Crispin Murray: what’s driving Australian equities this week

Here’s what’s driving Australian equities this week according to Pendal’s head of equities Crispin Murray. Reported by portfolio specialist Chris Adams.

• Find out about Crispin Murray’s Pendal Focus Australian Share Fund

Concerns over the Delta variant’s potential to derail economic recovery, both domestically and overseas, dominated headlines.

Nevertheless, equity markets remain resilient. The S&P/ASX 300 gained 1.96% and S&P 500 0.96% for the week.

We don’t see this as an unsustainable disconnection between growth concerns and market returns. There are a number of factors providing support, including a strong US earnings season and ample liquidity which is fuelling M&A activity. Concerns over growth have also seen bond yields fall, bolstering returns for growth stocks.

US employment data at the end of the week was a reminder that economic growth may prove more resilient than the market thinks.

COVID – US

The US is bracing for an inevitable rise in cases as Delta takes hold. The main issue is that, unlike in the UK, the rise in new cases is leading to a material increase in headline hospitalisation rates.

The link between vaccination and a less severe infection is holding. However, there are states with low rates of vaccination, leading to a pick up at the headline levels of hospitalisations as new cases surge. We are also mindful that new case numbers are clearly being understated, as people are less likely to get tested.

The impact on mobility is yet to be seen. Mask mandates are being reinstated and are now recommended indoors by the Centre for Disease Control and Prevention (CDC). There is a high degree of resistance to this – from both vaccinated and unvaccinated people. At this point there appears to be no appetite for returning to lockdowns and there has only been limited signs of more subdued economic activity form this wave.

Find out about

Crispin Murray’s Pendal Focus Australian Share Fund

Read more

We are watching Missouri and Florida closely as some of the first states to experience the Delta wave. Based on the Indian and UK experience cases here could peak around 60-70 days into the wave, which would be by the end of August. There is some risk to this, given it would coincide with the return to school. Nevertheless, signals of a peaking wave in these states could be the trigger for a rotation back to cyclicals.

COVID – China

There are reports that China is facing Delta outbreaks in 17 of its 32 provinces. Beijing faces a similar challenge to Australia in that the political strategy has been elimination of Covid and there are not sufficient people vaccinated. Only 16% of the population is fully vaccinated and 60% have had one dose. Data suggests that the Chinese vaccines are also less effective than the mRNA-based approaches.

China is implementing lockdowns as a result, which of course affects growth. This is dragging on commodities and resources. However, it also means Beijing is more likely to pull the lever of traditional stimulus – property and infrastructure – given consumer demand growth remains muted.  

Covid – Australia

The domestic emphasis is on the run rate of vaccinations. This has been accelerated by the shift in recommendation for AstraZeneca. 

We are now running at 0.7% of the population being vaccinated each day. Peak rates in places such as Israel and the UK ranged from 0.8% to 1.0% per day. Australia could reach that rate on the current trajectory by the end of this month if people continue to take up AZ, where supply is available. 

Nevertheless we go into reporting season with some wariness around domestic cyclicals, given uncertainty over the economic consequences, policy response and likely cautious tone from a number of these companies. 

Economics

The narrative of concern around a slow-down seems to be nearing a crescendo – just as we get a reminder that the real US economy is still going well – in the form of jobs data.

• US July payrolls rose 943,000 on the previous month versus expectations of 870,000. The previous months’ result was also revised up by 199,000.  Government jobs were an important contributor, but the private sector was also strong driven by leisure and hospitality.
• The Unemployment rate dropped from 5.9% to 5.4% which is real progress to the Fed’s goal of full employment.
• Hourly earnings were also up 0.4% month-on-month and 4.0% year-on-year. Wage growth in leisure and hospitality is now running >12%.

2021 Money Management of the Year Awards

Pendal Australian Shares Portfolio
Winner – SMA Australian Equities

Pendal Property Investment Fund
Winner – Australian Property Securities

Read more

This demonstrates ongoing resilience in the US economy, despite the narrative of “peak growth “ and surge in Delta. 

There is also capacity for more upside surprise with >5m jobs still not returned. This will become apparent once the holiday season ends, although the Delta strain has likely reduced the pace of this job recovery. 

This strength is reflected in shifting expectations around policy. The strong jobs data means consensus now expects the Fed to announce tapering of QE in November and implement it immediately, or in December, rather than waiting until 2022. The market is also now assuming that the pace of tapering will be swifter than was the case a few months ago.  

Inflation

Inflationary expectations are also playing a role in this view. There are some indications that the supply bottlenecks which caused the spike in short-term inflation may prove more persistent than first thought. For example, the number of ports seeing capacity issues has actually increased. 

