Weekly market update - 5th of September 2022
Written and accurate as at: Sep 05, 2022 Current Stats & Facts
Asset markets remain weak due to the US Fed’s hawkish tone, renewed concerns about Europe and China’s Covid lockdown in the south-western city of Chengdu. Ten-year US government bond yields last week rose 15bps to 3.19%. Commodities were also weaker: iron ore was -9.8%, copper -8% and Brent crude -8.5%. The S&P/ASX 300 fell 3.1% and the S&P 500 lost 3.2%. The latter has unwound quickly and is now 9% off its August 16 high. It now sits on a key support level, just above 3900.
US employment data was somewhat positive for markets. There is emerging evidence that labour force participation is recovering and wage growth slowing. This may be enough to swing the Fed to a 50bp move on September 21. All eyes will be on the Sep 13 CPI data. Our domestic reporting season was broadly in line with historical averages in terms of revisions. FY22 delivered 23% EPS growth, driven by 38% EPS growth in resources. Bank EPS rose 15% as bad debt charges fell and Industrial EPS was up 7%. Consensus now expects market EPS to grow 3% in FY23. This is essentially unchanged over the past month. Resources EPS is expected to fall 3%. Industrials are expected to grow 9%. This is down from 11% a month ago.
There are two very different paths forward from here:
- Positive case: The combined effect of diminishing supply chain pressures, slowing labour demand and rising participation allows the Fed to avoid raising rates too far. Falling inflation requires only a moderate economic slowdown. Risk premiums fall, along with the outlook for rates, enabling markets to recover.
- Negative case: Inflation remains embedded too high. Combined with the European power crisis and ongoing lockdowns in China, this forces central banks to raise rates into a global economic slowdown. Such an environment may induce some form of additional financial shock, further exacerbating the downturn and market pessimism.
Economics and policy
US employment data was firm, but dovish on balance for the rate outlook. This was reflected in US 2-year yields dropping 13bps on Friday. August payrolls rose 315k, but prior months were revised down 107k. The 3-month moving average has slowed from 437k to 378k as a result. This is positive, but ultimately it needs to get down to sub-100k to meet the Fed’s objectives.
There were three dovish aspects of the data:
- Average hourly earnings growth was stable at 5.2%. This was +0.3% month-on-month (0.1% lower than expected). On a sector-adjusted basis it was also lower than expected.
- Labour force participation rose more than expected, up 0.26% to 62.4%. The unemployment rate increased to 3.7% as a result. Greater labour supply is key to slowing wage growth.
- Weekly hours were down. This meant aggregate hours for the month were slightly lower, demonstrating the labour market is marginally easing off.
All this raises the odds of a 50bp hike in September rather than 75bp. CPI data will be key in this call. Several market commentators remain of the view that Fed chair Jay Powell’s tough talk is aimed at holding inflation expectations down, allowing the Fed to avoid raising rates as far as feared.
Job openings data was more negative — there was no sign that the worker shortage was improving in the latest Job Openings and Labor Turnover survey. However job ads on Indeed.com are falling and the “quits” rate has begun to decline. This suggests employees are a little less confident on the labour market outlook.
On balance, employment data is better. But it’s a long way from the degree of cooling required to solve the inflation problem. Consider these factors:
- The employment gap — measured relative to what is considered sustainable employment —remains near historic peaks. This is consistent with wage growth staying too high.
- This is reinforced by a sector breakdown which shows the service sector is still catching up to pre-Covid levels. We will need to see goods and trade sectors employment free up more to offset this.
- The ratio of job openings to the number of unemployed remains at a record high. This needs to move materially lower to return to levels consistent with a looser labour market.
- Underlying income growth in the economy remains high once you combine employment growth with wages and hours. Nominal income is rising about 7% on three and six-month basis, supporting consumer ability to spend and absorb inflation. This needs to head towards 3-4% to be consistent with the inflation target.
- Wage growth remains too high. Just staying where we are is not enough for policy makers. We need to see significant loosening in the labour market.
