Weekly market update - 8th of November 2021
Written and accurate as at: Nov 08, 2021 Current Stats & Facts
INFLATION concerns eased last week, and there were implications for central bank messaging. There had been concern that higher inflation would prompt central banks to shift messaging more aggressively towards potential rate hikes. That seems to be allayed for now.
This came via statements from central banks, a US labour report that indicated a return of supply, and a firmer chance that Jay Powell would be reappointed for a second term at the Fed. Bond yields fell in response. In combination with a decent US earnings season and good news on Pfizer’s antiviral pill, the S&P 500 rose 2.03%, and the S&P/ASX 300 gained 1.91%.
US equities have had a strong run, up 9.17% for the quarter to date. Australian equities have lagged, up only 2.02%.
Central banks outlook
Various statements from central banks went a long way to calm the market’s concerns about how quickly rates will need to rise. The Fed announced it would begin tapering asset purchases by US$15 billion per month, implying that Quantitative easing would end in mid-June 2022. This is in line with expectations and was a dovish statement given speculation that the rate might have been accelerated.
Chair Powell was at pains to talk down inflationary fears. He noted that “transitory” did not necessarily mean “short-lived” — rather, they were not expecting “permanently higher inflation”, ie a wage-price spiral. They did give themselves room to adjust their plans. A strong showing for the Republicans in gubernatorial elections in Virginia and New Jersey is seen as beneficial for Powell’s chances of securing a second term as Fed Chair. The view is that the Biden Administration will not want to appoint a potentially less-predictable candidate to the Fed at this point.
The Bank of England caught the market on the hop when it kept rates stable. A 15bp rise had been signalled and widely expected. The BoE pushed back against the market projection for rate increases — citing signs of slowing economic momentum — and made the case for transitory inflation. The market is still pricing in a 15bp move for December and is split as to whether the following one will be February or May. So at this point, major central banks are signalling a lagged response to rising inflationary pressure. This also flowed through into a lower trajectory for projected ECB rate rises.
The RBA also adjusted its messaging. The three-year yield target was removed as expected. The possibility of a rate rise in 2023 was also mentioned for the first time.
The Reserve noted that the labour market was stronger than expected, but border re-opening should provide additional supply.
This remains to be seen.
The market is still wary of inflationary pressures, particularly in housing. Nevertheless, there was relief that the RBA didn’t take a dogmatic stance towards the target for the first hike in 2024.
Economic outlook
The dominant narrative at this point is that global growth is accelerating following a hit from the Delta strain and disrupted supply chains.
Bottlenecks persist but there are signs the situation is improving.
This was reinforced by US payroll data, which showed 531,000 jobs were added in October, versus 450,000 expected.
The previous month was also revised upwards by 235,000 new jobs. The private sector added 604,000 new jobs, which was good, while the government sector shed 73,000 jobs.
The underemployment rate fell from 4.8% to 4.6%. Wages grow rose 0.4% to 4.9% year-on-year.
The household survey showed the labour force rose 104,000 after falling 183,000 in September.
However, the participation rate remains a key variable in the outlook for wage inflation. It was 63% pre-pandemic, fell to 60% during the economic downturn and is now steady at 61.6%.
The St Louis Federal Reserve estimates there have been more than 3 million retirements in excess of what would normally be expected. This represents more than half the 5 million people who left the workforce since the beginning of the pandemic.
The resulting tight labour market can be seen in the ratio of employed workers to each new job opening, which is at its lowest point since measurement began in 2001.
So the outlook for inflation and bond yields — and the effect on growth stock premiums in the equity market — will be very tied to wage growth in the US.
This continues to move higher and is probably the key macro factor to watch in the coming year.
That said, it is worth noting that given the high rates of inflation, current real wage growth is negative.
This helps explain a backlash against the Democrats last week and a rising incidence of industrial action in the US.
COVID and vaccines
New daily cases in the US continue to flatten.
