Late-cycle dynamics can be tricky to navigate. Here are five tactics Pendal’s head of income strategies AMY XIE PATRICK is considering for the path ahead

• Late-cycle dynamics can be vulnerable to shocks
• While growth slows, inflation remains a concern
• Why bonds, why now? Pendal’s income and fixed interest experts explain
• Browse Pendal’s fixed interest funds

EQUITY markets seem to have recovered from their August gyrations for now.  

But investors are left wondering if those moves were a one-hit wonder or a warning shot of more to come.  

The key characteristic of this “late cycle” economy is that growth – while still positive – is slowing down.

This is broadly the case the world over, though some places like China never even lifted off during the good part of the cycle.  

Late-cycle dynamics are tricky to navigate, since they carry the risk of being caught wrong-footed in both directions.  

If we get concerned too early we can miss some impressive late-cycle market rallies. We’ll also miss out on good corporate bond coupons and decent equity dividends along the way.  

Get too greedy, though, and we can be caught in the down-draught with little to no ability to sidestep any of the pain.  

Knowing what to prioritise and staying focused on our investment goals can give us the agility and tenacity we need to navigate uncertain macro environments.  

This article covers the top five things that our team are prioritising for late-cycle trading in our income portfolios.  

1. Conviction in quality

Now is the time to kick the tyres of every corporate bond we own.  

As the economy slows, credit quality will disperse and generally deteriorate. 

Companies that can preserve strong cash positions and demonstrate resilient business models will do well. Those who have few levers to pull against the headwinds of slowing sales and narrowing margins won’t. 

Another feature of late-cycle dynamics is a system more vulnerable to shocks.  

Physical corporate bonds in Australia are usually the first to lose their trading liquidity at any sign of trouble. The most extreme example of this was during the early weeks of Covid, as Australian credit markets ground to a halt.  

Since fundamentals are deteriorating and liquidity events can happen without notice, the only way to prepare is to test our conviction of every issuer we own. Those who can’t pass that conviction test need to leave the portfolio. 

Our portfolios passed our conviction tests with flying colours.  

We have always had a through-the-cycle quality discipline with the assets we buy.

Sure, our tyre-kicking exercise left us with slightly scuffed shoes, but it also meant little need for additional action.  

2. Demand the right pay

It is more recent bond issues from the primary market that tend to fail our conviction test.  

Marginal and first-time issuers have been extending the maturities of new debt and offering to pay very skinny spreads to us investors. 

There are points in the cycle where investors must succumb to these sellers’ markets.  

When most portfolios have stayed on the sidelines for too long, cash levels are high, and bond issuance is measured and high quality, we have no choice but to accept what is on offer to keep our portfolios invested.  

The economic backdrop is usually benign in those times. Growth tends to be stable or accelerating, inflation won’t be in Google’s most-searched items, and global economic cycles will be in sync.  

That is not what the economic stage looks like today.  

While growth is slowing, inflation remains a lingering concern. And while the US economy grows at 2% per annum, Australia is seeing growth at its lowest level in two decades (outside of the pandemic).  

Even if strong issuers come to this market, investors need to be compensated for the likely volatility those businesses could experience economically, or the certain volatility their credit spreads would experience if recession were to hit.   

For inaugural issuers, investors need to be compensated for both of the above, as well as what can’t be known beforehand: how will this bond behave and what will its trading liquidity be like through a prolonged bout of market volatility?  

3. Liquidity is our flex

Notwithstanding the cyclical liquidity of physical corporate bonds in the Australian market, now is the time to make sure we have enough overall liquidity in our portfolios.  

Not only does this mean carrying plenty of cash buffers, it also means making sure that whatever exposures we’re taking in addition to credit is through the most liquid means possible.  

Liquidity allows for agility, and that is a prized asset in late-cycle markets.

The volatility in early August was a glimpse into how the market’s assessment of economic fundamentals can change on a dime.  

One minute, a soft-landing was the received wisdom. The next, the US economy was already in a recession. And a few minutes (or days) after that, a soft-landing was back on the table.  

Our portfolios were exposed to both defensive and risky levers throughout this volatility episode.  

Our implementation was through the most liquid means possible, so that we did not need to rely on the rather clunky and slow functioning of physical bond markets to enact our views.  

As rates market enthusiasm peaked, looking for emergency cuts from central banks, we quickly trimmed our interest rate positions to protect profits.

As equities and global credit indices passed through their lows, we were able to add some exposures for our portfolios so they could join in on the recovery – even though they didn’t participate in the fall.  

