Weekly market update - 9th of May 2022
Written and accurate as at: May 09, 2022 Current Stats & Facts
Tightening monetary policy prompted further market falls last week. The issue is not so much the rate hikes — which have been well flagged — but widespread scepticism that central banks can tame inflation without causing a recession. Inflation is presented as a material issue. But in the same breath central banks are saying rates only need to get back to neutral levels to contain it. The market is concerned that the goal of a “soft landing” is wishful thinking.
Negative sentiment was compounded by the Bank of England warning of recession as they increased rates, raising the risk of stagflation. China’s reiteration of Covid-zero adherence also weighed last week, as did weaker US productivity data and the need to rebuild oil reserves. The positive correlation between equities and bonds continued.
US 10-year Treasury bond yields rose 19bps, breaking through 3%. Meanwhile, the S&P 500 failed to maintain a mid-week bounce, finishing the week down 0.2%. It is now off about 11% since March 29 and down 13.1% for the calendar year to date. Growth continues to do worse. The NASDAQ is given up 17% since Mar 29 and 22.2% year to date.
The S&P/ASX 300 could no longer maintain its previous disconnection, falling 3.2% for the week as REITs joined growth stocks in underperforming under the weight of higher bond yields. Resource stocks also declined as commodity prices weakened on concerns over future demand. Confidence in the RBA’s inflation credentials appears low — 10-year yields rose 35bps to 3.47%, versus 1.6% at the start of the year.
Economics and policy
The US Fed raised rates 50bp and indicated moves of the same size at the next two meetings, with 25bp per meeting likely thereafter. Chair Powell said a 75bp move would not be necessary. This initially reassured markets. But it was later viewed as an unnecessary constraint on the Fed’s ability to react to inflation, and bond yields continued to sell-off. Powell continues to soothe market concerns, saying he can bring inflation back to target without causing a recession. He noted the risk of recession was below what the market was pricing. He was also non-committal on the need to raise rates above the neutral level, which he puts at 2-3%.
However, the market is far more sceptical. There is a view – reflected in comments from recently retired Fed member Richard Clarida – that rates need to go well above neutral to reduce inflation. Clarida estimates at least 3.5%. Others are saying 4%. The way to think about policy is that financial conditions need to tighten to a level that brings growth materially below the trend of 2%. Based on historic relationships this requires equities to fall further, higher rates, wider credit spreads and a stronger US dollar.
This is all consistent with weaker markets. As long as it remains orderly we are unlikely to see the Fed intervene. Another way to think about this paradox is that unemployment is probably running 50bp below sustainable levels. To dampen wage inflation unemployment needs to increase by at least that amount, which history indicates is consistent with a recession.
The latest employment data was broadly neutral. Payrolls were a touch better than expected at 428,000 new jobs versus 380,000 expected. However, the previous two months were revised down by 39,000, offsetting the gap. Average hours worked were +0.3% vs expectations of 0.4%. All this signals the rate of expansion in jobs is slowing. The household survey saw a significant drop in jobs (-353,000) — but this needed to be -559,000 to be considered statistically significant. The participation rate also declined, reversing positive signs of people returning to work in the last couple of months. All up, none of this shifts the dial for the Fed in terms of resolving the fundamental problem of too few people available for each vacancy.
There are signs that inflationary pressures are beginning to moderate. Average hourly earnings are plateauing, some commodity prices (including copper) have stalled and money supply growth has decelerated.
This is not enough to dampen fears around the level of required tightening.
The market is also mindful of:
- Higher oil prices
- A stronger dollar
- Higher nominal yields
- High mortgage rates
- Tighter policy
Market outlook
Australia participated in the sell-off. This was partly due to concern over the impact of slowing growth on commodity prices. The big move in bond yields also weighed on REITs and the growth names. Energy is remaining defensive, with oil prices proving resilient.
There has been a large sector divergence across the ASX300 in the calendar year to date.
