Weekly market update 25th of October 2021
Written and accurate as at: Oct 25, 2021 Current Stats & Facts
Markets had a good, broad-based rally last week. This was despite a continued rise in bond yields and ongoing concern about Chinese growth. The diminishing probability of a hike in US corporate taxes helped sentiment. So, too, did generally supportive US earnings. The S&P/ASX 300 rose 0.72% and the S&P 500 1.67%.
COVID and vaccines
Case trends in the US and Asia are generally headed in the right direction, though there are concerning signs in Europe.
A renewed wave in the UK suggests it may be following the same path as Israel, where case numbers picked up as vaccine protection waned.
German cases are also increasing. Some Eastern European countries, where vaccination rates are low, are also seeing a surge. Romania is a case in point.
There is also an outbreak in Singapore, which is notable since 81% of the population is vaccinated.
We may be at an inflection point for a renewed surge in cases, led by Europe. The critical relationship between vaccinations and fewer severe infections and hospitalisations continues to hold but needs to be watched.
Pfizer released results from its first booster trial.
A sample of 10,000 vaccinated people showed five new Covid infections among the half who received the booster and 109 in the remainder who had a placebo.
Importantly, there were no severe infections in either group. This reinforces the idea that while a vaccine’s ability to prevent infection wanes, its ability to prevent severe infection may be more enduring.
Economics and policy
It was generally a good week for data. Flash PMIs, a leading indicator of activity, came in better than expected in Japan and the EU.
In the US, the manufacturing flash PMI was weakened by supply chain factors, but strength in the services PMI more than made up for it. This is important since the service sector — which is benefiting from re-opening — is roughly five times larger than manufacturing in the US.
It is worth watching US credit growth. This was persistently disappointing in the post-GFC era, one symptom of the lacklustre recovery.
It has remained muted in this cycle due to excess household savings accrued during Covid. But US bank results suggest we might be seeing credit growth building. If this occurs it will further support the sustainability of economic growth as the demand environment remains firm.
Inflation and yields
The inflation issue remains very live.
The UK is seen as something of a bellwether. September inflation data in the UK was a little softer than expected, but forward expectations are rising sharply. The market is pricing in a 21bp rate increase in November as the Bank of England needs to be seen to react to rising inflationary expectations.
Longer-term indicators of US inflation — such as house prices, wages and retailer pricing power — continue to rise. So too are prices in the service sector.
This is flowing through into a continued re-pricing of the short end of the bond curve.
US two-year government bond yields have doubled from about 20bps to 46bps in October, reflecting the expectation of tightening. The consensus view is that when tapering begins it will do so at the higher end of the range (about US$20 billion per month) and the first-rate hike will come in June.
Policy moves
Negotiations around President Biden’s reconciliation bill are nearing a conclusion. The final package looks likely to be around US$1.8 trillion rather than the original US$3.5 trillion plan.
The debate over how it is funded has been interesting. Democrat senator Kyrsten Sinema of Arizona refused to withdraw an objection to any change in corporate, capital gains or personal tax rate. If corporate tax hikes don’t eventuate — which is now quite possible — US earnings expectations could rise 5 per cent.
In China, beleaguered property developer Evergrande paid interest on its first bond, due just before the end of a 30-day grace period. It has avoided default for this week. But another payment is due Friday and there are more after that.
Meanwhile, Beijing is dealing with another Delta outbreak — 10 of 31 provinces have reported cases. Restrictions have been imposed, potentially providing another economic drag.
The central government is telling provinces to accelerate their issuance of government bonds, to use up the 39% of annual allocation they have remaining for 2021. The spending is unlikely to make an impact this quarter but is supportive of Chinese growth in the coming years.
This week the European Central Bank will meet. At this point, the market is pricing a 40bp hike in rates by the end of 2023. It will be interesting to see if there is any push-back by the Bank — or if it acknowledges underlying inflationary pressure.
Markets
While inflation pressures remain significant, there is a case for nearer-term stability in bond yields as China remains in a slumber, global Covid cases start to rise again and supply chain pressures ease.
This would support a rotation back to growth.
US earnings
About a quarter of the US market has reported quarterly earnings so far. Some 65% have beaten consensus expectation by more than one standard deviation. If this holds it will be another strong quarter with earnings running 8% ahead of estimates.
Revenue growth has exceeded expectations in 57% of companies compared to a long-term average of 35%.
The market is focused on labour costs, which are rising. But to date, most companies have indicated they can offset this via higher prices.
While the quarter looks strong, this has not flowed through to large consensus upgrades for CY22, since the market remains wary of supply chains and labour costs.
It’s worth noting that social media company Snap Inc’s result highlighted a second-order effect of supply chain issues: companies with less product to sell are scaling back advertising.
This may provide a read-through for Google and Facebook, which are yet to report.
Australia
Stocks leveraged to Chinese supply chains started to do better, reflecting our observation last week that signals such as power availability and freight rates were improving.
We saw a disconnection in commodity markets. Oil remained well supported but there were corrections in other commodities. It is worth noting technical signals that some commodities such as aluminium have peaked for now.
Mineral Resources (MIN, -9.2%), Alumina (AWC, -8.4%) and Rio Tinto (RIO, -4.6%) were among the weakest in the ASX 100 as a result.
RIO delivered a disappointing quarterly production report, combined with a strategy update that flagged a material pick-up in CAPEX to cover the cost of decarbonisation. This is becoming a broader trend in resources.
At this point, markets tend to focus on the CAPEX bill, though companies should be able to pass these costs on in higher commodity prices. This is yet another contributing factor to longer-term inflation.
The recent strong run in oil stocks came to an end, despite oil remaining stable. Woodside (WPL) was down 7.59%, Oil Search (OSH) lost 4.3% and Santos (STO) fell 4.1%.
The guidance provided at Tabcorp’s (TAH, -4.73%) AGM was a little disappointing, reflecting the effect of lockdowns.
Bank of Queensland (BOQ, -2.47%) delivered a mixed result. The acquisition of ME Bank is delivering margin benefits and synergies, but these will now be reinvested in gaining market share in lending and accelerated investment in technology.
On the positive side Aristocrat (ALL, +3.32%) announced the acquisition of UK gaming platform company Playtech. The $3.9 billion price tag is steep, especially given the material amount of non-core businesses that come with it. But the deal makes strategic sense.
Playtech’s key asset is a technology platform for real-money gaming — a combination of sports betting and online casinos which are progressively being permitted in US states. While ALL has historically had the content, it has lacked the platform for distribution. This can solve that issue.
IAG’s (IAG, +3.86%) AGM guidance was in line with expectations. This is a good outcome, particularly given they are absorbing a higher peril allowance. That said, the company played down the benefits of lockdown, which were material last year, noting they were offset by supply constraints and a need to reinvest in reserving.