What’s driving the ASX this week?
Here are the main factors driving the ASX this week,?according to Pendal’s head of equities CRISPIN MURRAY. Reported by portfolio specialist Chris Adams
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GROWTH concerns triggered by policy uncertainty remain a headwind, with further tariff threats and signals from some US companies, like airlines, noting weakening demand.
The move in markets has been exacerbated by a significant positioning unwind in hedge funds.?This is the nature of markets today, where automated risk-cutting forces a wash-out of crowded trades – in this case, momentum stocks.
By the end of the week, the positioning wash-out played out and markets began to bounce.
We are likely to see an uneasy truce for the next few weeks as forced selling ends and some quarter-end rebalancing may help equities, but the real driver of markets will be evidence of how the US economy is going.
The benign scenario is that we have seen around a 50-basis-point (bp) stepdown in US GDP growth to the mid 1.0%-2.0% range. This is probably factored in.
The risk scenario is that uncertainty sustains for longer and we see a self-reinforcing slowdown, as spending caution translates into job cuts. This could see markets fall further.
The “Fed put” is not yet in play, as inflation is not yet benign enough and the issue of how to manage the impacts of tariffs remains up for debate.
There is some good news as Germany looks set to get support for its fiscal stimulus, which will support growth in the EU.
China-exposed assets are also holding up, signalling the worst may have passed there.
The S&P 500 was down 2.23% for the week. At its Thursday low, the US market had sold off about 10% from its February high, while post-Friday’s rally is down some 8%.
The S&P/ASX 300 fell 1.87%. It’s off about 9% from its high, or 8% when adjusting for stocks going ex-dividend.
To understand why we have seen such a sharp move, we need to consider both fundamental and technical issues.
Fundamentals
The fundamental catalyst has been fears of a quick slowdown of economic growth.
A combination of concerns over tariffs, the erratic policy narrative, DOGE cuts, and deportations has led to businesses and consumers winding back investment and spending.
Last week, we saw more anecdotes to suggest growth was slowing:
Expectations among Republican voters are much higher but have also rolled over.
To give a sense of what has shifted in expectations, Goldman Sachs has moved its estimated effective tariff rate rise from 4.3% to 10%.
For context, the combination of the 25% tariff on steel and aluminium plus 20% on China and 10%-25% on some Canadian and Mexican imports already represents a 3% uplift in the tariff rate.
In addition to these, tariffs are expected on specific products such as autos, electronics, and critical minerals, as well as reciprocal tariffs to equalise those put on US goods.
According to Goldman Sachs, the overall economic impact may drive core Personal Consumption Expenditure (PCE) inflation from its current mid-2.0% range to 3.0%, and increase the tariff-related hit to GDP growth from 0.3% to 0.8%.
This takes its estimated Q4 year-on-year growth down to 1.7%. While this is below trend, it is a long way from a recession call.
No Fed pivot in the short term
An issue compounding these growth concerns is that inflation data is not currently sufficient to give the Fed a reason to bring rate cuts forward.
The University of Michigan Survey also highlighted a material rise in forward inflation expectations.
While both Consumer and Producer Price Index (CPI and PPI) data is benign, the components of it that are relevant for the Fed’s preferred PCE indicator signal that this is not coming down.
Core CPI data was up 0.23% month-on-month (3.1% year-on-year), which is the lowest level since April 2021.
However, the three-month annualised rate has stalled and is running at a 3.6%, which is not improving enough.
Furthermore, the relevant inputs from CPI and PPI signal that February’s PCE will be higher, with PPI for hospital prices and insurance premiums stepping up in February.
This makes it difficult for the Fed to move earlier than the market expects, which is one 25bp cut in either May or June and a second by November.
Technicals
The second reason for the selldown has been market positioning.
Given the rally from November 2023, positioning was extended and concentrated in momentum stocks such as technology and financials.
Therefore, as expectations have changed, there had been a sharp unwind of risk positioning –particularly in systematic strategies, which have automatic risk-cutting rules.
We have seen the sharpest rate of investor de-grossing (i.e. reducing positions to lower overall risk) since 2022.
Hedge fund net leverage has unwound substantially. It is interesting that gross leverage has stayed high, so hedges have been deployed but some of the core positioning may not have been unwound.
The momentum factor has worn the main impact and is off about 17% in the S&P 500. There are signs that this wash-out has largely played out.
The key question is, what happens from here?
We believe we will see a period of stabilisation or a bounce-back in the market short term, as the technical drivers of the sell-off have played out and there has been a material rebasing of growth expectations.
