to equity markets. The S&P 500 fell 2.66% last week and has now given back about 60% of the year’s gains.
The Australian market (S&P/ASX 300 was down 0.29%) held up better than the US. Reporting season is broadly signalling earnings resilience for the time being.
A firming bid for Origin (ORG, +15.4%) also helped. The Australian market has now given back about half of its 2023 gains.
Higher rates are driving the US dollar higher. Resulting tighter global liquidity adds an additional market headwind.
The S&P 500 has fallen back to its 200-day moving average support level, so this week’s payroll data will be important.
There is debate as to whether the mild winter is playing havoc with seasonal adjustments and the underlying economy is in fact slowing.
The downside risk comes with sticky inflation forcing the Fed to be tougher, ultimately exacerbating a second-half slowdown or recession.
US Economics and policy
Last week’s jobless claims data, PMI surveys and personal consumption all reinforced the trend of stronger-than-expected economic conditions.
In combination with the PCE reading, this has prompted the market to shift rate expectations to a peak of 5.25% to 5.5% and a slower descent from the peak.
The PCE rose 0.62% month-on-month and 5.38% year-on-year.
Core PCE rose +0.57% month-on-month, its strongest monthly gains since June 2022. It is up 4.71% year-on-year. We also saw upward revisions to recent months.
Core services PCE is the key battleground determining how quickly inflation will fall. It had its largest three-month moving-average increase for the cycle.
The bottom line is that these numbers are too hot for the market’s liking and leave the Fed in a challenging place.
At this point a return to a 50bp hike in the next meeting remains unlikely. But the bar for a pause in hikes has been lifted.
This is all underpinned by an economy holding up better than expected.
The Atlanta Fed’s GDPNow indicator remains materially higher than market forecasts for Q1 – and is still rising, driven by non-residential investment and consumption.
High-profile job cuts that have come with US reporting season are not reflected in US Initial Unemployment Claims, which remains at historical lows.
Clearly there is a direct effect of unemployment on wage inflation.
In addition, low unemployment and concern around job security have a significant bearing on propensity to spend and the savings rate. Last week’s personal consumption data highlighted the continued use of excess savings to support spending, despite the low savings rate.
We also saw more data revisions, raising the current savings rate from 3.4% to 4.7% (which is not as low as feared).
This inferred that excess savings have been run down less than thought. The potential size of excess savings also ranges widely depending on the calculation methodology.
The upshot is that it could continue to support spending anywhere between six and 12 months. This will also be tied to confidence around employment prospects.
Markets
This week’s US payroll data – and the inference for inflation and economic conditions – will be important with the S&P 500 falling back near a technical support level.
A bounce off the 200-day moving average would be a clear positive. If the support level fails, the December low of 3800 – or even potentially a cycle low of 3600 – could be tested. The US dollar index has risen back to resistance levels.
If these are broken, it would remove a prior tailwind for equities.
Finally, the US 30-yr bond yield is approaching a key resistance point at 4%. Concern over housing will build if it breaks through.
In the oil market, we are seeing counter-seasonal increases in crude and product inventories. This can no longer be blamed on the release of the US strategic petroleum reserve.
This is inconsistent with what you would expect, given stronger US economic data and the re-opening of China. Nevertheless, it is occurring and is downward putting pressure on oil prices.
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Brent crude currently looks range-bound between US$70 to US$86 a barrel. With spot at $US83, the near-term risk is to the downside.
Australia
Resources (-2.28%) fell as sentiment around China’s economy continue to deteriorate.
Any signs of continued recovery after the Chinese New Year have been limited, though this may simply be due to the winter.
The National People’s Congress which began yesterday will see the official announcement of new government positions and economic targets.
Utilities (+6.22%) outperformed as the Brookfield consortium’s re-cut bid for Origin Energy (ORG, +15.43%) was more favourable than the market expected.
ASX half-year reporting season
With only two days left we have a clear read on reporting season.
The broad theme has been stronger revenue offset by weaker margins
December-half revenue has risen 12% at an index level. About 38% of companies have beaten expectations while 18% have missed.
However this has not translated into operating leverage, since costs have risen 15% at the index level.
A margin squeeze has seen 49% of companies miss EPS expectations, versus a historical average of 30%.