4. Good decision-making

This seems superfluous, since investors need to make decisions all the time. But a strong process for decision-making is something to be prioritised in uncertain times.  

The uncertainty that plagues late-cycle market dynamics tend to lead to binary outcomes. Recession, or no recession? Default rates surge or stay benign?  

There is no room for vague decision-making when these are the potential outcomes. Making half a bad decision causes portfolio managers to spend all of their energy dealing with the consequences of that decision.  

It’s important to be clear that a good decision isn’t defined by the outcome.  

Good decisions take into account as accurate and as objective an assessment of the relevant information. They are based on a rational assessment of the risks and rewards.  

Good decisions are made when we are honest about what we know, and what we don’t or can’t know. Good decisions involve taking risks and cutting losses.  

One way to ensure a strong decision-making process is to understand what the markers of success and failure will look like before taking on any exposures for the portfolio. That way, an action plan can be formed with the benefit of rationality.  

This removes the demand for cool-headed decisions to be made in the heat of the moment.

5. Look around the bend

If a recession were to happen, whether it be global or local, the worst thing would be to have held a portfolio of expensive and illiquid assets through a significant market drawdown.  

The second worst thing would be not to have acted on dislocated market opportunities for our portfolios.  

Recession isn’t a done deal – we just know that simply because the momentum for growth is now slowing, it necessarily raises the odds for a hard landing.  

A hard landing looks like accelerating unemployment, drawdowns in house prices and rising rates of debt default.  

In markets, it looks like large drawdowns in equity markets (think 25%+), significant widening of credit spreads (think US high-yield spreads above 1,000bps compared to 320bps currently), and a low in 10-year bond yields below 2.5%.  

The difference between a recession in the real world and how it plays out the markets is that the latter happens far more quickly. Most will remember the V-shaped move in equity markets through the rolling years of the Covid pandemic.  

If recession happens, it’ll be caused by the lagged effects of monetary policy tightening.  

The main reason for the long lags in this cycle has been the magnitude of cash stimulus during and after the pandemic. With cash in pockets, consumers had a lesser need to borrow and hence the economic sensitivity to interest rates was lower.  

Now that much of the excess cash has been spent, the next cycle can only start once the cost of borrowing falls materially. New leverage will be necessary to fuel consumption.  

Failing to look around the bend means waiting for economic activity to recover before adding risk to the portfolio. By then, the opportunity to buy the dip will have come and gone. 

Summary and performance

In summary, our active approach is geared towards prioritising five things to navigate late-cycle dynamics.  

Since growth is slowing, we are staying with only the highest-conviction exposures that we’re happy to hold even through a recession.  

We are demanding to be paid the right spreads for those exposures. And any exposures on top of that, we are prioritising liquidity since it arms us with the flexibility to act as things change.  

As always, we need to ensure that our decision-making processes stay solid. This means we won’t be blinded to future opportunities by any debris that may fall from near-term chaos. 

Total returns* of Pendal’s income strategies 

Fund name	Total return	RBA Cash Index	Active return
Dynamic Income Fund	9.0%	4.3%	4.7%
Monthly Income Plus Fund	8.9%	4.3%	4.6%

*Returns are net of fees, to end of August 2024 

What the latest GDP data tells us | Opportunities in small caps and Chinese equities | AI chip-maker takes a tumble

Active small-cap managers are delivering strong returns despite index underperformance. Pendal portfolio managers LEWIS EDGLEY and PATRICK TEODOROWSKI explain why

• Small caps could return to favour as conditions evolve
• Quality earnings the key
• Find out about the Pendal Smaller Companies Fund

IS IT time to invest in ASX-listed small caps?

It’s a question investors are asking ahead of potential global rate cuts which could bring a long period of small-cap underperformance to an end.

But while it’s tempting to focus on timing, the unique nature of small-cap indices means a careful stock-selection approach can outperform regardless of broader market conditions, argue Pendal’s Lewis Edgley and Patrick Teodorowski.

“As a whole, small caps have been a significant underperformer relative to large caps over the last two years and people are asking us ‘is now the right time to be investing?’ says Edgley.

“My answer is the underperformance problem isn’t just a two-year problem – it’s a two-decade problem.

“The Small Ordinaries index has generated a 5.5 per cent compound annual return for 20 years, versus the ASX 100’s 8.8 per cent.

“But the median small-cap manager has returned 9.7 per cent over the same time.

“That tells you what an active small-cap manager can do when they’re able to sift through the maze of good and bad investment opportunities that the Small Ordinaries provides.”

