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Global equity markets were stronger last week with the MSCI World Index rising +0.9% in AUD terms.

A weaker AUD (-1.3%) once again underpinned the index which magnifies returns when US denominated assets are converted back into AUD.

Key themes for global equities last week were US retail sales which climbed for the third consecutive month highlighting that households continue to spend despite placing further pressure on inflation.

Retail purchases climbed +1.7% in October which was the biggest jump since March and follows on from an upwardly revised September figure of +0.8%.

As discussed last week we think inflation still has some way to go, particularly with November and December 2020 inflation prints of +0.2% set to roll off in the coming months which will be replaced with significantly higher November and December 2021 readings.

Even more concerning from those in the ‘transitory’ camp is that upward pressures on inflation are starting to impact areas of the economy that is likely to prove persistent – housing costs in the US just posted one of their largest monthly gains in decades.  

Housing costs for renters rose +0.4% in October and coupled with rising home values, accounted for nearly a third of the +0.9% overall jump in inflation last month. Even if supply chain disruptions do ease, the housing affordability crisis is likely to remain elevated, which is one of the reasons we believe inflation will prove to be persistent.

Another important driver for markets this week will be the Biden Administration announcing a new Federal Reserve chair. The decision to reappoint Jerome Powell would likely see markets weaker than a decision to appoint Lael Brainard.

Brainard is considered to be more dovish so if she is named chair, we expect markets may price in an even more dovish central bank which may in turn provide some further short-term support for equities.

US equities rallied +0.3% for the week.

RBA Minutes

The latest RBA minutes showed wages growth needs has further to rise in order for the RBA to consider passing on rate hikes.

Governor Lowe argued without wages growth you won’t see sustained inflation, and without both the RBA policy is unlikely to hike rates until 2024. This is in stark contrast to the 2022 rate rise that markets have factored in.

Essentially, The RBA is arguing that Australia’s inflation story is different to the rest of the world’s. As we are starting to see central banks pull back from their ‘transitory’ views, the RBA is steadfast in its approach believing ultimately it will prove to be correct.

We believe the RBA will ultimately need to rethink its approach. So far, bond markets have taught the RBA to never provide forward time-based guidance again, and to abandon its YCC 2024 policy.

Markets are currently in the process of teaching the RBA that its QE policy is not warranted and the economy doesn’t need it and most importantly that the RBA will need to hike rates because it will be wrong on inflation, wages and unemployment, and that the RBA will have to do so far earlier than 2024.

Where this ends up in the case of the RBA is anyone’s guess, but our own sense is that markets lead the RBA in terms of bond pricing of macro fundamentals, rather than the RBA leading the bond market on cash rates and yields.

So, the bond market is the indicator to follow, and currently they are saying that the RBA will be hiking in H2 2022 and that the RBA and their forecasters will be wrong.

Wages Growth

Wages climbed +2.2% over the 12 months to the end of September which was in line with market forecasts.

The ongoing concern around wages growth however is that a rise of +2.2% remains well below inflation of 3% meaning in real terms workers received a pay cut in the last year.

Whilst the wage price index (WPI) has now returned to pre-pandemic levels it worth reminding everyone that even before the pandemic wage growth was considered somewhat stagnant.

We would expect an uptick in the WPI in the coming months as unions demand wage increases in line with CPI.

CBA & the outlook for banks

CBA delivered a $2.2b cash profit in Q1FY22 which while +20% on the prior corresponding period was still ~4% lower than expected.

Whilst bad and doubtful debts came in lower than expected, weaker revenues as a result of compressed net interest margins (NIMs) and mildly higher expenses ultimately weighed on performance which fundamentally led investors to drive CBA shares -9.5% lower for the week.

The result showed that CBA’s strong franchise is not immune from the elevated margin pressures impacting retail banks. Above system growth in home loans and business lending was offset by NIM pressure and heightened competition across lower margin fixed rate loans.

Certainly, we were disappointed by the result with the reduction in NIM highlighting that the trends we witnessed a fortnight ago with WBC appear to be affecting CBA.

