What happens in US, won’t stay in US

The local market had another positive day with global investors buying our big cap market on relatively low turnover. 

Crowded trades in the micro-cap space continues to see profit taking from fund managers and retail investors on elevated market risk. Micro-cap index has been the fan favourite space for the market since the pandemic due to the 300% total returns in the index. The sign of changing times is that the micro-cap index has been negative for the past 4 out of 5 days while the overall market has had a positive week. The trend has been about buying from the global investors on the large caps (i.e. mainly in the top 20) while selling from fund managers and retail investors in the small/micro caps. Base metals fell further than Gold overnight and the fall in AUDUSD buffered the Aussie miners downside from weaker commodity prices. But the selling pressure on Gold stocks over other miners were a classic example of retail panic selling. 

We have delivered 11 consecutive weeks of aggregate weekly turnover below $40 billion. Health care and banks were the best green sectors again while Miners and Tech were the only red sectors.

Global markets are at an inflexion point where the solution to all market problems may have reached the use by date. Global markets have relied on fiscal and monetary stimulus to buffer them through economic, credit and pandemic crashes. We were able to do that for more than a decade with no end in sight due to manufactured weak inflation. That cycle ended last year as China moved from exporting deflation to exporting inflation. There are additional factors like supply side issues and currency debasement that have made things worse since the pandemic and the data suggests it is going to be higher and be around for longer than what the market expects. Central Banks are moving from describing inflation as “transitory” to “persistent”. Data suggests that the economy will have to evolve to higher wages to cater for the higher level of costs. Markets have not yet accommodated for higher taxes that are coming to pay for all the stimulus while rising input costs are going to get boosted by higher wage costs.

US is the market that will be key to the cycle. As the global currency and the dominant part of the global GDP, what happens in US won’t stay in US….it will affect the rest of the world. US Fed is starting to unwind number of emergency steps taken over the past year to buffer the economy through the pandemic shut down. Non farm payrolls data will be out tonight and that should be strong given the recent employment data beating expectations. Whitehouse is in the media talking about tax hikes and global minimum tax limits. It is clear US corporates are going to end up paying higher aggregate tax and higher cost of borrowing. Neither of that is being priced into the markets.

Similarly, RBA is expected to let some of the emergency cheap stimulus expire at the end of the month. The latest housing data shows that the property markets are red hot due to weakening of lending rules, and the RBA is in no hurry to turn that back till the election cycle. The value of new loans granted for owner-occupied homes in Australia for April was $23 billion. Just for context, the pre-GFC peak was less than half that amount. Banks are already raising fixed rates and will be forced to raise variable in the back end of this year. It is clear that RBA will be forced to unwind the weak lending rules into 2022 when the budget will see substantial cuts to spending and tax rises to pay for all the stimulus.

Chinese Yuan to USD has broken the recent two months uptrend. USD Index has broken the recent short term downtrend. Tapering worry is expected to drive market risk off trade and that is likely to boost USD in the short term. Historically that has been negative for markets, commodities and AUDUSD. Time will tell if this time it is different.

Let us run through the main data points released in the last 24 hours…

The IHS Markit Eurozone Services PMI was at 55.2 in May 2021, little-changed from the preliminary estimate of 55.1 and pointing to the strongest pace of expansion since June 2018. All nations recorded an improvement in activity since April, with Ireland and Spain leading the way, following the easing of COVID-19 restrictions. New business rose for the first time since last July, and at the fastest rate for 40 months. Backlogs of work increased for a second month in succession and employment growth was the strongest since February 2020. On the price front, operating expenses rose at the greatest rate for over a decade, while output charge inflation was relatively modest despite hitting a 25-month high. Looking ahead, business sentiment hit a 17-year high.

The IHS Markit Composite PMI for the Eurozone was revised higher to 57.1 in May of 2021 from a preliminary of 56.9, pointing to the strongest growth in private sector activity since February of 2018. Services growth accelerated sharply (55.2 vs 50.5 in April) and factory activity rose at a record pace (63.1 vs 62.9). Private sector new work went up to the strongest degree since June 2006. Sales growth was also broad-based, with gains recorded in both domestic and international markets. Such was the rise in new work that companies struggled to keep on top of overall workloads, as evidenced by a rise in backlogs of unfinished business for a third month while firms take on additional staff for a fourth successive month. Input prices overall increased to the sharpest degree in over a decade and output ones at the strongest rate ever.