Edgley and Teodorowski co-manage Pendal Smaller Companies Fund, which invests in companies outside the top 100 listed on the Australian and New Zealand stock markets.

Together the pair have 25 years of experience with Pendal Smaller Companies Fund.

Unique opportunities and challenges

The Small Ordinaries index – which includes companies included in the ASX 300, but not in the ASX 100 — presents unique challenges for investors due to a wide array of industries and companies.

The index can often include faddish companies that enter the index with high expectations before underperforming as their popularity wanes.

It can include single-play resources companies that rally and fade as commodity prices fluctuate.

“We get themes that run and components of the index that get significantly exposed to that theme. Then as the theme runs its course, performance ends.

“But despite the fact that the benchmark has only delivered a 5.5 per cent a year over 20 years, by being dynamic and identifying the better-quality companies, we’ve been able to navigate that and find money-making ideas.”

Since inception in 1992, the Pendal Smaller Companies Fund has generated an after-fees return of 11.95 per cent. You can view the fund’s performance over other time frames here.

Rate cuts could spur performance

Small caps are historically correlated to changes in interest rates, argues Edgley.

“We have a blueprint for this in many cycles, whether it’s the GFC or Covid – declining interest rates are usually a tailwind for small caps relative to large caps.

“Over the last two or three years, small caps have essentially been driving with the handbrake on.

“We don’t know when rates are going to start coming off. But when they do, small caps should start to get a tailwind.”

What does that mean for timing?

“We think it actually doesn’t matter – our history shows there are ways of finding money-making opportunities regardless of what rates are doing.

“Small caps have historically traded at about an 8 or 9 per cent premium relative to large caps for the past 10 years – and they are at about that same premium today.

“Most people want to buy small caps when they are cheap. You could argue that as it stands, small caps aren’t cheap.

“In any case, our view is that buying the cheapest small caps generally isn’t the best way to make money.”

Earnings drive performance

“We don’t focus on the price-to-earnings ratio as the starting point – we focus on earnings and earnings quality,” says Teodorowski.

“Through the last two years of a challenging macro and market environment for small caps, we’ve been able to identify two groups of businesses: structural growth businesses that we were able to put more capital in at a better valuation; and businesses with more defensive earnings than the market thought, which have rebounded significantly.”

Edgley adds: “The reason we feel confident that we can continue to do this is due to the composition of our performance over time.

“The value we’ve created hasn’t just come through a very small number of big bets going well, it’s come through a broad combination of lots of things going well.

“That’s much easier to replicate going forward.

“If you can do lots of small things well over time, that can compound to a really great outcome.”

The latest GDP data shows a weak Australian economy, but the numbers should pick up from here, says Pendal’s head of government bonds TIM HEXT

• Commodity boom waning, households going backwards
• Why bonds, why now? Pendal’s income and fixed interest experts explain
• Browse Pendal’s fixed interest funds

TODAY’S June quarter GDP numbers paint a reasonably bleak, but not unexpected, picture of the Australian economy.

Quarterly GDP was 0.2% for the third consecutive quarter, leaving annual growth at 1%. It was the weakest financial year – excluding the Covid hit of 2020/21 – since the recession of 1991/92.

We are avoiding a technical recession overall this time, but the consumer is going backwards – even with 2.5% population growth.

Remember, the main GDP you hear reported is a chain volume, not price measure.

I prefer looking at numbers on a state basis, split into consumption and investment. This gives a better picture of what is going on in the economy.

Source: ABS

Here are five key takeaways from today’s numbers:

1. Government spending remains strong despite government investment tapering off

Government expenditure contributed 0.3% to GDP, government investment 0.1%, while government spending rose by a strong 1.4%.

The main driver is social benefit programs for health services (largely the NDIS).

This also remains a major source of strength for employment and inflation, and is central to the current animated debate between Treasurer Chalmers and the RBA (though Governor Bullock has wisely toned down prior comments, leaving RBA proxies to continue it).

State governments are also major drivers of growth and inflation.

However, NSW has now seen government investment go negative (down 3.8%) as major projects like the Metro are completed. Victoria (up 5.4%) and South Australia (up 5.8%) clearly didn’t get the RBA memo asking for restraint.

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About Tim Hext and Pendal’s Income & Fixed Interest boutique

Tim Hext is a Pendal portfolio manager and head of government bond strategies in our Income and Fixed Interest team.

