While the cancelled Firmus IPO dominated local headlines, an easing of bond market concerns helped equities in what was otherwise a quiet week.
There was limited economic data, although purchasing managers indices (PMIs), an indicator of the outlook, continue to suggest the underlying global economy remains firmer than expected.
In the US, the S&P 500 gained 1.2% while locally the S&P/ASX 300 was up 0.4%.
Equity markets saw rotation away from AI/semiconductor sectors, partly due to some noise around OpenAI’s revenue run rate, however there were some issues with the accuracy of these claims.
The market for US Q3 earnings season to kick off for a lead on the latest AI capex updates and insight on the revenue benefits from that investment.
It is interesting to note that any expectation of slowing AI spend is now seen as bond friendly, due to less crowding out, and would lead to less monetary tightening which in turn would support the financial, consumer discretionary and REIT sectors.
In Australia the cancelled Firmus IPO was the main event. It was thwarted by an interplay of valuation, funding and execution concerns as well as a potential stock overhang.
This does not derail the company’s prospects, in our view, but we suspect we will see them undertake another private funding round and any future IPO to be in a different market.
Energy
Somewhat paradoxically, the oil price remains high (brent crude $104/bbl) while the flows through the Strait of Hormuz have returned to pre-war levels.
Around US$20 of the current price is estimated to be risk premium, reflecting the ongoing attacks on tankers going through the strait and fears of an escalation in the conflict either ahead of the US election by Iran – or after it by the US.
There is a significant additional issue with freight, as the movement of oil is relying on using smaller shuttle carriers through the strait, which then do ship-to-ship transfers which can tie up very large crude carriers (VLCCs) for up to 10 days.
In addition, 126 Iranian VLCCs are off the market (~13% of the global fleet) and a number of the tankers are taking longer routes.
All this means there is almost no spare capacity in freight, leading to transit costs rising to ~US$30/bbl and beyond, versus around US$2 to US$5 pre-crisis.
A buyer in China is now effectively paying close to US$140/bbl for oil from the Middle East, which is seeing them bid up for oil from other regions.
The likely outcome is that this will force European hydroskimming refiners (which produce lower-margin fuel oil) to curb production and reduce oil demand to alleviate the pressure, but this will add to the supply pressures on refined products.
There were attempts to alleviate the diesel shortage with the G7 announcing 100 million barrels to be released from emergency stocks over four months.
A portion of this had previously been announced, so it is not necessarily going to shift balances meaningfully, although there will be a greater focus on diesel releases over crude.
The release of Russian diesel announced by US President Donald Trump is also relatively small and likely to have limited impact.
This gets to the core challenge for markets; diesel is very expensive.
The price in AUD has doubled this year and this is an input into a broad range of sectors including mining, goods freight, agriculture, and building materials. We are beginning to hear about surcharges being reintroduced, all of which will continue to put pressure on inflation.
Global macro
There was limited data last week outside of the global manufacturing and services PMIs.
The latter signalled the global economy is getting stronger, despite all the issues with fuel prices.
This is good for equities and earnings but continues to put pressure on central banks to contain inflation.
Regionally the US is strong and in Europe, Germany is picking up.
The Fed and outlook for rates
The Federal Open Market Committee (FOMC) minutes provided the forward guidance that Chair Kevin Warsh is so reluctant to give, essentially signalling a pause in October but another hike before the year’s end and the need for at least two more hikes this cycle.
In addition, Fed Governor Christopher Waller, speaking at a central bank forum in Turkey, noted the reasons why he has pivoted from a previously more doveish perspective. The key factors were:
- The persistence of disruption from the Iran conflict and the flow on effect to diesel prices,
- The apparent flow on effect of the AI boom on other prices, and
- The emergence of new potential tariff pressures (e.g. Canada).
Given inflation has exceeded the Fed’s target for five-and-a-half years, these new pressures may lead to a shift in expectations of inflation.
Markets
Bond markets were calm last week, with US 10-year yields ending down 4 basis points (bps) at 5.24%.
This Wednesday’s (US time) release of September consumer price index (CPI) data will be the next test.
Yields have backed up a lot recently, with the move exacerbated by market positioning and the need to hedge positions.
It appears this pressure has eased and the 10-year yield has found some resistance at 5.35%
The global AI/semiconductor sector was weaker last week, on not a lot of news flow.
Some noise around OpenAI’s revenue run rate may have been a factor, with reports that the end September number was US$50 billion versus previous reports of US$70 billion.
However there appear to be issues around the basis of this measure and accuracy of some of the statements.
Regardless, this does highlight the issue that the AI trade currently relies on Anthropic and OpenAI to underpin compute demand.
Both these companies are private, so don’t provide audited financial numbers and we don’t know how sustainable these revenues are.
For example, there is a view that Anthropic revenue is currently inflated by other companies using their models in the intensive phase of developing their own products but once completed, the likes of Microsoft and Meta may migrate to cheaper, open-weight models.
Overall, the tech sector retains good technical support going into US quarterly reporting season.
What saw a bounce in some of the rate sensitive sectors (REITs, consumer discretionary, utilities) last week, partly on the stabilisation in bonds which reduced the probability of a spike towards 6% yields, helped with the rating on these sectors.
It is also becoming apparent that the rate trade is negatively correlated to the AI trade on the view that the stronger the AI investment cycle, the higher rates will have to go and the more that will impact on rate sensitives.
The key sector to watch is financials, particularly banks, which have struggled since Warsh’s Jackson Hole speech on concerns high rates will negatively affect the economy.
The US financial sector appears technically oversold in a long run uptrend going into results, which start this week.
Australia saw a similar theme with REITs (+3.5%), utilities (+3.6%) and discretionary (+2.5%) performing the best last week.
The rally in rate-sensitive stocks reflects recent economic data showing weakening momentum across housing (building approvals down), manufacturing (PMI back in contraction), broader activity (composite PMI slowing), and consumer sentiment (falling to a six-month low).
If growth slows, this may limit the hikes required by the RBA.
There is risk to this view given the inflationary pressures we are seeing globally and the need for the Fed to continue to raise rates.
Australia is one of the most sensitive economies to rising fuel prices given its diesel usage, which may lead to ongoing inflation pressures even with lower growth.
When it comes to rate sensitives we believe we should distinguish between longer-duration bond sensitive stocks and those with economic risk (e.g. consumer discretionary) as the only reason for the RBA to stop hiking is a weak consumer, which would impact that sector’s earnings.
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