CBA flagged reductions looking forward to earnings growth of around 4-5%. The key question is whether CBA will be able to maintain the premium that it has traditionally commanded against the other retail banks.

We still believe CBA’s premium is justified given CBA’s very strong deposit base, however, we do accept that much of the earnings growth that we saw last year which was delivered from the banking sector won’t be repeated going forward.  

That being said, dividends across the major banks are sound and can still grow and balance sheets remain robust. Whilst the earnings growth going forward will certainly be far more modest, we believe there is still justification for having exposure to the retail banks.

View on the Australian Equity portfolio

Our preferred exposure in the resources sector remains BHP and we recently advocated for those who were underweight resources to add to BHP.

In our view the iron ore price of over US$200/tonne was never going to be sustained over a period of time so the dramatic pullback in iron ore prices was a case of when, not if.  

Resource companies are still achieving very high returns on capital with a strong discipline in that area and are underpinned by incredibly strong balance sheets. If you take a long term trajectory of iron ore prices at around $70, these resource companies are now back to fair to modest value.

We also think BHP could return up to $5b of surplus capital to shareholders once it finalises the sale of its oil and gas assets to Woodside (WPL).

On the industrial side, companies like CWY, GMG and QUB have all suggested that they’re seeing strong growth in their underlying businesses which is particularly encouraging, and they are particularly important components of the overall economy.

We think those trends will continue as we reopen and as we move into the federal election where fiscal stimulus will play a vitally important role.

ASX Weekly Wrap

The ASX200 fell -0.6% week with mid-caps (+1.1%) outperforming whilst large caps (-0.7%) dragged on overall returns.

Tech (+3%), healthcare (+3%) and consumer staples (+1.8%) outperformed. Accounting software provider Xero (XRO) rallied +6% after a number of brokers upgraded their target prices following the release of XRO’s 1HFY22 results the week prior. WOW led the staples sector higher climbing +1.9%.

Banks were the worst performing sector last week falling -3.6% after CBA’s Q1 update disappointed the market. Given CBA makes up more than one quarter of the financials index it is unsurprising given the CBA results that financials weighed on the broader market.

Looking ahead

Monday 22nd November 2021 – Friday 26th November 2021

• Monday: N/A
• Tuesday: AU Markit Manufacturing PMI (NOV)
• Wednesday: US Durable Goods Orders (OCT)
• Thursday: AU Private Capital Expenditure (Q3), US FOMC Minutes,
  New Home Sales (OCT), Personal Income (OCT)
• Friday: N/A

Friday 19th November, 5pm values

Friday 19th November, closing values

Key dividends

Monday 22nd November 2021 – Friday 26th November 2021

• Monday: Div Ex-Date – Elders Limited (ELD) Div
  Pay Date – CGFPB (CGFPB)
• Tuesday: Div Ex-Date – Amcor (AMC)
• Wednesday: Div Ex-Date – GrainCorp Limited (GNC)
  Div Pay-Date – Janus Henderson (JHG)
• Thursday: Div Pay Date – CGFPA (CGFPA), CGFPC (CGFPC)
• Friday: Div Pay-Date – Vita Group (VTG)

Contact

If you would like to discuss your situation, please speak to your adviser or email clientservices@primefinancial.com.au

The information in this article contains general advice and is provided by Primestock Securities Ltd AFSL 239180. That advice has been prepared without taking your personal objectives, financial situation or needs into account. Before acting on this general advice, you should consider the appropriateness of it having regard to your personal objectives, financial situation and needs. You should obtain and read the Product Disclosure Statement (PDS) before making any decision to acquire any financial product referred to in this article. Please refer to the FSG (www.primefinancial.com.au/fsg) for contact information and information about remuneration and associations with product issuers. This information should not be relied upon as a substitute for professional advice, and we encourage you to seek specific advice from your professional adviser before making a decision on the matters discussed in this article. Information in this article is current at the date of this article, and we have no obligation to update or revise it as a result of any change in events, circumstances or conditions upon which it is based.