We also saw the US ISM Manufacturing Survey index at 52.8 — stronger than an expected 51.9. It implies a 1.4% rate of GDP growth. This suggests the economy is not slowing as precipitously as some believe.
Europe
Moscow suspended natural gas flows into Germany for three days on the premise of maintenance work. Russia then announced an indefinite suspension due to a technical fault, following the G7’s announcement of a price cap on Russian oil. This will further curtail manufacturing. ArcelorMittal, for example, announced it would close two plants. European policy-makers are in a far more difficult position than the US. Gas and power issues combined with a weaker currency are exacerbating inflation. German two-year bond yields have moved from 0.5% to 1.1% since the middle of August.
Markets
We continue to note the total financial conditions index feedback loop — where too big a rise in equities starts to work counter to the Fed’s goals and leads to a hawkish shift in their messaging. This emphasises that the Fed will need to see inflation and the economy much softer before it is comfortable with a sustained rise in equities. The S&P500 is sitting at a key support level at 3900. A fall through it would likely set up a test of the June lows around 3600. Germany is already testing these previous lows and may provide a lead on other markets.
However the market retains scope for speculative episodes as seen in the IPO of China’s Addentax Group in the US. The Shenzhen-based garment manufacturer rose more than 20-fold on its first day of trading, only to collapse below issue price the following day. This is another reason to remain wary.
Australia
The S&P/ASX 300 got caught up in last week’s global sell-off. Resources (-7.2%) led the market lower on the back of the new lockdowns in China. Energy (-4.6%) also declined as the oil price continues to fall despite lower inventory levels. Technology (-3.9%) fell as bond yields continued to rise and the market rotated to defensive sectors such as staples (+1.5%) and healthcare (-0.7%).
Stocks
A2 Milk (A2M, +18.7%) beat consensus estimates on revenue, EBITDA, margins and NPAT for FY22. There are signs business momentum is improving and they are managing a headwind from declining China birth rates better than expected, picking up market share to help offset a decline in industry volumes. China’s birth rate declined from 14.6m pre-Covid to about 9m in 2022. The turn in this trend will be key for A2M.
Woodside Energy (WDS, -6.4%) delivered a strong result given the commodity price backdrop, but profitability missed expectations after adjusting for the gain on an asset sale. The dividend at 80% payout is in line with policy, but somewhat disappointing there wasn’t more. Major growth capex of US$9 billion to 2024 is higher than anticipated and will hold back returns to shareholders as the company will likely gear up. Exposure to the spot LNG price is forecast to be strong, which is a positive thematic.
Mineral Resources' (MIN, -8.3%) solid FY22 financials were eclipsed by two key announcements: the decision to proceed with the Onslow/Ashburton iron ore project and initial terms of the new Albemarle Lithium joint venture. The company benefits from infrastructure payments and a mining services contract with the mine. The re-organisation of the lithium relationship with Albermale is still to be signed. But if it goes ahead this will enable an integrated approach to mining and processing spodumene, which has the potential to drive a substantial uplift in earnings.
NextDC (NXT, -6.9%) had a reasonable result. A small miss on revenue was offset by a small beat at the EBITDA line. Management guided to 17-22% growth in revenue for FY23, slightly stronger than consensus. EBITDA guidance of 12-17% growth in is line with market expectations. Pricing remains good and there is material capacity rolling out in FY23 — particularly in Sydney where NXT one of few players with capacity in a tight market. The data centre company has potential of an asymmetric return profile with downside protected by real asset base and significant upside from rolling out planned capacity
Northern Star’s (NST, -2.6%) result was good amid a tough environment for gold miners. It announced a $300 million buy-back as a sign of confidence in the business and balance sheet — a stark contrast to more leveraged peers. FY22 financials were largely in line and guidance unchanged.
Healius (HLS, -6.2%) delivered a strong result, but the high leverage to Covid-19 PCR tests will become a headwind. Normal testing activity is not snapping back, which pressures the outlook.
Fortescue Metals (FMG, -13.4%) delivered in line with expectations and kept FY23 guidance unchanged. But a lack of any detail around potential returns from the investment in Fortescue Future Industries remains an issue.