However, there is still risk in the market should growth soften and begin to affect corporate earnings.
Reasons for near-term recovery include:
There are, however, two things to remain mindful of.
First is that ETF flows remain strong. This is also consistent with the level of retail investor speculative behaviour and does not appear to have been washed out.
Second, while volatility (as measured by the VIX) has spiked, it has not yet reached the August 2024 high when the yen carry trade was unwinding.
Historically, in periods such as this, we do tend to see re-tests of the volatility high, as happened in 2022.
Market outlook
Looking forward, the market’s valuation de-rating is consistent with the selloffs we have seen in more recent drawdowns.
In some, such as in April and August 2024, the valuation recovered from here.
In March 2022, the de-rating continued following concerns over stagflation and the need for substantial rate hikes which were expected to hit growth and earnings (i.e. an extended period of uncertainty about the economy).
So the signals to follow now are the economic fundamental ones.
As it stands, the US economy looks to have stepped down to around a 1.5% GDP growth run-rate from the mid-2.0% range. Should this prove to be the case, then the risk of a material further drawdown is low.
Evidence that this is the case can be seen in:
While these signals are benign, we are in a unique situation with a new US administration focused on fixing what it sees as a flawed global economic model.
Its view is that the US effectively borrows money from other countries to buy its products and payments are recycled into US financial assets.
This creates an outcome where jobs are exported from the US, the US becomes increasingly vulnerable to global supply chains, the US debt level is increasingly unsustainable, and the US Dollar is overvalued.
While the desire to unwind this global trading model is understandable, the process is fraught with uncertainties and risks.
There are two key differences between the current administration and Trump 1.0.
The first is there is a more ideological approach to policy – it is not necessarily just the “art of the deal.” The administration, for example, has been staffed with people who believe in this as an existential risk to America’s future.
The second difference is Trump 1.0 was able to offer the carrots ahead of the stick i.e. tax cuts came first, driving demand and investment, with tariffs coming later. This time, the stick comes first with tax cuts later – and these are more about extending existing ones rather than new ones, with little economic impact.
Perhaps the administration will find a path to cut taxes further, but this is a more complicated challenge given the fiscal deficit.
So, for now, the economy is probably still strong enough for the market. But this could be a very different cycle to ones we have seen in the last twenty years.
German fiscal package
The new federal German coalition has secured support from the Green party for its fiscal package, with only minor modifications.
In the exclusion of defence spending above 1% of GDP from the budget, the definition of defence spending has been widened e.g. to include support for Ukraine.
The EUR500bn infrastructure fund has been extended from 10 to 12 years, with a concession to allow EUR 100bn to be put towards climate projects.
This deal is expected to pass through both chambers next week and could potentially add 1.5% to 2.0% to GDP per annum.
This has had a significant positive impact on confidence surveys in Germany.
Australian equities
ASX performance was in line with the US, rather than Europe.
Sector rotation was once again substantial, with previous laggards such as resources (+0.7%) and energy (+0.3%) up, and banks (-3.2%), technology (-4.1%) and consumer discretionary (-3.2%) down.
Stocks exposed to US consumers such as Aristocrat Leisure (ALL, -4.4%) continued to fall, while Qantas (QAN, -6.2%) fell on the back of the US airline downgrades, though the Australian domestic market looks very different.
In the data centre sector, there has been much debate regarding hyperscalers cutting back roll-out plans.
We now have more insight on this: it appears one hyperscaler has over-procured 1 giga-watt (mostly in the US), which is roughly four months’ worth of capacity and is driving the pause in its data centre leasing.
It has apparently been making polite inquiries of some of its customers to see if there is an opportunity to delay or reduce some of its commitments, understanding that it has no legal basis to request this.
Certain players dependent on this customer may feel obliged – others with more mixed business models are likely to decline.
About Crispin Murray and Pendal
Crispin Murray is Pendal’s Head of Equities. He has nearly 30 years of investment experience and leads one of the largest equities teams in Australia.
Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management.
This article has been prepared by Pendal Fund Services Limited (PFSL) ABN 13 161 249 332, AFSL No 431426. It is general information only and is not intended to provide you with financial advice or take into account your objectives, financial situation or needs. You should consider, with a financial adviser, whether the information is suitable for your circumstances.
The views expressed in this article are the opinions of the author as at the time of writing and do not constitute a recommendation to buy, sell, or hold any security. Any views expressed are subject to change at any time.?To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information.