Logic Monday Espresso Podcast

Monday Espresso Podcast - 30th October 2023

[00:00:00] Sheldon MacDonald: It's the 30th of October today. Another disappointing week last week in equity markets, certainly risk off mode continues. Now, we did have a slight improvement on the bond front, but really equity's down one or two, perhaps 3%, and in the US that's taken us into correction territory. That's down 10% from the recent highs experienced on the 31st of July.

[00:00:25] Sheldon MacDonald: So why are equity's down? A couple of reasons. First of all, there's the geopolitical concerns that continue. Although there has been a slight easing of those concerns, the fact that the conflict in the Middle East looks contained, looks like it's not going to become a wider regional conflict and that saw the oil price down about 4% and that'll play into inflation in the weeks and months ahead.

[00:00:49] Sheldon MacDonald: We'll come to inflation in a second though. The higher rates though, that's really a big part of the reason for the equity weakness. Now that higher for longer interest rate outlook is taking hold.

[00:01:01] Sheldon MacDonald: We had growth figures coming out of the US 4.9% economic growth in Q3, that's the annualized rate. Now, no sign of a recession there and that means there's no likelihood, no need for a rate cut anytime soon. Now those higher rates plays into equities in a couple of different ways. First of all, there's the opportunity cost. With a very nice high rate, instead of buying equities, you can buy relatively safer bonds at a nice valuation and earn a decent yield.

[00:01:34] Sheldon MacDonald: There's the fundamentals. Higher rates impacts on your borrowing cost. You're paying more in interest. That reduces your earnings as a company. And then finally there's discount rates. If you're discounting future earnings at a higher interest rate, the current value is much lower. So a couple of different reasons there why equities feel the brunt when interest rates are high.

[00:01:57] Sheldon MacDonald: On the other hand though, we've had decent earnings. Nathan bringing you in on this, earnings have been improving in the States.

[00:02:03] Nathan Sweeney: Yeah, so companies in the US are currently reporting their earnings for the third quarter of the year and if we look at those companies, they're reporting earnings, which are in line or slightly better than expected.

[00:02:16] Nathan Sweeney: Now, the challenge, I suppose is, is that earnings growth coming from an increase in revenue because things are really good, or is it because companies are cutting costs? So their margins, and it's actually because of that, the latter. So companies helping cutting costs, and this is helping improve their margins, which is helping earnings.

[00:02:37] Nathan Sweeney: But you mentioned the fact that we have really strong economic growth, and that's good news because that will then filter into a better backdrop for companies. So we're still seeing that strong economic growth, that 4.9% that you mentioned. So that's one thing we'd be looking at for earnings as we move forward.

[00:02:55] Sheldon MacDonald: The one positive area in equity markets last week was China. China up about 1%. What's going on there?

[00:03:01] Nathan Sweeney: Yeah. So for China, this is really a standout from the crowd for last week because we did have weaker equity markets. China was up over a percent and what you're seeing there is a continuation of support.

[00:03:14] Nathan Sweeney: So we mentioned the fact before on some of these podcasts that the Chinese government is implementing stimulus, but it's a slow, steady, targeted pace. So last week, they are looking to issue 137 billion of government bonds and with the money they raised from that, they're going to use that to support disaster recovery and infrastructure improvements.

[00:03:35] Nathan Sweeney: But again, this is just another example of increased stimulus into the economy, and we really are starting to believe that we're getting a stabilization in that economy. The economic growth is suggesting that, and it's looking a lot more attractive from an investment perspective. So we're doing a bit of work on that.

[00:03:50] Sheldon MacDonald: Now, I said earlier, we'd circle back to inflation. That's obviously been the topic at the top of everyone's mind for, well, the best part of the last two years, inflation still coming down, but very much slower, perhaps settling at these higher levels.

[00:04:05] Nathan Sweeney: Yes, this is an interesting one. So we had the core PCE numbers out in the US last week, and it's just a way of measuring price rises or inflation.

[00:04:14] Nathan Sweeney: So that figure came in at 3. 7%, slightly down from 3. 8%. So it looks as if it's coming down at a slower pace. But you have to remember, growth in the US is stronger, so you should expect to see some price pressure, and growth in the US is much higher than, say, the UK or Europe.

[00:04:31] Nathan Sweeney: So you might see different inflation dynamics as we move forward in Europe and the UK versus, say, the US so we'll monitor that closely, but it is a sign of the actual, the good growth that's coming through as well. So less of a concern.

[00:04:46] Sheldon MacDonald: Now returning to the higher for longer theme, we did have the European Central Bank meeting last week and they've left rates unchanged. And we do have the Fed and the Bank of England meeting this week.

[00:04:58] Nathan Sweeney: Yeah, so the real thing to watch out for there is, you know, have we seen a peak in interest rates? It looks like it. So the ECB didn't raise interest rates last week. We're expecting no rate rise from the Bank of England this week. No rate rise from the Fed or the US Central Bank this week also. So it really draws a line under the sand. We've had those peak rates.

[00:05:16] Nathan Sweeney: The only thing that could really change that is a resurgence in inflation. And we don't see that happening. You can see the oil price down again last week.

[00:05:24] Sheldon MacDonald: We'll watch also this week, the US employment figures are out, always very closely watched.

[00:05:29] Sheldon MacDonald: As we know, the Fed chairman has been very hot on wanting to see an easing of the pressures in the employment market. If those continue, then perhaps that might just leave the door open a little bit for interest rates to come down sooner rather than later. We'll keep an eye on those this week and bring you all the news next week.

[00:05:48] Sheldon MacDonald: Thank you.