Tim has extensive experience in banking, financial markets and funding including senior positions with NSW Treasury Corporation (TCorp), Westpac Treasury, Commonwealth Bank of Australia, Deutsche Bank, Bain & Co and Swiss Bank Corporation.

Pendal’s Income and Fixed Interest boutique is one of the most experienced and well-regarded fixed income teams in Australia.

Find out more about Pendal’s fixed interest strategies here

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About Pendal

Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management.

In 2023, Pendal became part of Perpetual Limited (ASX:PPT), bringing together two of Australia’s most respected active asset management brands to create a global leader in multi-boutique asset management with autonomous, world-class investment capabilities and a growing leadership position in ESG.

Contact a Pendal key account manager

Despite a cloudy narrative, Pendal’s emerging markets team remains overweight in Chinese equities via a highly selective set of stocks. Here, they explain why

• China bond market moves look rational
• Good results among domestic companies
• Find out about Pendal Global Emerging Markets Opportunities fund

This article is more than 12 months old. Find our latest insights here

THERE’S been a lot of focus recently on what bond market signals are telling us about the outlook for growth.

This is true for emerging markets such as Brazil and Mexico as well – though investors have tended to overlook some dramatic moves in Chinese bonds.

The US five-year bond yield has fallen slightly this year.

Medium-term bond yields have risen in many emerging markets, amid concerns that a strong US dollar might delay interest rate cuts, or even (as is the case in Indonesia) prompt interest rate hikes.

In China, though, the five-year bond yield has fallen from 2.4% to less than 1.9%.

This has led China’s central bank (also known as the People’s Bank of China or PBoC) to worry about a bubble in Chinese government bond prices.

As a result the PBoC has been gently intervening in markets to try to prevent bond yields falling too far or too fast.

Bond yield moves look rational

Despite the central bank’s concerns, these moves in yields look rational to us.

Inflation in China is low and quite possibly negative. The latest inflation measures are +0.5% for CPI, -0.8% for PPI (both to July) and -0.7% for the GDP deflator.

Deflation increases the real yield on bonds, while real estate and equities are potentially hurt by deflation in a leveraged economy.

As well as the signal from inflation, the credit environment is also signalling an ongoing deflationary economic slowdown.

July lending data shows a contraction in bank loans as corporates and households look to pay down debt.

This is the first contraction in lending in the economy since 2005, including during Covid and the GFC.

Given the historical pattern of a decade-long, debt-driven real-estate boom followed by what looks like a debt-deflationary slowdown, there is a temptation to see China falling into the same kind of balance sheet recession that Japan experienced after its late 1980s boom.

Only just this year has Japan’s Nikkei equity index exceeded its 1989 peak.

Do Chinese equities also face a similar “lost decade” as Japan did in the 1990s?

One group that might be worried are the western multinational companies that have been reporting sharp downturns in their China sales in recent quarters.

From beer to luxury products to cosmetics to cars, a clear pattern has emerged of results commentary warning about Chinese demand.

We feel a more detailed look at company results shows a different, more promising pattern.

Good results among Chinese companies

In the above consumer segments – as well as areas such as travel, tourism and e-commerce – many Chinese domestic companies are reporting good results and earnings growth.

Consensus estimates of future earnings are also being revised up.

We feel this reflects Chinese consumers pivoting to different products and lower price points, as well as a new preference for domestic Chinese brands.

For example, foreign car makers have fallen from 64% market share in China to 38% over the past four years.

A similar pattern is emerging in other products, including beer and cosmetics.

With these companies performing well, China’s broad equity market weakness in recent years (especially for Hong Kong-listed names) has pushed some stocks to attractive valuations – especially compared to falling bond yields.

Yes, China’s economy is struggling for growth.

Its credit environment is particularly difficult and there has so far been no turnaround in the wider real estate market.

Yet there are opportunities to be found in Chinese equities.

We remain overweight Chinese equities in the portfolio, with exposure to a highly selective set of stocks.

About Pendal Global Emerging Markets Opportunities Fund

James Syme, Paul Wimborne and Ada Chan are co-managers of Pendal’s Global Emerging Markets Opportunities Fund.

The fund aims to add value through a combination of country allocation and individual stock selection.

The country allocation process is based on analysis of a country’s economic growth, monetary policy, market liquidity, currency, governance/politics and equity market valuation.

The stock selection process focuses on buying quality growth stocks at attractive valuations.

Find out more about Pendal Global Emerging Markets Opportunities Fund here
 
Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management.

