The US has a relief rally due to lower bond yields, why we look at the PCE Index, and more...

The markets had a relief rally last week. The Nasdaq 100 surged 7.5% and the S&P 500 was up 6.5% on the back of bond yields decreasing to two-week lows. US 10 Year Treasury’s are around 3.14%, down from a peak of nearly 3.5%. This was due to sentiment that the economy would slow down, which may result in the Fed reducing rates soon after they complete the monetary tightening cycle.

So why did this help stocks go up? Well, the market places a high importance on interest rates when it comes to stock performance. A lowering of interest rates reduces the amount companies’ earnings are discounted, which gives upside to their share price.

The Australian stock market also benefited from this sentiment, ending the week up by 1.6%. However, this lagged the surge the US markets experienced last week, primarily due to negative sentiment weighing down mining and energy stocks. A slowdown would result in lower demand for commodities such as iron ore.

Speaking of the Fed’s tightening cycle, a key inflation indicator is coming out. Although it doesn’t grab the headlines, the core PCE (personal consumption expenditures) Price Index is one of the main indicators the Fed follows when setting policy. The Fed prefers the PCE index over the CPI Index, as they consider the PCE a broader and timelier measure of consumer behaviour than the CPI. The PCE Index is expected to come in at 4.8% in May, which would be down 0.1% from the month prior. This is something we hope to see.

Jobless claims in the US are expected to stay flat at around 227,000, which would be further evidence that this indicator has well and truly bottomed out since late March. This means that the peak of the tightness in the labour market may be passing, which would ease labour cost pressures in the coming year.

The print for CB Consumer Confidence in the US is expected to be 100.9. Anything over 100 shows that the American consumer has more of a positive sentiment than negative. However, this confidence level has been tracking downwards, which is another thing that will ease inflation pressures from the demand side.

Despite the mixed outlook for the economy, we believe the market has offered some opportunities. Although these opportunities are harder to find than they were in 2020 when the markets took off, there are increasingly more companies reaching attractive valuations. We have a few key themes that we are bullish on as well.

With food inflation likely to persist in the short to medium term, we still see upside to food and agriculture companies. With interest rates still rising, have a look out for companies that benefit from rising rates which hasn’t been priced in yet. This may be companies that sit on a lot of cash or safe debt instruments as a part of their business model, in which even without changing their operations they will see their balances grow from interest payments.

Furthermore, look for companies with strong and effective management. It will be effective management that can lead companies through challenging times. The type of characteristics we look for are those who have a principal mentality rather than agency mentality, have appropriate alignment and incentive structures, are operationally aggressive but financially conservative and having a positive relationship with the board.

We are still of the view that we should avoid long-duration stocks, as well as companies facing inflating cost pressures and no pricing power to offset this. Companies without pricing power either have to face reduced margins if they keep prices constant or face the prospect of losing customers to competitors if they raise prices. This would be a lose-lose situation.

Interesting Finance Fact

There are 60 stock exchanges in the world

The largest stock exchange in the world is the New York Stock Exchange, with the smallest stock exchange in the world being the Cambodia Securities Exchange.

Have a great week,

Sam Waldron - Research Analyst

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