Investment markets and key developments over the past week

Sharemarkets were down slightly over the week reflecting 1) a pause in the rally that started in mid-June and 2) uncertainty before Fed chair Powell’s speech at Jackson Hole meeting on Friday morning (US time). US shares were down 0.7% so far, with the largest falls in tech, healthcare, consumer discretionary while energy and materials were up. Australian shares are down slightly (-0.1%) with the largest falls in tech, real estate, consumer discretionary and communications while energy, utilities and materials are up. European shares are down by 1.5%, Japan -1.6% and Chinese shares are 0.8% lower over the week.

Bond yields were rising at the beginning the week (which also explains the weakness in equities), with the US 10-yr reaching over 3.1% (still down from its mid-June high of 3.5%) as markets are pricing in a higher Fed Funds rate in 2023 (at around 3.8% in a years time, up from 3.5% a few weeks ago). Yields started to decline again towards the end of the week with the US 10-year back to just over 3% while the Australian 10 year is at 3.6%. The US dollar retreated slightly over the past week after reaching a new cyclical high and the $A is just under 0.70USD.

Commodity prices are rising again (although prices for most metals and agricultural commodities are well below mid-2022 highs). European electricity and gas prices remain very high on hot weather causing high air-conditioning demand and reduced wind capacity. Agricultural commodities are also rising again like corn and soybeans as US drought and heat are negative for crop production. High energy prices are also lifting the cost of fertiliser which drives food prices. Oil is back up over $90/barrel. In contrast, iron ore is down to $98/tonne from its earlier highs of $140 in early 2022 on concerns about Chinese growth.

Central bank officials meet at an annual summit in Jackson Hole, Wyoming from Thursday to Saturday with this years topic “Reassessing Constraints on the Economy and Policy”. The most anticipated speech is from US Fed Chair Powell on Friday morning (US Eastern time). Ahead of Powell’s speech, other Fed speakers have sounded hawkish and all have indicated that there is further room to go in raising rates and that monetary policy will have to be restrictive. Kansas Fed’s George said that the Fed Funds rate “could be over 4%”, Philadelphia’s Harker said that rates would have to get to a “restrictive stance” and sit at that level for “a little while”, Atlanta Fed’s Bostic sees a 3% Fed Funds rate as neutral and St Louis President Bullard said he wants rates to be at 3.75-4% by the end of the year and expected inflation to be “more persistent than what many on Wall Street expect”. This messaging is not too dissimilar to market pricing for the Fed and sharemarkets still rose after those comments and yields went down. So if the market doesn’t interpret Powell’s messaging to be more hawkish than these comments, there could be room for a relief rally in share markets.

Economic activity trackers

Our Weekly Economic Activity Trackers ticked up a little. The US tracker improved from lower jobless claims and an improvement in hotel bookings, retail sales and traffic and mortgage applications. The Australian tracker improved from better consumer confidence, mobility, hotel bookings and retail foot traffic. The European tracker improved from higher restaurant booking, hotel bookings and retail foot traffic.

Inflation tracker

Our inflation tracker continues to decline as supply chain issues improve. But, high commodity prices could see the inflation tracker start to shift up again in the short-term, or at lease go sideways.

This week, another regional bank (the NY Fed) came out with a report around how much of recent high inflation was due to demand and supply dynamics. On their estimates, demand has driven 60% of recent high inflation while 40% is due to supply issues. If central banks believe that high inflation is more demand than supply driven, then rates could be taken higher than expected. Economist Joseph Stiglitz was quoted this week saying that higher rates may not be necessary, as a lot of the recent increase in inflation is due to supply which higher rates won’t solve and could actually deter supply chains.

