As a result of an unexpectedly strong September market (historically, September is the worst
month for equity markets in the United States and Australia) the spring was coiled tighter for a
market retracement during October.
This inevitable retracement finally manifested in the last few days of the month although the correction in the majority of indices was marginal at best– evidence that there remains plenty of money in the system looking for a home in equities as interest rates – at least globally – are coming off their highs.
In the US we saw the Dow off only 1.3% and the NASDAQ barely negative at -0.5% as US economic data continued to indicate that inflation pressures were easing without significant handbrakes being applied to the broader economy.
In Australia our major indices – the All Ordinaries and ASX 200 were only down -1.4% and -1.3%
respectively with banks continuing to perform strongly.
The strong performance of the banks (Financials were up 3.3%) negated to a large degree the pull back across our commodities indices – Materials and Energy (down -5.2% and 4.7% respectively) – caused through the initial optimism of the China stimulus package announced in September fading to a lighter shade of cynicism that it could well be just smoke and mirrors and unlikely to increase China’s growth rate.
Back to the US however and the prime reason for the late month pull back in US markets was that the US 10 year yield rallied to nearly 4.4% by month end – this compares with its low of around 3.6% during September.
This rise of nearly 1% within a monetary cycle where official interest rates are trending down is counter intuitive to the expected trend of bond yields and is evidence that the markets see both US Presidential candidates – Harris and Trump – as having expenditure policies that will require significant new borrowing through the US Bond market by the Federal Reserve.
Bond traders, sensing this have been selling lower interest bonds in order to participate in the expected higher yielding issues to come.
This fiscal stimulus could cause some new global inflationary pressures but the critical aspect of the election for Australia is if either party manages a clean sweep – that is the Presidency as well as the House of Representatives and the Senate. If this occurs then the full fiscal stimulatory and tariff policies of either candidates would likely be legislated with the most obvious cause and effect being reduced Chinese exports into the US but also potential tariffs on Australian exports into that country.
At the moment it is pointless jumping at shadows but we need to reman diligent as should this occur some market sectors will undoubtedly benefit but for others it could be a long winter.
Within the Australian context our resource exports are a critical aspect of our economy (they dominate our exports to China, Japan, South Korea and India) and so strong commodity prices generally means a strong Australian economy.
As the following chart shows our resource stocks continue to lag the broader market despite a rapid rally following the China fiscal stimulus announcement in September.
As discussed in last month’s newsletter this stimulus package, purportedly the largest since the Covid pandemic, contained measures to lower borrowing costs, inject additional liquidity into the financial system, and ease the mortgage repayment burden for households.
Such spending measures implied demand for commodities would accelerate and the resource sector of the market reacted positively – well at least initially until some doubts merged that it may be nothing more window dressing.
Time will tell.
What it did demonstrate however is how sensitive commodity prices and by extension resource stocks are to any positive news. During September for example we saw copper prices up by 8.7%, nickel by 3.8% and aluminium and zinc up by 7.1% and 6.8% respectively.
Unfortunately across the base metals the majority of these gains could not be sustained during October.
Australian third Quarter CPI
The Australian Bureau of Statistics (ABS) released Australia’s consumer price index (CPI) for the three months ending 30 September which showed that the headline measure of inflation rose by 2.8% for the 12 months to 30 September but only by 0.2% for the September quarter.
Through the quarter the key inflationary drivers were rents (+1.6%), new dwelling costs (+1.0%), property rates and taxes (+4.9%) and gas and other household fuels (+7.3%) – together these items contributed 0.36% to the September CPI (before being balanced out by reductions in other measures)
Ordinarily a headline rate of 2.8% and a quarterly rate of only 0.2% would be met with dancing in the streets as they were both below expectations and were the lowest numbers seen since March 2021.
However (in economics there is always a however) the CPI was in reality an artificial number dragged down temporarily by heavy state and federal government subsidies across electricity and rental assistance grants as well as lower petrol prices.
The effect of these factors was quite significant with most commentators estimating that if the government subsidies alone were excluded, the headline annual rate would have been closer to 3.6%.
Looking more closely at the data it does seem that it is becoming less broad based with the key challenges for the Reserve Bank (RBA) before it cuts rates is to see a moderation in the remaining drivers – rent costs (the rental market still remains very tight), new dwelling costs (are moderating but are still at eye watering levels compared to three years ago), insurance (up 14% year on year), health (up 5.3% year on year) and education (up 6.4% year on year)
Whether we will see a quick reduction in these costs remains problematical, particularly in the area of housing. I that regard, within Australia there cannot be a home or property owner who has not seen a significant escalation in the value of their asset over the past 3 years – or for even that matter the past 12 months.
It is fair to say that Australia is experiencing a housing boom like no other – and a boom that has been driven by the Federal government allowing immigration to significantly exceed sustainable levels. This has in turn placed enormous negative pressure on land availability, the environment, tradespeople and goods and services.
Whilst land developers are obviously rejoicing in this concentrated sugar hit, the negative consequences are already being felt across society with the cost of rents, rates & charges and utilities increasing markedly.
The Share Market – Looking Ahead
Whilst to the casual observer the share market seems to assume a life of its own, the reality is that it is one of the best predictors for what the economy is likely to be out 6-12 months. That’s not to say the market never gets it wrong (it’s not great in seeing the dreaded Black Swan events such as the GFC for example) but all in all weighing up the many inputs it is more often more right than wrong.
Naturally along the way there is plenty of noise from influencing factors as geopolitical tensions, supply disruptions, fiscal stimuli and tightening’s and of course factors such as the US Presidential elections.
At the moment all these factors are in play and by the time you are reading this newsletter we should have a fair idea at least as to who will be leading the free world for the next four years.
Through all of this noise the share markets have been showing strong confidence for the future with price earnings multiples (PE) expanding even though the underlying earnings per share was showing little growth.
With PE expansion investors often gets a little too confident as they expect earnings to do a catchup and for the companies to consequently out-perform guidance which does not always happen.
Over the past few weeks we have seen a number of examples of this in Challenger, Flight Centre and Macquarie – just to name three.
All three have provided trading updates which broadly endorsed guidance but have suffered some significant selling pressure which, given the outlook for each, was an overreaction for investors seeing through the noise.
This creates buying opportunities and should you be looking to increase your weighting to equities all three provide a longer buying opportunity.
Speaking more broadly we expect a relief rally as we pass through the US election and a reasonably positive end to this calendar year.
The monthly seasonality analysis (Chart 6) which we published in last month’s newsletter is worth repeating as it suggests we are coming into the strongest period of the year for equity market performance with the period November through to February show a greater probability of being positive rather than negative with potential gains averaging around 1.5%.
As always, please do not hesitate to contact your financial advisor to discuss any of the themes or stocks mentioned in this monthly letter. And we also always appreciate feedback if you are finding the monthly letters of interest or would like to see changes made on how it is presented or topics discussed.
