Several factors are driving the ASX’s January run — but investors should stay watchful, particularly on company earnings, says Pendal midcap portfolio manager BRENTON SAUNDERS

• China re-opening drives optimism
• Outlook remains uncertain
• Find out about Brenton’s Pendal MidCap Fund

THE ASX’s strong start to 2023 has raised market confidence of better returns over the coming year.

But investors should resist getting swept up in the optimism and wait to see how company earnings fare in the face of rising interest rates, says Pendal’s midcap portfolio manager Brenton Saunders.

Three factors are driving the rapid turnaround from last year’s pessimism, says Saunders:

• The faster-than-expected re-opening of China
• Signs that inflation is reaching a peak
• Increasing evidence that a hard-landing global recession can be avoided

The S&P/ASX200 is up more than 8 per cent in January, bond yields have fallen and the US dollar has dropped sharply.

But Saunders says there are still clouds over the global economy including the prospect of a downturn later this year and the uncertainty of the Russia-Ukraine conflict.

The impact of rate rises on corporate earnings is also still unclear.

As a result, investors should take a cautious approach.

“The new year has started with a bang,” says Saunders, who manages Pendal MidCap Fund.

“Chinese sentiment has improved quickly, which has manifested in higher iron ore and other commodity prices. We’ve also seen a step up in expectation that the downturn in inflation is accelerating.

“This has been quite positive for markets.”

How China is impacting the ASX

The reopening of China has had a particularly pronounced effect on the Australian market.

As recently as mid-December, expectations were for damaging impacts from the spread of Covid across the Chinese population.

Find out about

Pendal Midcap Fund

Read more

“Despite high infection rates Chinese consumers have adapted quickly and we’re seeing fast normalisation in activity levels,” says Saunders.

“There have certainly been high, widespread infection rates — and anecdotally have associated mortality levels, along with health systems battling to cope.

“But what’s changed quite diametrically is that the Chinese people have adapted to it quickly.

“The enormous fall in activity that we had through the first half of December reversed and activity levels normalised very quickly despite the high infection rates.”

Saunders says the market impact of that adaptation has been immediately felt in the iron ore price and is now flowing through to other commodities too.

Improving trade relationship

Supporting ASX sentiment is a thawing of the trade relationship between Australia and China.

“Australia has a lot of tentacles into China.

“The most obvious one is resources, but there’s a lot of companies that benefit from increased tourism, increased student flow, increased migration. That will all benefit from the China reopening.

Some 40,000 Chinese students are expected to rush back to Australia after Beijing announced they must return to face-to-face study at overseas universities

Saunders is also hearing anecdotes from Australian coal companies about cargoes heading to China for the first time in two years: “That’s some evidence that the relationship has improved.”

At the same time, the easing of global inflationary pressures is positive for markets.

“It has tempered people’s expectations of the extent of the outstanding rate rises – and the likelihood of a hard landing recession is declining,” says Saunders.

“That has seen bond market yields turn lower and continued to see the US dollar sell off and that’s been positive for markets generally.”

Unknowns on the horizon

Still, there are unknowns on the horizon.

Europe’s warmer-than-expected winter has eased fears of an immediate gas crisis, but a recent cold snap could change that picture.

Russia’s war in Ukraine continues. And the impact of tighter monetary policy is yet to fully impact households.

“We’re still pretty cautious,” says Saunders.

“This year is probably going to be quite choppy. We have improving longer-term expectations with the prospect of some potentially negative short-term implications.

“We still think that there’s a fairly high level of binary risk out there that is yet to be quantified.

“Earnings is still the area that we’re most worried about — ratings are starting to improve but there’s still material risk around earnings.”

Why bonds, why now

Ausbiz’s Nadine Blayney interviews CBA chief economist Stephen Halmarick and Pendal head of bonds Tim Hext

ON-DEMAND WEBINAR

Watch Now