Contact a Pendal key account manager here

Here are the main factors driving the ASX this week, according to Aussie equities analyst and portfolio manager ELISE MCKAY. Reported by portfolio specialist Chris Adams

• Markets are pricing in a 33bps Feb cut in September
• The Australian Boomer is continuing to boom
• Register now: join Crispin Murray’s Beyond the Numbers webinar
• Find out about Pendal Focus Australian Share fund

REPORTING season has shown that the consumer is holding up better than expected – helped largely by Baby Boomers – and credit conditions have improved, benefiting the REIT sector. Capital discipline has been rewarded.

The S&P/ASX 300 gained 1.01% last week, but the US market was muted.

The S&P 500 was up 0.27%, while the NASDAQ was down 0.91% as NVIDIA’s (down 7.7%) result was not good enough for the market.

NVIDIA reported strong revenue, with data centre sales up 154% year-over-year (YoY) and ahead of expectations, signalling that AI demand is intact. However, its gross profit margin guidance disappointed, resulting in much more muted EPS upgrades. 

It was a quiet week on the macro front.

US Personal Consumption Expenditures (PCE) inflation data is no longer a major market mover, unlike earlier this year, as the Fed has moved its primary focus from inflation to labour.

With a September rate cut now a given in the US, the labour data released this Friday (6 September) will be key to helping determine the size. 

While the market is pricing a 50% chance of a 50-basis-point (bps) rate cut, the Atlanta Fed GDPNow Tracker is forecasting a robust 2.5% real Gross Domestic Product growth for Q324 – suggesting that we are still on track for a soft landing. 

US policy and macro

PCE data

July’s PCE inflation was in line with expectations on both a headline (up 0.2% month-on-month (MoM) and 2.5% YoY) and core (up 0.16% MoM and 2.6% YoY) basis.

This is the third consecutive month where we have seen the MoM number come in below the Fed’s forecast. As a result, we expect that the Fed committee will need to revise down its Q2 2024 inflation forecast at next month’s meeting, which is currently sitting at 2.6%. 

There was nothing in this print to upend the view that the Fed has moved from being inflation-first to labour market-first. 

The market’s question now is whether the Fed cuts by 25bps or 50bps in September. This Friday’s labour data will be key in this regard.

PCE Core goods inflation is back in deflationary territory, with a MoM print down -0.1%. 

The Fed’s preferred metric, Core services (excluding housing), increased from 0.16% last month to 0.21% MoM. But the trend is in the right direction, with the three-month annualised rate now at +2% YoY. 

Personal consumption

Consumption growth has maintained decent momentum – with real consumption spending coming in at 0.4% MoM (versus consensus at 0.3%), driven primarily by goods expenditure (up 0.7% MoM). 

Spending on autos picked up meaningfully to 4.1% MoM, but even stripping this out, goods expenditure still grew a robust 0.4% MoM.

Consumption appears to have accelerated from the 2.9% annualised rate in Q2. This is at odds with income growth, which is on the weaker side. 

Personal incomes grew 0.3% MoM in July and real after-tax income rose by just 0.1% MoM, with the annualised number only just over 1%. 

With consumption running roughly 2% above income growth, consumers are saving less in order to fund their lifestyles. The savings rate dropped to 2.9% in July – the second lowest rate since 2008 and well below the pre-Covid average of about 6%. 

It is reasonable to assume that, should the labour market continue to soften, we should see people start to save more in precaution, thus dampening consumption growth. However, this is yet to be seen in practice.

US pending homes sales

The strength in consumer spending has not made its way into a stronger housing market. Pending home sales fell 5.5% in July, versus expectations of 0.2% growth. 

This index is now at a new all-time low for its 24-year history. 

Mortgage rates have been dropping and are now, on average, 70bps lower in August than in May, but this has not yet reached levels sufficient to support mortgage demand. 

Unlike in Australia, mortgage rates can be fixed at the outset for the full term in the US. As a result, the differential between existing mortgages and market rates makes it too expensive for many homeowners to move, which should continue to weigh on the supply of homes for sale.   

Upcoming Fed meeting

The next meeting is scheduled for 17-18 September. 

Over the past week, the market has moved to price in a 33bps cut in September (i.e. roughly halfway between a 25bp and a 50bp cut) and about 100bps of cuts by the end of the year.  

We would likely need to see an unemployment rate at 4.3% in this Friday’s labour data to support a 50bp cut. This remains to be seen, though weekly claims data is supportive of an unemployment rate below 4.3%, with the four-week average claims running at 232k. 