Major global economic events and implications

Global PMI business conditions for August showed that the major countries composite PMI indices are now below 50, which means a contraction in activity (see the chart below). The US manufacturing PMI was down 0.9pts to an index of 51.3 while services was worse, down by 3.2ppts to an index of 44.1. The Eurozone manufacturing PMI fell 0.1pts to 49.7 and services was worse down by 1pt, although services activity is still positive with the index at 50.2. The Eurozone activity data is holding up better than expected (especially for services), given very high energy costs. Eurozone activity could be holding up thanks to summer tourism, although this will start to fade in coming months.

The Australian composite PMI fell into contraction in August, with the index declining to 49.8 with manufacturing down to 54.5 (from 55.7) while services activity went negative to 49.6 (from 50.9) as activity slows from higher interest rates. The PMI data is consistent with other signs of slowing global growth in 2H2022 like falling Taiwan and Korean export data but not bad enough to signal a global recession. We expect global growth of 2.6% in 2022 – well below expectations of 4% growth at the beginning of the year and below the historical average of 3%pa.

The components of the PMI’s showed that input and output prices continued to decline, delivery times improved which are consistent with an easing in supply chain disruptions which is why our inflation tracker also continues to decline. But backlogs of work and new orders are also declining which shows a weakening in demand.

US data this week included an update on regional manufacturing activity with the Richmond Fed manufacturing index moving into contraction at an index of -8 (from 0 last month) and the Kansas City Fed manufacturing index was down 10pts to 3 which means further downside to the national manufacturing PMI in coming months. Housing data continues to soften with new home sales down by 12.6% in July (well below expectation, pending home sales were down by 1% in July (although this was better than expected) and MBA mortgage applications were down 0.5% over the week to 19 August. July US durable goods were flat in July, below expectations but the core data (which excludes transport) was better which is good for third quarter GDP. US second quarter GDP was revised up 0.3 percentage points to a -0.6% annualised fall, so there is still a chance that the recession in 1H2022 is revised away! Initial jobless claims were 243K over the week to 20 August, below last week’s 250K which shows that the labour market remains tight.

The People’s Bank of China cut the one and five-year loan prime rates on Monday to 3.65% (from 3.7%) and 4.3% (from 4.45%) after reducing the rate of the medium-term lending facility last week. China remains one of the few economies where interest rates are still getting cut rather than hiked (see the chart below).

China’s State Council also announced a 19-point stimulus package worth $146bn USD (under 1% of GDP) to boost economic growth as China is facing many concurrent issues including drought, power shortages, property crisis and Covid-related restrictions. Although, Covid-19 cases are rolling over – see the chart below which could help covid restrictions.

Chinese GDP growth is likely to disappoint this year at under 3%, well below the 5-6% rates assumed at the beginning of the year and 4% assumed after the covid outbreak.

In Eurozone, consumer confidence actually ticked up in August by 2.1pts to -24.9 although sentiment is still extremely negative near its July all time lows (see the chart below).

The German IFO business climate survey was down 0.2 percentage points to 88.5, better than expected but still low relative to its historical average.

In New Zealand, retail sales volumes fell by 2.3% in the June quarter, after also declining in the March quarter and missing expectations of a rise in spending. Weakness was concentrated in furniture, hardware and electronic goods which reflects the start of consumer spending weakness related to higher interest rates.

Australian economic events and implications

The Australian June half reporting season is nearly complete with nearly 90% of companies (by market capitalisation) having reported. Overall, the results have come in a little on the soft side – although things could have been worse given the weakening growth environment. Around 33% of earnings results have surprised on the upside (below the norm of 43%).

55% have seen earnings up on a year ago (norm is 64%).

47% have increased dividends versus a norm of 59%.

50% of companies have seen their share price outperform the market on the day of results (below the norm of 54%).

What to watch over the next week?

In Australia, the Jobs and Skills Summit is being held in Parliament House in Canberra (on Thursday – Friday) to address issues around skills shortages, worker shortages declining real wages, slow productivity growth for more information see here. Outcomes from the Summit are likely to include a boost to the migration intake and potential changes to the enterprise bargaining system. Data this week around enterprise agreements lodged in the first half of July with the Fair Work Commission showed an average annual pay rise of 3.2% – above the recent 2.6% in the wage price index but not too high that would risk a wage-price spiral. EBA’s lodged by unions are higher – averaging at 4.8% per annum.

