Weekly market update - 6th of July 2022
Written and accurate as at: Jul 06, 2022 Current Stats & Facts
The Australian market outperformed peers again last week as fears of a US 2023 recession started to increase. We saw significant falls early in the week but recovered mainly by Friday. The local market (measured by the ASX300) ended down 0.46%, the US (S&P500) retreated 2.2%, and the Nasdaq fell 4.13%.
Positive returns late in the week were driven by China finally beginning to reopen and theories on peak inflation — which gathered momentum and resulted in a fall in bond yields globally. Despite this recession, fears remain.
Speculation about a smaller-than-expected 50bps rate rise at the Fed's upcoming July meeting is impacting sentiment — following weeks of a consensus view at 75bps. A smaller rise could prove to calm markets. But it is still very much an outside chance considering recent rhetoric from the Fed.
China
After many months under a zero-covid policy, Shanghai is officially moving out of lockdown. China is also reducing quarantine for inbound travellers from 30 days to ten days, which is a small positive step. China believes the spread of the virus will have far more significant consequences than the lockdowns themselves, so there is caution on any change. Unlike Australia, China's workers have no unemployment safety net and provide a challenge to overcome in restoring confidence.
China has talked up monetary support for the economy with 300 billion yuan ($A 65.6 billion) in extra funding for infrastructure projects, though nothing else has been confirmed. Beijing is still optimistically targeting annual GDP growth of 5.5%, so it's expected further funding will be provided. As we've seen worldwide, activity accelerates rapidly after exiting lockdown — and we saw that in the latest Chinese PMI data.
The likelihood that China will shift from a zero-covid policy to living with covid remains very low even as the rest of the world moves forward. One reason is that vaccination rates among the elderly are still comparatively low. Unlike Australia, China has not committed to a policy on Covid-linked vaccination rates and is unlikely to see vaccinations increase quickly. Full vaccinations among Chinese nationals aged 60 and over have risen to 64.8% (up 8.3 percentage points) over the past two months.
If the rate continued steadily at 0.6 points per week, it would hit 90% in April 2023. But in recent weeks, vaccination rates have slowed, which could delay a complete reopening.
We will likely see a continuation of the stop/start mentality in China, which lowers confidence and makes it incredibly difficult for economic growth and unemployment to be restored. On top of a global growth slowdown and strengthening US dollar, these likely mean headwinds for commodity prices. The good news for markets with China's reopening is the easing of supply chain pressures which will create some relief from rising inflation.
Inflation
Inflation — and inflation expectations — remain a key driver of markets. There are no short-term signs confirming inflation has peaked, but there is an emerging sentiment it may top out sooner rather than later. Fed rhetoric may have been too strong since the market is starting to consider the prospect of rate cuts in 2023. Calls around peak inflation are not left of field given the current magnitude and base effects.
The economy was expected to return to normality after a post-covid bubble year. But it's important that the speed and magnitude of rate rises do not break the economy before then. The pace at which inflation subsides will be key. We've seen signs of this already. Significant falls in many hard and soft commodities and swelling inventories can absorb some inflation within corporate margins as demand fades. However, for inflation to come under control, demand must fall and supply constraints must ease.
Covid created a world of free money to support consumption, but at the same time, it severely restricted the world's ability to produce and transport goods. Add in the turmoil in energy and commodity markets spurred by Russia's invasion of Ukraine, and we have the ultimate recipe for inflation.
Consumer confidence in the US continues to slide to a near-decade low as inflation concerns weigh heavily on households. Despite 3.5% unemployment in the US, job vacancies are about twice that. This indicates that right now, consumer confidence is not too bad at the aggregate level, though it is likely to worsen. Rapidly falling consumer confidence is a market problem and must be watched closely.
There are theories that household savings generated throughout the pandemic will act as a buffer for consumption. Using Australia as an example, household savings average around 11% compared to the 5% from the pre-pandemic days. It is possible that a collapse in confidence within an inflationary and rising rate environment that most societies haven't seen before will result in the savings rate rising before it helps to buffer inflation. This would lead to a much faster fall in demand/consumption than many might expect.
On a more positive note, the supply side continues to improve — helped recently by China's reopening. This is a positive indicator of inflation peaking. The other factor giving hope for a near-term inflation peak is the rapid reversal in many commodities from their previous high. Notable examples include sell-offs across the board in soft commodities and iron ore.
While weakening commodity prices are good news for inflation easing, we must remember that most of the inflation has come from food, energy and other core goods. Services inflation has yet to filter through. How wages evolve will also be key.
There are headlines worldwide about wages chasing inflation — with step-ups of 4-6% under consideration. Companies such as Qantas and Nine offer tactical cash bonuses to stave off a permanent wage increase. This will not be the norm as wage pressures increase by the week.
Bonds
Bond yields fell as market pessimism drove the market last week. US and Australia 10-years fell 23bps and 12bps respectively. The US 30-year mortgage rate has also retraced back to 5.61%. This week's RBA announcement should be largely uneventful. A 50bps increase is expected to bring the cash rate up to 135bps.
Australian Markets
The markets are becoming quite narrow, considering the broad themes discussed above. Last week the markets performed better than expected as recession fears grew and bond yields retraced. Utilities (2.6%), Consumer Staples (0.68%) and Financials (0.36%) saw gains throughout the week. In contrast, Resources (-1.58%), Tech (-2.35%) and REITS (-1.8%) fell.
Stocks
Resources suffered another rough week. Evolution (EVN, -29.59%), Northern Star (NST, -14.77%) and Newcrest (NCM, -12.02%) were the biggest detractors. Evolution saw downgrades largely based on increased costs. Costs for gold miners have historically been highly correlated to oil, with knock-on effects from the squeeze on diesel refining. On top of that, the labour disruption impacting many industrial companies is now affecting Evolution.
Companies deemed less sensitive to economic weaknesses, such as Computershare (CPU, +5.07%) continued to eke out gains. Some non-REIT bond sensitives such as Transurban (TCL, +3.74%) and APA (APA, 3.30%) also saw positive performance.
Elsewhere we saw Metcash (MTS, +2.42%) report well ahead of the market at all levels, including EBIT at $472m and NPAT at $300m. With strong sales, and momentum Metcash continues to grow revenue at the fastest clip in all segments versus peers.