Markets think we're there - but are we?
Markets think ‘we’re there’ in the global fight against inflation – but are we? Last week the RBA also proclaimed confidently that local inflation had peaked, so you might think it’s all downhill from here. This is certainly what investors want to hear. As we all know the real market moving action is in the US, and the evidence so far this year has seemed to corroborate that view – with goods deflation tumbling and US services inflation at least slowing. Nevertheless, markets waited with bated breath in the early part of the week to see if Jerome Powell and the Federal Reserve Open Market Committee (FOMC) shared this sanguine view. The graph below shows the market atmosphere before and after the FOMC rate decision and following press conference. Tumbleweeds rolled through the stock exchanges in the early part of the week until the Fed press conference, when markets came to life quite dramatically. Powell was quite adamant in an interesting Q&A session that he thought markets were overestimating how quickly inflation in services would subside. Investors must have been expecting him to talk markets down even more than he did, as just the mention of good price disinflation sent interest-rate-sensitive tech and real estate stocks sharply higher, while stronger caveats about services and wage inflation were largely ignored. A US payrolls report on Friday has since dampened market enthusiasm somewhat, but European and US markets remained up by a couple of percent last week, while gains in Asia and Australia were more muted. The UK market also caught some of this updraft, and the FTSE 100 hit all-time highs, being one of the few markets not to fall in 2022.
Bond yields initially fell, but jumped again after the US jobs report, and ended the week where they started, underlying the fact that – as Chair Powell was at pains to project – there is still a significant degree of uncertainty about where rates go from here. It has been suggested that Chair Powell was somewhat taken aback that his comments were perceived as being dovish, and he might just be about to set the record straight in an interview that is scheduled for early morning in Australia. Since Friday, a raft of other central bankers from around the world have also sought to dampen the markets enthusiasm, including the RBA who today raised rates by an expected 0.25%, while also adding a more measured comment at the end of their statement saying that they "expect that further increases in interest rates will be needed over the months ahead to ensure that inflation returns to target". Local bonds yields rose and equities fell, which might imply a new zeitgeist, and that last month’s news is just that – last month’s news – now that central banks are all getting on the same page, a different page than the one the market has been reading.
With half of the S&P 500 now having reported, it looks like corporate earnings will be down on year earlier by a few percent, but they were not quite as weak as expected in the last quarter. This has bolstered hopes of a soft landing. Much of the earnings slowdown has been concentrated within real estate and tech stocks. While the prospects for real estate remain uncertain, there was hope at the end of the tunnel last week for the tech titans that came from an unlikely source. Most of these companies are now under pressure by investors to focus on profitability after a 2020/2021 hiring spree that was more aimed at aspirational revenue and market share growth than increasing near term cash flows. Meta (formerly Facebook) was forced to start this journey early, and a year after its fall from grace, and only three months after its last round of extensive layoffs, it was able to deliver a 40% surprise uplift in profits. The market in turn rewarded it with a 25% increase in its share price, also helped by its mercurial CEO’s apparent shift towards operational efficiency (increasing ad revenue as well as investing in the less tangible ‘metaverse’). Amazon, Apple, and Alphabet (Google) all reported lacklustre results and warned of deteriorating operating conditions, but these warnings were largely overlooked on the back of slightly lower rate expectations, underlying again the relative importance to the market of interest rates vs earnings – for the time being at least. Meta’s experience suggests that the focus of markets might yet shift to individual company profitability at some point, especially if earnings continue to slow.
Commodity markets were generally on the back foot, and the local miners were the biggest detractors during the week for the ASX, so it was left to CSL and a handful of local consumer and real estate stocks to keep the local market in positive territory. CSL has benefited from continued momentum in plasma collection and distribution as post-COVID pent-up demand continues to unwind, a common theme in healthcare at the moment. Local retailers were confounded at the Australian Bureau of Statistics announcement last week that retail sales fell in the last quarter. The market is putting this down to seasonal adjustments, while anecdotal evidence suggests more buoyant conditions. This will be confirmed (or otherwise) as the local reporting seasons gathers pace next week.
Finally, bonds continued to have a good run last week, although that appears to be very much last week’s news as rates have started to ease up again this week.