The Australian earnings season is nearly complete, with a few more companies reporting next week including Harvey Norman, Woodside, Fortescue, a2 Milk and Mineral Resources.

Australian economic data releases include the July retail sales data (released on Monday) which we expect will show a fall in monthly spending of 0.1%, building approvals data (on Tuesday) should show a decline of ~1% in July as steam continues to come out of the housing market, June quarter construction work done data (on Tuesday) is expected to show a moderate rise of 0.7% which is part of the June quarter GDP data, July credit growth (on Wednesday) is likely to rise by 0.7% over the month, below its recent pace, CoreLogic home price data (on Thursday) should show a fall in capital city home prices of around 1.2% (based on the daily data), with Sydney down by more (-1.8% over the month) than the other capital cities, housing lending data on Thursday will show a further slowing (we expect lending to fall by 2% over July) and the capital expenditure data should show a very small increase of 0.2% for the June quarter, which also feeds into the GDP data. The capital expenditure data also includes the third estimate of 2022-23 planned business investment spending which we think will be around $145bn, which would be a smaller than usual upgrade at this stage of the financial year.

US data includes the July personal consumption deflator (tonight) which is another measure of inflation and is expected to be flat over the month or 6.4% year on year. The University of Michigan will release the final consumer inflation expectations index (on Friday) which will be watched for long-term expectations, which are expected to stay anchored at 3%.

Other US data includes the Dallas Fed manufacturing activity (likely to remain negative at 12.3 in August, but an improvement from last month), home price growth should continue to slow down, the August Conference Board consumer confidence is expected to increase, the August manufacturing ISM index is expected to decline to 52.4 from 52.8 in July and August payrolls next Friday is expected to show employment growth slowed to ~300K (from 528K last month) and the unemployment rate remained unchanged at 3.5% with average hourly earnings to rise by 5.2% over the year to August. July factory orders are likely to show a small rise of 0.3% (down from 2% in June).

In China, the official PMI data (on Wednesday) for August is expected to rebound for manufacturing to 49.4 from 49 last month and slow in the non-manufacturing space to 52.8 from 53.8 last month as China faces issues around a slowing property market, power shortages and continued Covid disruption. The Caixin manufacturing PMI data is expected to slow slightly to 50.2 from 50.4 last month.

In Japan, the July unemployment rate is expected to be unchanged at 2.6%, industrial production is likely to be weak in July, down by 0.5% and retail sales should remain solid at 1.9% over the year to July.

In the Eurozone, economic sentiment for August is released, August consumer price data which is expected to show annual inflation above 9% year on year, the July unemployment rate which is likely to be around 6.5% and July producer price data which is running at extremely high levels at close to 36% year on year.

Outlook for markets

Shares remain at high risk of a pull back in the months ahead as central banks continue to tighten to combat high inflation, uncertainty about recession remains high and geopolitical risks continue. However, we see shares providing reasonable returns on a 12-month horizon as valuations have improved, global growth ultimately picks up again and inflationary pressures ease through next year allowing central banks to ease up on the monetary policy brakes.

With bond yields looking like they have peaked for now short-term bond returns should improve a bit further.

Unlisted commercial property may see some weakness in retail and office returns (as online retail activity remains well above pre-covid levels and office occupancy remains well below). Unlisted infrastructure is expected to see solid returns.

Australian home prices are expected to fall 15 to 20% top to bottom into the second half of next year as poor affordability & rising mortgage rates impact.

Cash and bank deposit returns remain low but are improving as RBA cash rate increases flow through.

The $A is likely to remain volatile in the short term as global uncertainties persist. However, a rising trend in the $A is likely over the medium term as commodity prices ultimately remain in a super cycle bull market.