August Macroeconomic Update
Rob Hogg, Chief Investment Officer
There seem to have been several factors that have come together and given us this period of turbulence and they’re all somewhat interrelated but they’re all also independent, but they’ve all come together to have quite a significant impact over the period of a couple of days earlier in August.
Magnificent Seven reporting
One of the first factors causing this has been a series of somewhat disappointing profit reports and company outlooks with some of the so-called ‘Magnificent Seven’ in the United States. Companies like Nvidia, Microsoft, Meta, Alphabet, those extremely large tech companies, have been reporting in the US in late July/August. What the market looks for is not only comments about current quarterly earnings but also outlooks for expected earnings profiles.
Now these stocks all trade on what we describe as high Price/Earnings ratio. So, investors are paying a lot for each dollar of earnings and over the last several years, as these companies have surprised on the upside again and again with their earnings, analysts have tended to revise upward even further expected earnings, leading to high P/E multiples.
Now, the catch is that if and when you get to the point where those earnings expectations in any way disappoint, and that doesn’t mean a fall in earnings, all that suffice is a slightly lower rate of growth in earnings, that can be enough to cause quite a significant change in sentiment and that seems to have been occurring to cause that period of turbulence.
That was possibly the first thing that started to really impact markets through July.
US Economic data
Then in the last week of July in particular, we’ve had a couple of economic releases in the United States that were a little bit weaker than expected, employment for July and also a measure of the manufacturing sector. That’s a very well-known survey, with decades of past profile and the fact that it fell quite sharply in July was enough to cause some market jitters.
Weaker than expected US data was probably the second element in what we’ve seen.
Japanese yen
Another very important element has been what’s been happening in Japan. For most of calendar 2024 the Japanese yen has been weakening against the US dollar but also against the Australian dollar and most other currencies around the world.
But in July the Bank of Japan, the key central bank, raised interest rates for the second time this year. That seemed to be a little bit of a surprise to the market and that caused quite a sharp turnaround in the yen during the course of the month and that seemed to unsettle investors as well.
Together, those factors, disappointment in US growth, disappointment at the margin with earnings for the Magnificent Seven and then a turnaround in the yen – that was enough to unsettle investors and we’ve seen in the past few days some significant gyrations in markets, the Nikkei being probably the most affected along with the Japanese yen.
So, what’s the outlook?
What are investors looking for? What will be probably most important are things like some stability in the yen, but probably more importantly, some slightly better numbers, better than expected in the United States.
The US economy is slowing for quite a number of months and that pace of slowing picked up a little bit in the last six or eight weeks.
What market participants will be looking for in particular is whether that pace of slowdown is accelerating or slowing somewhat from what may well have been weaker than trend numbers that we saw last week.
Things like the payroll numbers which come out at the start of each month, the manufacturing sector survey which again comes out at the start of the month as well, and it’ll still be things like the consumer price index in the US.
Provided consumer prices continue to ease (and they seem to be doing that), provided manufacturing and payrolls ease only slightly from current levels, that should be enough to reassure market participants that the US economy seems more likely than not on the path for a softer landing.
Now of course if we get continued acceleration downward in these key surveys, if they were to all step down from current levels, then market fears are very likely to return.
Australia inflation story
Australia is different to many other countries in one key way and that is the inflation story.
Domestically, the inflation profile still remains very sticky. The rate of change in the June quarter CPI was around 3.5-4 % depending which measure is used. What is holding inflation up in Australia and preventing it from easing like it’s doing in most other countries around the world, are few particular elements of the CPI.
Things like insurance costs, whether for car, for vehicles, for homes, for contents, those premiums continue to rise at a rapid rate.
We’ve also seen that housing related costs, rents in particular going up and continue to go up quite sharply.
More broadly the services sector in Australia is continuing to exhibit really quite significant inflation momentum as well, and this is what’s causing the Reserve Bank quite a deal of angst, because there are a number of macroeconomic indicators that are softening at the same time.
Reserve Bank of Australia’s predicament
Whether we look at retail sales, the overall economy which barely advanced in the most recent quarter, at overall building approvals, consumer sentiment -almost all these measures are consistent with a slowing economy and they will be eventually consistent with slowing inflation pressures.
But it’s these particular elements mentioned above that are holding up the whole inflation structure.
Presently the Reserve Bank does not yet have the freedom to start cutting interest rates in the face of these increasing signs of weakening in the economy. And it’s only when the Reserve Bank is more confident that the inflation profile is more clearly downward that they will be able to move interest rates down.
Now that may well happen before the end of the year, perhaps by November or early into 2025, but at the moment the Reserve Bank just does not have the freedom to move rates down in answer to the signs of weakness.
There’s one number that remains very strong here and that’s the employment number.
However, private sector employment is extremely weak. The reason employment is doing so well in Australia, is related to various government funded health and disability related jobs and they’re keeping the entire payroll complex at a very healthy level.
Reporting season
Turning to the reporting season, Australian listed companies report twice a year in February and August so we’re just going into the reporting season now.
Now as always and particularly at the juncture that we’re at now with the economy slowing, the Reserve Bank still reluctant to cut rates, and inflation still remaining sticky, one of the key factors that investors will be looking at will be the strength of consumer spending.
We know from the numbers produced by the Australian Bureau of Statistics that discretionary spending has weakened an awful lot mainly because non-discretionary spending (insurance costs, mortgages, rates, etc.) continue to rise and are squeezing the ability for consumers to spend on more discretionary areas.
The reports from discretionary orientated areas of the market will be a key test for the market and inform investors as to whether or not economic conditions and demand conditions continue to weaken.
Another factor that will be important is the more general outlook statement, because not only will companies report on their most recent half year and full year, they will also provide outlook statements.
These will be again a very key measure for how companies are feeling about the outlook for demand, the outlook for investment and more broadly the outlook and nature of their businesses. The story with margins in particular and potential margin pressure will be a key focus for investors, even more amplified by the fact we have this ongoing inflation.
Read Rob’s previous macro updates
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