Companies have signalled that costs are decelerating – though they will need to, since revenue can’t continue at this pace.
The net effect is that the misses have not flowed through to a spike in negative forward-year earnings revisions.
The mix of upgrades and downgrades to forward-year EPS was in line with historical trends.
Interest costs are beginning to build as a headwind to EPS, but still remain at relatively low levels.
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 an independent, global investment management business focused on delivering superior investment returns for our clients through active management.
Here are the main factors driving the ASX this week according to portfolio manager Jim Taylor. Reported by portfolio specialist Chris Adams
JOB cuts and Fed rate hikes have not curbed the animal spirits of the US consumer.
The consumer is employed, enjoying strong wage growth, unworried about job loss – and still has some savings left over from the lockdowns.
Net lenders to the system are enjoying rates that were not expected for many years. That’s basically free money in the pocket right now.
The net effect is the assured deflation story is being called into question. The market has reacted by pushing up peak rates and removing a large portion of cuts that were priced in for this year.
The complicating factor in this seemingly straightforward trade is the magnitude of the violent market melt-up we saw a few weeks ago.
This is keeping the bears at bay – and seemingly reluctant to put the potential-end-of-deflation trade on.
Reporting season results are mixed.
There are plenty of misses, but some big moves where results are better than expected or where stocks were excessively discounted in anticipation of a poor result.
The S&P 500 was essentially flat last week (-0.2%) while the S&P/ASX 300 shed 1.1%.
Australian macro conditions
RBA governor Phil Lowe’s address to parliament reiterated the recent hawkish shift and the RBA’s “tightening bias”.
“The board expects that further increases will be needed over the months ahead to ensure that inflation returns to target and that this period of high inflation is only temporary,” he said.
“How much further interest rates need to increase will depend on developments in the global economy, how household spending evolves and the outlook for inflation and the labour market.”
He did caveat that the RBA was “conscious that there are risks in both directions”.
He also noted the RBA “meets every month, which gives it frequent opportunities to evaluate how these various risks are evolving and to respond flexibly as appropriate”.
Consumer sentiment fell 6.9% to 78.5pts in February, retracing a bump from the last few months and taking the reading back to November 2022 levels.
The decline was broad based, but perceptions of family finance and economic conditions over the next 12 months were particularly weak.
On the other hand, trading conditions for businesses remain near all-time highs, according to the latest NAB survey.
January’s ABS Labour Force Survey was weaker than expected, with total employment falling 11.5k versus +20k expected. The unemployment rate rose 15bp to 3.67% and hours worked fell to 2.1% month-on-month.
However, the Bureau flagged caveats to January’s data linked to difficulties in post-Covid seasonal adjustment; a larger-than-usual number of people ‘waiting to start work’ (but registered as unemployed or not in the labour force); and a higher-than-usual uptake of annual leave.
US macro conditions
There were mixed messages from the Fed last week.
Federal Open Market Committee voting member Lorie Logan warned the Fed may need to raise rates more than expected to ensure prices moderate.
Thomas Barkin, a non-voting member, said much the same thing: “Inflation is normalising but it’s coming down slowly.”
Patrick Harker, a voting member, took a more dovish line, noting that “we are not done yet… but we are likely close.”
January’s CPI data was in line with consensus at 0.5% month-on-month. The yearly figure of 6.4% was a touch ahead of expectations, though down from 6.5% the previous month.
Services excluding energy and housing – the Fed’s favourite core measure – was +0.4% on a monthly basis and +5.6% year-on-year.
In the core, primary rents and owners-equivalent-rent both rose at the slowest monthly pace in three months.
The 3m/3m annualised rate is now at 4.5%, down from 5.3% in December.
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That’s the slowest rate of increase on this basis since January last year, but it’s unlikely to slow further unless the monthly prints soften.
Vehicle repair prices were up 2.7%, lifting the yearly rate to 23.1%. Car insurance prices jumped 1.4%, well above the recent trend.
These two components together accounted for half the increase in January CPI services (excluding energy and housing).
The January PPI rose 0.7%, above a consensus expectation of 0.4%. The core rose 0.5% above a 0.3% consensus.
The headline PPI was lifted by higher electricity, natural gas and petrol prices, which should subside in February.