One factor to watch here will be the combination of waning immunity from vaccines and the onset of colder weather. We are seeing the number of people getting a third jab picking up quickly.
We are also watching the situation in China, which is going it alone in pursuit of zero-Covid. This could see an impact on economic growth — and potential demand for commodities.
The more important news was that Pfizer published data on its anti-viral pill, which so far in trials is indicating an 85% reduction in severe cases.
Markets
The US equity market may be a touch over-bought in the near term. But there are positive signals for the outlook into the year’s end:
Bond yields look to have peaked near term as supply chain issues improve
Market breadth is improving in the US, with the small cap Russell 2000 breaking higher after an eight-month consolidation and outperforming the broader market
We are seeing US consumer discretionary stocks break out versus consumer staples. This is a signal of consumer confidence, though we are yet to see this in Australia.
In the US, 89% of companies have reported quarterly earnings.
Market eps is up 38% year-on-year. While a deceleration from previous quarters, this is well ahead of the +27% consensus expectation.
About 60% of companies have beaten expectations by a standard deviation or more, versus a long-term average of 49%.
Given the headwinds of supply chain and Delta this is a very good outcome.
The S&P/ASX 300 did well last week despite a drag from resources, which is the now the worst-performing area for the year to date.
Stock news
Virgin Money UK (VUK, -13.70%) was the worst performer in the ASX100 last week. It was hit by a combination of the BOE not raising rates and management signalling in their FY21 result that costs will be flat next year, rather than down 7% as the market expected. They provided constructive 2024 targets, but there is a degree of scepticism in the market.
Domino’s Pizza (DMP, -13.67%) is experiencing the effect of re-opening as sales decline in Australia and Japan. Combined with higher food costs and a need for reinvestment, this is seeing the market question the stock’s 62x price/earnings ratio.
Westpac’s (WBC, -9.82%) result was not well received. The margin outlook was disappointing. It looks to be aggressively discounting to hold share across the loan book. The mix shift from variable to fixed-rate mortgages, investment to owner/occupier and interest-only to principal and interest are also having an effect. Put simply, WBC has adopted a strategy of volume overvalue. Historically, the market has not liked this in banking or in other industries. There was also disappointment in costs. There was some offset from a $3.5 billion off-market buy-back, though the market was also hoping for more here.
Afterpay’s (APT, -4.70%) future owner Square reported. There was nothing particularly concerning, though gross profit growth was below expectations. The company continues to invest a lot into product development and distribution. Top-line momentum has slowed, potentially due to the effect of stimulus cheques wearing off.
Woodside (WPL, -2.92%) downgraded reserves yet again, cutting expected production for part of its Pluto asset by 10%. This follows a 27% downgrade of Wheatstone two weeks ago. The group’s total proven and probable reserves have been revised down 10% since they announced the BHP merger.
There wasn’t much to flag in Amcor’s (AMC, +2.75%) Q1 result. It delivered 12% eps growth and maintained guidance of 7-11% growth for the financial year, driven largely by synergies from Bemis and a buy-back. The flexible packaging business grew 9%. Rigid packaging earnings fell 15%, reflecting a shortage in inputs such as resin. Underlying demand remains strong and the company was largely able to pass through higher input costs.
Property fund manager Charter Hall Group (CHC, +11.25%) was the best in the ASX 100 last week. It upgraded full-year guidance by 11%. This was 3% ahead of consensus. This reflects higher performance fees due to valuation uplifts in industrial funds, as well as a stronger transactional activity that can flow through into higher FUM.
Elsewhere in real estate, Goodman Group (GMG, +8.40%) upgraded guidance. The key feature was an increase in their development pipeline on the back of global investment in supply chains. Earnings growth should be in the order of 15%-plus. While the stock trades on a hefty valuation multiple, it is unlikely to de-rate while the supply chain thematic persists.
The market liked REA Group’s (REA, +10.4%) quarterly update. Revenue grew 35% year-on-year, reflecting the continued strong property market and the low base effect. The question is whether momentum can continue into next year as fixed rates rise.