Weekly market update - 6th of October 2021
Written and accurate as at: Oct 06, 2021 Current Stats & Facts
Mounting fears of stagflation — higher inflation and slowing growth — weighed on equity markets last week.
The S&P/ASX 300 fell 2.12% and the S&P 500 was off 2.19%.
Several factors are driving concern. These include persistent supply chain bottlenecks, the potential impact on export volumes from Chinese power shortages and a more hawkish tone on inflation from Fed Chair Powell.
OPEC’s decision not to add any additional supply to the oil market beyond already-planned increases — despite evidence demand is re-accelerating as the Delta Covid wave fades — added fuel to this fire.
In response to stagflation fears, equities and bonds have sold off, while commodity prices have risen.
In equity markets, higher bond yields have prompted a rotation away from growth stocks towards re-opening plays and companies offering protection against inflation.
Powell’s hawkish turn
After a relatively dovish tone on inflation at Jackson Hole, Powell was slightly more cautious in the September Fed meeting. He was more hawkish still in his presentation to the European Central Bank’s (ECB) Sintra conference last week.
This reflects inflationary data persistently coming in higher than expected and evidence that its drivers are shifting away from short-term factors.
In particular, the Fed Chair noted tension between the Fed’s goals on inflation and employment. He also noted “transitory” inflation may last longer than expected.
Powell later moved to soften the message, but the market is dwelling on the uncertain outlook.
The sub-plot is Powell’s likelihood of a second term.
Some suggest this is in question due to the recent Committee trading scandal — and that the narrative has, as a result, shifted to the inflation risks to be addressed, rather than the story of growth.
Powell is regarded as one of the more hawkish potential leaders of the Fed.
Any shift at the top of the Federal Open Market Committee will reinforce market expectations that inflationary pressures will be accommodated.
The inflation question
The Fed’s favoured inflation measure — US Core personal consumption expenditures (PCE) — rose 0.3% for the month and is running at 3.6% year-on-year.
Notably, some of the “Covid bounce-back” categories are no longer big drivers. This is evident in the quarterly annualised growth of 2.7% in the Core PCE — the highest since 2008.
There are two broad forms of inflation to consider:
Cost pressures building from input prices and shortages, as we are seeing now. This usually resolves itself via reduced demand as prices rise or products are unavailable. But through this process, we have a period of higher inflation and lower growth, which is not a good combination for equities.
Expectations of inflation translating into rising real wages as workers leverage labour shortages. This enables higher spending which reinforces inflationary pressure. This is a far more sustained inflation — the wage-price spiral — which ends only when central banks slam on the brakes.
At this point we are witnessing the first form of inflation.
The hope is that it fades quickly as supply chains are restored and demand is fulfilled, easing inflationary pressure without any impact on growth.
The concern is that if supply chain issues persist too long and we get significant energy price spikes in the Northern hemisphere winter, it will drive a more severe impact on the global economy.
An additional fear is that current labour shortages in a number of countries — combined with central banks maintaining their current aim of higher real wages — would see inflation entrenched via wages.
For example the current wage negotiations at US equipment manufacturer Deere & Co will be worth watching, with employees threatening their first strike since 1986.
There is a long way to go, but risks have risen.
This all puts central banks in a tough position.
Either they react through tightening policy as we are seeing in countries such as South Korea and potentially New Zealand.
Or they hold the line as the US is doing, which risks fuelling continued strong demand, exacerbating the issue.
China’s inflation impact
The market has been focused on China’s role in the inflation question. The focus last week was power outages which have led to curtailed output in some industries.
There are three factors at play here:
The most significant factor is Beijing’s policy of less energy-intensive growth – ie electricity consumption growing slower than GDP. Nine provinces have missed targets for electricity consumption, prompting those governments to limit power supply. This is a self-inflicted issue but tied to a signature policy for China’s leadership.
The shortage of coal supply. This is partly driven by the ban on Australian exports and compounded by Covid-linked supply issues with Mongolia and Indonesia. Environmental policies are limiting efforts to ramp up domestic supply.
At the margin, a dryer-than-usual wet season has reduced hydroelectric generation.
Power shortages are flowing through to higher prices in inputs such as cement and aluminium.
They are also limiting output in a number of processing industries and retail suppliers, exacerbating supply shortages.
Beyond the role this plays in potential inflation, we need to be mindful of Australian companies with exposure to Chinese supply chains.
The current situation limits China’s ability to stimulate in response to slowing growth, with potential implications for the ASX’s miners.
Covid and vaccines
Delta seems to be waning as a market issue. New daily case trends are improving in developed and emerging markets. This is flowing through to better activity levels in countries affected by restrictions.
The main news was the approval of the Merck / Ridgeback oral antiviral pill which roughly halved hospitalisation and morbidity rates among Covid patients in trials.
Ease of use and manufacturing scalability make this a real potential tool in the response to Covid.
A similar product from Roche / Atea and also from Pfizer is due to report trial results soon.
Markets
US 10-year bond yields were only 1bp higher last week but rose 18bps over the course of September.
Commodities continued to climb higher. Brent crude was up 1.5% and iron ore 4.4%. Even without a material shift in yields, this was enough to support the continued rotation away from growth stocks.
As a result technology (-5.94%) and healthcare (-5.62%) underperformed. Concerns over China weighed on the miners, but the energy sector (+4.48%) showed signs of life on the back of a stronger oil price.
NextDC (NXT, -12.7%) was the worst performer in the ASX 100. Fellow growth stocks Afterpay (APT, -10.06%) and CSL (CSL, -7.42%) also lost ground.
Concerns over China were reflected in weakness from Mineral Resources (MIN, -10.04%) and BlueScope(BSL, -8.14%).
Chemical company Orica (ORI, +17.50%) was the best performer. It pre-announced some write-downs but the market was reassured by management maintaining underlying earnings guidance.
A2 Milk (A2M, +9.44%) rose on hopes that recent inventory issues were beginning to resolve themselves.
Energy stocks such as Woodside (WPL, +7.13%), Oil Search (OSH, +6.20%), Origin (ORG, +%.78%) and Santos (STO, +5.30%) dominated last week’s leader board.