Initial jobless claims dipped to 194K from 195K, slightly below the 200K consensus expectation.
US retail sales rose 3% in January, versus 2% expected. This reflected very low unemployment and growing wages.
It is worth noting that the EVRISI Pricing Power survey – having fallen sharply in recent months – is now moving sideways at a still-elevated level. This reflects the strong consumption data noted above.
Overall, a resilient economy has resulted in a step-up in expectations of peak rates. A significant chunk of 2023 rate cuts – which had previously been priced in – have now been removed.
Markets
ASX results season dominated returns last week.
Good results
The market had been worried about the impact of claims inflation and reinsurance costs for QBE Insurance (QBE, +8.8%). But it delivered on 2022 expectations and issued confident guidance for 2023. The CEO believes volatility has been taken out of the business. This was further supported by a transaction removing 1.9bn of problematic US reserves. The message was reduced risk plus expanding earnings – an attractive combination that should help the multiple recover.
Endeavour (EDV, -0.6%) beat earnings expectations by about 8% as lower-than-expected cost growth buoyed margins. The company continues to lose market share in retail. Gross margins are elevated, up 242bp versus pre-covid levels. This is a risk to future earnings.
Wesfarmers (WES, +3.6%) delivered a solid result, helped by improved retail trading in November and December. Kmart is delivering near 10% margins. Bunnings was weaker with incremental margins at about 4% versus an overall margin of 13.4%. Retail continues to hold up, but is still a looming risk for the company. Chemicals earnings have also been boosted by ammonia and DAP prices, though that earnings leverage has now largely played out.
Seven Group (SVW) had good results with Westrac EBIT +21% and Coates +25% year-on-year EBIT growth. Management upgraded guidance from low double-digit for both Westrac and Coates to mid-teen and high-teen growth respectively. This seems conservative given the first-half strength, giving SVW room for another update or upgrade later in the year.
Indifferent results
Commonwealth Bank (CBA, -8.2%) delivered a solid result with sequential growth of 12% revenue and 25% pre-provision profit. But the market focused on a cautious outlook, which suggested margins had peaked as a result of intense mortgage competition and emerging deposit competition.
Telstra’s (TLS, +3.4%) EBITDA for the half came in just above consensus. It looks on track for the high end of guidance and everything is going well operationally. There are a few items that will probably result in the second half being sequentially better than the first. International roaming is also coming back, with $100m of revenue growth. This takes it to 70% of pre-Covid levels.
Computershare (CPU, -3.4%) reiterated strong guidance for margin income given rising rates. But EBIT ex-margin income fell 40%. CPU needs a sharp recovery in transactional activity (corporate actions, share plans activity) to meet guidance.
National Australia Bank’s (NAB, -5.8%) quarterly update ran counter to CBA with continued margin expansion of 15bp (ex-markets). NAB is potentially best placed in the short term given its skew to small-to-medium enterprises (SME). NAB would also have benefited from running below system growth in mortgages, though it will likely start to re-engage in this market.
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JB Hi-Fi (JBH, -2.3%) had a positive (pre-announced) result with earnings up 15% vs pcp. The surprise came in the form of margin drivers. The cost of doing business is up 24% versus pre-Covid for both the JB Hi-Fi and The Good Guys divisions. This was the first period where the cost base was unaffected by Covid-trading disruptions. Revenue growth rates are now falling behind cost-growth numbers. This creates a scenario for earnings to fall below pre-Covid levels if revenues continue to normalise along with gross margins.
Newcrest’s (NCM, -4.8%) half-year result was largely in-line with expectations. The board has formally rejected Newmont’s takeover offer, but granted limited due diligence. Any increase in the offer price arguably leads a decline in Newmont’s share price, negating any increase. Newmont will no doubt incorporate NCM’s 20cps special dividend plus 15cps interim dividend into their calculations.
South32’s (S32, -1.1%) half-year result was largely as expected with production guidance unchanged. As expected, free cash flow was muted given a few one-offs and a working capital build. S32 nevertheless extended its share buy-back program. Outlook commentary was positive, particularly with respect to current free cash flow generation and project development in the US.