Private businesses in the US hired 978,000 workers in May of 2021, well above a downwardly revised 654,000 in April and forecasts of 650,000. It is the highest reading since June of 2020 as the labor market continues to recover amid a rapid reopening, despite labor and raw material shortages. The service-providing sector added 850,000 jobs led by leisure & hospitality (440,000); education & health (139,000); trade, transportation & utilities (118,000); professional & business (68,000); and financial activities (20,000) while the information sector lost 3,000 jobs. The goods-producing sector added 128,000 jobs, boosted by rises in construction (65,000), manufacturing (52,000) and natural resources and mining (11,000). Companies of all sizes experienced an uptick in job growth, reflecting the improving nature of the pandemic and economy.

The number of Americans filing new claims for unemployment benefits dropped by another 20,000 to 385,000 in the week ending May 29th, falling below the 400,000 mark for the first time since March 2020, when the pandemic hit the economy. The reading came in also below market expectations of 390,000, as a steady decline in the number of daily coronavirus cases due to vaccinations allowed the country to continue its re-opening efforts and prompted businesses to hire more workers to respond to growing demand. In addition, many states recently decided to withdraw from federal unemployment benefit programs, following reports that it has been more difficult to hire as the benefits pay more than most minimum wage jobs.

The IHS Markit US Services PMI was revised higher to 70.4 in May 2021, up from a preliminary estimate of 70.1 and pointing to the steepest pace of expansion in the sector since data collection for the series began in October 2009. New order growth hit an all-time high, helped by the continued reopening of the economy following COVID-19 restrictions and by the quickest rise in new export orders for nine months. The pace of job creation softened as firms reported difficulties filling vacancies, but remained solid overall. On the price front, input cost inflation accelerated for the seventh month running and was the sharpest on record, amid ongoing supplier price hikes. In an effort to pass on greater costs, service providers raised their charges at an unprecedented pace. Looking ahead, business confidence was strong, with optimism stemming from looser COVID-19 restrictions and stronger client demand.

The ISM Services PMI increased to 64 in May of 2021 from 62.7 in April, breaking a fresh record high and beating market forecasts of 63. Faster increases were seen for business activity (66.2 vs 62.7), new orders (63.9 s 63.2), backlogs of orders (61.1 vs 55.7), new export orders (60 vs 58.6) and inventories rebounded (51.5 vs 49.1). On the other hand, employment (55.3 vs 58.8) and supplier deliveries (70.4 vs 66.1) slowed and price pressures intensified (80.6 vs 76.8). There was continued growth in the services sector in May. The rate of expansion is very strong, as businesses have reopened and production capacity has increased. However, some capacity constraints, material shortages, weather-related delays, and challenges in logistics and employment resources continue,” says Anthony Nieves, Chair of the ISM.

The value of new loans granted for owner-occupied homes in Australia rose by 4.3% from the previous month to a new record high of AUD 23.0 billion in April 2021, faster than a 3.3% rise in March, driven by increased loan commitments for existing dwellings. Compared to the same month a year earlier, the value of these loan commitments jumped 70.1%.

Comments on US market last close…

US market pulled back on US Fed showing signs of tapering, global minimum corporate tax rate plans and inflation worries. DOW -0.07%, S&P -0.36%, RUSSELL -0.81% and NASDAQ -1.03%. Bond yields and USD popped higher on risk off and that hit commodities and AUDUSD hard. Oil still defies supply and demand dynamics and ticked higher. There is a reason we have had a preference for Aussie gold miners. They have built in margin protection in risk off trade. US delivered big beats in ADP and Jobless data and that drove the recovery and opening up trade that helped DOW more than NASDAQ. US is now pushing rampant vaccine production for the world and again that will drive inflation. VIX is over 18 after finishing May in the 16. Staples and Utilities were the best green sectors while Retail and Tech were the worst red sectors.

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