Delta’s rise in Asia is also raising concerns for global supply chains if lockdowns remain in place. Anecdotally, US auto dealers are sitting on several million fewer cars in inventory than would normally be the case at this time of year.

In addition to this, survey data indicates US companies currently have more pricing power than we have seen in decades.

The upshot is that inflation concerns are still real, despite what the decrease in bond yields in recent months might suggest. 

Markets

The confluence of surging US cases and outbreaks in China exacerbated concerns over global growth and weighed on commodities last week. Brent crude fell -7.4%, iron ore -6.0% and copper -3.0%.

Commodity prices remains largely hostage to Covid sentiment in the near term.  This will be tied to the rate of new US cases and hospitalisations, which are likely to deteriorate for at least 2-3 weeks. 

Bonds yields may be hitting their lows for the balance of the year. Concerns over growth feel like they are reaching a peak, while several technical supports also look to be near their maximums. The potential for more persistent inflation is also likely to play a role.

While we could not expect yields to fall much lower, we would not be surprised to see bonds holding in near these levels for the rest of the quarter. We don’t expect anywhere near the degree of sell-off seen in Q1 2021.  

US earnings season continues to be very strong. The S&P 500 is beating quarterly earnings forecasts by 25%. Re-opening stocks have fared best, beating expectations by 45% on average. However, the stocks have not reacted given concerns over Delta. 

Upgraded CY21 earnings expectations means the S&P 500 is now on 21x earnings. This isn’t cheap, but is reasonable given rates. At this point the consensus is only for 5% earnings growth in CY22.  

There was significant rotation on the ASX. Concerns over the growth outlook saw Technology (+12.7%), Staples (+2.8%) and Health Care (+2.6%) outperform the benchmark. Technology also got a kicker from Square’s bid for Afterpay (APT, +36.7%).

One key risk heading into reporting season is that the valuation multiple for a lot of growth and quality defensive companies remains elevated, reflecting high expectations. Any disappointment – or impact from lockdowns – leaves them vulnerable. 

Stocks

Resource stocks fared worst on the ASX 100 reflecting lower prices. Fortescue Metals (FMG, -7.5%) and Mineral Resources (MIN, -6.4%), both leveraged to iron ore, were the worst performers. Oz Minerals (OZL, -3.3%), Northern Star (NST, -2.7%), BHP (BHP, -2.6%) and Rio Tinto (RIO, -2.5%) were all close behind.

REA Group’s (REA, -1.4%) result was broadly in line. Management’s observation that Sydney listing volumes were down 22% in July should not have surprised anyone. However, it does emphasise the potential impact of near-term operating momentum on the more highly-valued parts of the index, as both it and Domain (DHG, -4.9%) came off. 

Santos (STO, 0.0%) and Oil Search (OSH, +3.9%) agreed terms on their proposed merger. We still have limited insight on synergies. However, the combined entity will be better positioned to navigate the on-going energy transition.

APT jumped on the bid and – given that it is now effectively trading as a proxy for Square – continued to benefit from rotation to the latter in the US market. It was the best performer on the ASX 100.

The bid highlights the escalation of the land grab in buy-now-pay-later (BNPL) and in payments more broadly. Square, Paypal, Shopify, Apple and Affirm are all jostling for positions within this system, alongside more traditional banks. The battle-lines are being drawn and competitive intensity is likely to increase. APT’s decision to sell seems a good one in this context.

Other growth stocks performed well mainly driven by thematics. Wisetech (WTC, +7.6%) and Xero (XRO, +6.0%) also did well, the latter announcing measures to drive revenue growth through its app store.

ResMed’s (RMD, +3.2%) result was a good one. The flowgen machine recall by Philips leaves RMD is a strong competitive space and is driving large increases in revenue, although they are running into some supply constraints. There is also some pressure on margins last quarter as a result of rising prices on polymers and components. The stock has been strong and is in a sweet spot. However, we are wary over the degree to which people are capitalising the share gains from Philips.  

Finally, it is worth noting that the Federal Court ruled in favour of Chubb Insurance in a dispute over business interruption cover with Star Entertainment (SGR, -2.3%) based on the lack of physical damage. This may help set a precedent for other similar cases. 

Find out about Crispin Murray’s Pendal Focus Australian Share Fund

About Crispin Murray and Pendal Focus Australian Share Fund

Crispin Murray is Pendal’s Head of Equities. He has more than 27 years of investment experience and leads one of the largest equities teams in Australia. Crispin’s Pendal Focus Australian Share Fund has beaten the benchmark in 12 years of its 16-year history (after fees), across a range of market conditions.

Pendal is an independent, global investment management business focused on delivering superior investment returns for our clients through active management. 

Find out more about Pendal Focus Australian Share Fund here.  

Contact a Pendal key account manager here.