Fortescue’s (FMG, +1.2%) financials were in-line with expectations. The dividend was 3% ahead of consensus despite a drop in the payout ratio to 65% vs 70% a year ago. The market’s focus remains on Fortescue Future Industries. FMG says five projects will go to final investment decision this year. But there is no incremental news on project scale or economics, or detail of funding. This remains a key concern, despite recent headlines on job cuts.
Evolution (EVN, -7.4%) came in slightly weaker than expected for the half, with net debt now at $1,455m and gearing at 31% versus an internal limit of 35%. However EVN surprised positively on the dividend, flagging confidence in its balance sheet and reiterating an equity raise is not needed. Net debt should peak this quarter, with deleveraging the focus from here. Commentary on Red Lake was positive, but capex uncertainty remains around Ernest Henry and the economics of the proposed Mungari expansion.
Challenger (CGF, +2.6%) had an in-line result with higher rates driving strong annuity growth. There had been some hope product margins would also expand given rising credit spreads. But management instead said it wanted to pass the benefit of base rates and spreads onto customers, to drive growth. This potentially limits further multiple expansion.
Whitehaven Coal (WHC, -2.5%) had pre-guided on EBITDA and net cash so it was all about the dividend, which came in at 32cps vs. consensus 48cps. WHC has said there would be more at year end, but we note it underspent on capex in the first half and a decision on Vickery is due imminently. Revenues are also expected to be lower, given a decline in thermal coal pricing.
Disappointing results
Aurizon (AZJ, -7.3%) missed expectations and downgraded full year guidance by 4%. Exposure to weather events surprised on the downside. Further capex of 215m announced for growth in bulk rail operations, ahead of any contract wins creates new uncertainty. Not a great deal to get excited about as the company continues with the challenges of transitioning away from reliance on Coal earnings.
The market had been looking for positive developments on costs and capital for AMP (AMP,-14.8%). But they did not materialise. Management recognised costs were too high and said they’d be flat in 2023 while a strategy is formed. Capital management was reiterated at $1.1bn but will take time to deploy and now appears to be inclusive of 2022 and 2023 dividends.
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.
Here are the main factors driving the ASX this week according to our head of equities Crispin Murray. Reported by portfolio specialist Chris Adams.
STRONG US payroll data and consumer expectation surveys last week painted a picture of an economy that continues to hold up well.
Bond yields rose in response and equities gave back some of their recent gains.
US two-year government bond yields rose 23bps and saw the largest spike since September. At 4.52%, the two-year yield is 46bp above the January lows and is 21bp off its cycle highs.
This led to rotation away from yield-sensitive technology and REIT stocks.
The S&P 500 fell 1.7% last week and the NASDAQ lost 2.4%. They remain up 6.7% and 12% for the year, respectively.
The sell-down was not broad-based and looks more like a consolidation than start of a sharp reversal.
In Australia we saw a sharper reversal in the short end of the bond curve. Two-year government bond yields were up 41bps, as the RBA pushed a more hawkish line on inflation than expected.
The S&P/ASX 300 fell 1.7% and is up 5.6% for the year.
Trends and potential scenarios
It’s too early in reporting season to identify trends, though domestic stocks appear to be holding up better so far. This year’s rally has been driven by signs of inflation and wages easing without a sharp economic slowdown.
This “soft landing” (or ”narrow path” or ”immaculate disinflation”) scenario is the most bullish of the three broad outcomes.
The market likes the idea of a limited earnings downturn combined with falling rates.
There are two other, more bearish, scenarios:
- Structural inflation: Some combination of limited commodity supply, structural constraints on labour, re-arming of nations, re-shoring of supply chains and de-carbonising power and energy infrastructure all contribute to inflation remaining higher for longer.
- Policy is already too tight: A lagged effect – currently hidden – will prompt a recession in the second half of 2023.
We are in a better place than we were three months ago, but material risks remain.
We need to regularly gauge the scale and direction of economic data to get a better read on which scenario is playing out.
US Economics and Policy
Rates
A strong labour market – plus signs of housing pressures easing and improvement in consumer sentiment – contributed to the market adding back in an expected rate hike.
This takes the peak to between 5% and 5.25% and means a pause after the May hike, rather than March.