From the best-performed to the worst:
- Energy: Positive fundamentals, making it the most defensive
- Consumer staples: Supported by predictability and lack of cyclicality
- Financials: Becoming less defensive in the past two weeks, probably as the market has started to focus on the prospect of a domestic economic slowdown
- Property: The break-out in Australian bond yields has turned this sector from defensive to under pressure in the last two weeks.
- Healthcare: Has lagged due to growth characteristics, but becoming more defensive recently
- Discretionary: Has been under pressure due to cyclical concerns and the unwind of Covid benefits
- Tech: Remains the weakest
Last week we saw some bank half-yearly results and a number of company updates.
The bank results were reasonable, but cost pressures seem to be emerging as an offset to the benefit of higher rates. The issue going forward is that they are domestic cyclical. We do not expect a major bust in the housing market but a softer outlook is likely to weigh on sentiment.
Corporate updates were generally positive. But the market is increasingly looking through the near term and focusing on the reality that the RBA — like the Fed — needs to engineer a material economic slowdown that will not be good for cyclical earnings.
Amcor’s (AMC, +5.4%) Q3 result was in line with expectations, with a small upgrade to the full-year guidance. It enjoys a relatively predictable ability to pass on cost pressures and is benefiting from decent volume growth in its rigid division.
ANZ (ANZ, -2%). The first-half pre-provision profit fell 11% sequentially, missing consensus. Lack of mortgage volume growth, margin declines, fee cuts and a drop in market income all dragged on revenue. Management is optimistic it’s past the worst with an emerging margin tailwind from interest rates. However, costs look to start creeping higher again given inflation and technology investment. The net effect was small market downgrades.
National Australia Bank’s (NAB, -3.1%) first-half, pre-provision profit rose 10% sequentially, although it missed high expectations by 1%. Revenues were supported by market share gains, stable margins and recovery in market income. Like ANZ, management was upbeat on interest rate tailwinds – and also flagged more cost growth. Earnings were largely unchanged and it remains the preferred bank exposure for many investors. Revenue momentum and quality remain sector leading.
Macquarie’s (MQG, -9.7%) second-half, net profit after tax (NPAT) jumped 30% sequentially, beating expectations by 8%, driven by asset sales and commodities. Management suggested both would subside, which appears broadly in line with consensus. The stock’s reaction suggests the market is fearful that earnings may have passed the peak. Nonetheless, the franchise is solid and management still has levers to manage the cycle.
Virgin Money UK’s (VUK, -8.8%) first-half, pre-provision profit rose 10% sequentially, beating consensus by 7%, driven by margins. Despite a good result, the stock fell sharply, with management sending mixed messages on margins, costs and capital. Margins were probably the biggest concern, with an outlook for modest declines following a bumper start to the year.
Qantas (QAN, -1.8%) delivered a positive trading update. H2 EBITDA was $450-550m versus a consensus of around $300m. This was driven by strong demand. Leisure travel is now at 110% of pre-Covid levels. Small-to-medium enterprise travel is also higher than pre-Covid. Corporate is back to 85%. Given these trends, Q4 FY22 is seen to be at 105% of pre-Covid levels for the combined domestic and international business. This was previously expected to be at 90-100%. Net debt is $4.5b, down from $5.5b as of the end of December 2021. This is almost $1b better than market expectations. Given a market cap of about $10b, it represents a material uplift in equity value.
QAN also announced two major aircraft capex programs. Project Sunrise will allow new direct flights to the UK and to some US destinations. The second is Project Winton, renewing the domestic fleet. This will see 20 Airbus A321XLRs replace the Boeing737s and 20 A220-300s replace the Boeing 717s. Deliveries will start in late 2023. On a per-seat basis, the 220s use 28% less fuel than the planes they replace. The 321s use 17% less.
Goodman (GMG, -14.1%) fell on concerns flagged by Amazon that slowing demand may affect demand for new fulfilment centres.
Nine (NEC, -8.-9%) reiterated its full-year guidance, which still looks on the conservative side. They see no signs of advertising demand slowing and ratings remain strong. However, the market seems to be bracketing this in the consumer discretionary camp and is expressing concern over the economic outlook.