Revisions to historic CPI (following the annual recalculation of seasonal adjustment factors) show the decline in core services inflation (excluding housing) may not have been as material as originally reported.
This means the three-month seasonally adjusted annual rate over the last three months is 3.5% rather than 2.6%. This helped support a shift higher in expected rates.
Labour markets and the economy
Economic contradictions are evident in a number of areas. Lead indicators such as the Conference Board Leading Economic Index (LEI) suggest forthcoming recession.
Meanwhile jobless claims are at historical lows.
The number of employed people is above pre-Covid levels, while the number of job openings is far higher. This all highlights the strength of the labour market.
The Fed is focused on the labour market becoming more entrenched as the transmission mechanism for inflation.
One possible reason for its ongoing resilience – and that of the economy more broadly – is that the lagged effect of tightening is longer in this instance.
Another is that other factors such as “labour hoarding” are working against the traditional transmission mechanism.
There have been a lot of headlines about job cuts in the US.
Last week Disney announced 7000 job cuts, NewsCorp 1250, Yahoo 1600, Dell 3500, Boeing 2000, Zoom 1300 and Affirm 485.
However aggregate data indicates overall layoffs are still relatively limited and well below levels consistent with recession.
Job cuts are concentrated in the technology sector, where average employee numbers have risen by 40% in recent years. Jobless claims data suggest people are still able to find roles elsewhere.
All this begs the question whether the recent down-trend in wages will continue.
The US economy remains strong. The latest Atlanta Fed GDPNow signal is well above consensus market forecasts for Q1.
Consumption remains a key driver.
Aggregate excess household savings are running down at a rate of $80-90 billion per month. But with $1.1 trillion remaining it could support the economy for another five to six months.
That said, there are some negative signals on the economy:
- The yield curve hit new lows in terms of inversion last week. History suggests a recession within 12 months of yield curve inversion.
- Money supply is running at -7.8% year-on-year in January.
The risk of recession remains. But history indicates that once rates peak they reverse relatively quickly.
Whether that happens this time depends on the stickiness of inflation.
Australia
There was an important shift in the RBA’s stance last week. The messaging became more hawkish, in response to December’s stronger-than-expected inflation data.
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This led to a step up in short-term rate expectations. Rates are now expected to peak around 4%.
The RBA has noted that while housing construction and house prices have reacted as expected to higher rates, consumption and investment are holding up more than expected.
The reason why is critical to the path of rates – and whether we see only another 50bps to 75bps of hikes, or if a more sizeable increase is required.
The benign case is that strong consumption reflected a one-off “celebration Christmas” post-Covid and that spending falls away quickly.
As it stands there is no data supporting this theory. However the impending step-up in rates for those with fixed mortgages may quickly change that.
The RBA is indicating it needs to jolt consumers into worrying more about the future. This would help contain consumption and would mean fewer rate increases.
The challenge is the RBA’s policy setting is looser than other central banks.
There are several reasons why this may not be logical:
- Inflation in Australia is still rising, even in durable goods. There is hope that the latter reverses sharply.
- Unlike the US, rents here are still rising thanks to immigration. Household formation rose through the pandemic. The RBA will be looking for this to reverse to ease pressure.
- We need to hope that Australia’s current terms of trade boost does not translate into more investment spend. So far it has not.
- We need the government’s support for inflation-linked wage increases for low-paid workers not to flow through into higher income groups.
There is a lot on the line.
In the near term the market gets the benefit of earnings holding up better than feared.
The risk will be if this ends up requiring much tighter policy.
Markets
The US equity market is not giving the same signals we saw in April, August and November last year, which led to more significant corrections.
The Australian market saw weakness in REITs and technology, which had been leading the market in 2023. Thematic rotation continued to play a major role in stock performance, but stock specifics also started to come through as results begin.
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 an independent, global investment management business focused on delivering superior investment returns for our clients through active management.
The RBA’s hawkish tone could mean a hard landing with a fast turnaround on rates later this year. That means fixed interest investors should be eyeing longer-dated bonds.
In Pendal’s latest webinar, Commbank chief economist STEPHEN HALMARICK reviews the latest economic data while Pendal head of bond strategies TIM HEXT outlines the impact on fixed interest investors. Here’s a summary.
WITH higher rates on their minds, Aussies have begun reining in spending in the past two weeks, says Commbank chief economist Stephen Halmarick in a new Pendal webinar.
Halmarick, who has a unique, real-time view of the spending habits of CBA’s 16 million customers, says consumer spending continued during the summer holidays, but is now slowing down.
The economist was speaking alongside Pendal’s head of bonds Tim Hext in Wednesday’s Why bonds, why now? webinar. (You can watch a replay here).
“People were saying: ‘I know interest rates are going up and I know inflation is high, but what the heck, I need to have a holiday’,” says Halmarick.
“That was pretty clear in the data. Things like eating out and recreation and travel were very strong.
“In the first week of February, things have definitely softened again.
“I’ve seen a turn-down in spending in the last two weeks on the CBA credit and debit cards.” (Halmarick stresses the data analysis is anonymous).
That will be good news for the RBA, but it’s unlikely to change its hawkish approach to inflation in coming months.
Why bonds, why now
Ausbiz’s Nadine Blayney interviews CBA chief economist Stephen Halmarick and Pendal head of bonds Tim Hext
ON-DEMAND WEBINAR
That’s partly because of strong wage growth – another area Halmarick has excellent real-time insights via the salaries deposited into savings accounts.
“The annual rate of wages growth is heading towards 3.5 per cent,” he says. That’s against official ABS data showing 3.1 per cent growth.
“If it gets too much north of 3.5 per cent towards 4 per cent, the RBA will be quite worried about the inflationary impact of that and then maybe you get more rate hikes.
“So, we’re definitely watching wages go up very closely.”
Odds increase on hard landing
While a soft landing is still likely, the chance of a hard landing in Australia is rising as the RBA takes a more aggressive approach to inflation, Halmarick says.
The strong tone taken by the RBA this week has narrowed the path for the bank to get control of inflation, with the official cash rate now expected to hit 3.85 per cent by April, up from 3.35 per cent today.
“We would describe that as very restrictive monetary policy,” he says.
“The RBA has been talking about a narrow path forward to get inflation back towards target while also having the economy grow.
“I think that path is getting narrower and narrower. The risks of a hard landing are growing.”
A short cycle?
Halmarick reckons the cycle will be short and rates could still fall this year.
He is forecasting “inflation declining at a much faster rate than the Reserve Bank’s forecasts”.
That means rates are likely to peak this year, he says.
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“We’re currently forecasting GDP growth this calendar year of 1.6 per cent but the risks are now on the downside for that.
“We think the RBA will need to start cutting interest rates before the end of this year. So, we’ve got a fairly quick turnaround in that cycle.”
What it means for investors
The upshot for fixed interest investors?
Pendal’s Tim Hext says it’s time to consider longer-dated bonds as insurance while locking in a decent income.
Bonds play two important roles in a portfolio: acting as an insurance policy against a downturn and providing income.
“It’s certainly not a time to be underweight bonds,” says Hext. “A 3.7 per cent triple-A government guaranteed return for the next 10 years is pretty decent income.”
But investors need to consider the duration of bonds as the economic picture changes, he says.
Take care with bond duration
Duration is a measure of the sensitivity of a bond’s price to changes in interest rates.
The longer the duration of a bond (for example ten years compared to two years), the more sensitive the bond’s price is to changes in market interest rates.
“Duration is the period you are locking in current rates for,” says Hext.
“If you buy a 10-year bond, you’re locking in for 10 years. If you buy a two-year bond, it’s only for two years.
“Bond prices are far more sensitive to interest rate changes the further out you go.
“If you think rates are going up, you should keep your investments as short as possible so you can take advantage of the higher rates down the track.
“But if you think rates are going to fall, you want to lock them in for as long as possible.
“Our advice to clients is if you’ve got quite short duration, you should be looking to lengthen that.
“With 10-year bonds around 4 per cent, we don’t think cash rates are going to be able to get that high. If they do, they’ll only be there very briefly.
“Therefore, you’re going to get a better income locking in for a longer term.”
Watch a short webinar with Stephen Halmarick and Tim Hext
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.
The team won Lonsec’s Active Fixed Income Fund of the Year award in 2021 and Zenith’s Australian Fixed Interest award in 2020.
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.