Soft landing data After strong 3% growth in GDP for Q224, of which two-thirds was driven by consumption, the Atlanta Fed GDPNow Tracker is looking for a robust 2.5% in Q324. This has ticked up following strong consumption data. 

Australia policy and macro

Australia’s July Consumer Price Index (CPI) fell from 3.8% YoY in June to 3.5% YoY in July.

This was 10bps higher than expected, but the timing of an electricity subsidy accounted for the difference.

The trimmed mean CPI slowed to 3.8% YoY from 4.1% YoY and is trending down broadly in line with the RBA’s most recent forecasts for Q324.

Retail sales were up 2.3% YoY in July but flat month-on-month and below consensus expectations of +0.3%.

This is somewhat surprising given the strong start to FY25, flagged by several consumer discretionary companies during reporting season.

One possible explanation is that the stronger players in each category – think Temple & Webster (TPW), Endeavour (EDV), Universal Stores (UNI) – are taking market share.  

As previously flagged, the Australian Boomer is continuing to boom. 

UBS estimates that the total retirement benefits paid out over FY24 rose to a record high of $160 billion, equivalent to roughly 11% of household income. 

This has been driven by record-high levels of retirement assets, which now total $3.9 trillion (about 147% of annual nominal GDP). 

Retailers that cater for an older demographic (e.g. Nick Scali (NCK)) have benefited in this environment. 

We also saw the latest capex data for Q2 2024.

It suggests that mining companies are becoming more cautious on the outlook for investment in the sector, with FY24 estimates downgraded and forward estimates tracking for a fall in FY25. 

That said, we have seen some companies buck this trend during reporting season, with both Fortescue (FMG) and Mineral Resources (MIN) guiding to increased capex spend. 

Eurozone inflation

The August print was in line with expectations, keeping the European Central Bank on track to cut by 25bps at the September meeting. 

Headline inflation is now running at 2.2%, while core inflation is running at 2.8%.

Services inflation (at 4.2%) remains stubbornly sticky and may have been assisted by one-off factors such as the Olympics. 

NVIDIA result and AI

NVIDIA yet again beat expectations and raised guidance in its quarterly results last week. 

Revenue grew 15% to US$30 billion for the quarter (versus consensus of 10% growth) and guided to US$32.5 billion for Q3 2025 (versus the market at US$31.5 billion). 

Data centre demand remains strong and broad-based across hyperscale, consumer internet and enterprise customers. 

The demand for sovereign AI has strengthened further, with low double-digit billions in sales forecast for FY25 (increased from high-single digits). This reflects sovereign states’ desire to build AI models that are based on local datasets, language and cultures. 

However, the disappointment was on gross profit margin guidance at 75% for 3Q 2024, which was 40bps below expectations and implied guidance for gross profit margins in the low-70s for Q4 2024. 

This reflects the introduction of the new Blackwell family of chips, which start at a higher cost before reaching scale during 2025. 

Revenue upgrades on a bullish outlook for data centre demand were mostly offset by cost upgrades, limited EPS upgrades to low-single digits. 

Valuation does not look unreasonable in our view, with NVDA trading roughly 15% below its five-year average multiple.

NVDA’s 154% YoY growth in data centre revenue is supportive for the local Australian-listed plays, like Goodman (GMG), NextDC (NXT), Macquarie Telecom (MAQ) and Infratil (IFT), of which the first three are held across a variety of Pendal’s Australian equities portfolios.

Australian markets

The final week of reporting season was a good one, though the S&P/ASX Small Ordinaries was a touch softer (down 0.19%). 

Financials (up 2.21%) and REITs (up 2.20%) were the best-performing sectors, while Technology (down 1.65%) and Consumer Discretionary (down 1.30%) were the weakest.  

A few industry-level observations emerged from reporting season, including:

• Bank net-interest-margins (NIMs) surprised on the upside and domestic general insurance trends have strengthened.
• The contractors and services companies have been getting it done – those already in good shape (e.g. Seven Group (SVW) and Ventia (VNT)) have excelled in an easier labour environment, while the tough operating environment in recent years has helped whip the rest of the sector into much better shape (e.g. Downer (DOW) and Worley (WOR)). 
• Consumer discretionary has been a mixed bag, but the highest-quality operators have continued to take share and grow in a challenging retail environment (e.g. Breville Group (BRG), Temple & Webster (TPW), JB Hi-Fi (JBH), Universal Stores (UNI), Super Retail (SUL)).
• Travel has been more challenged and FY25 is likely to be more volatile, particularly for the travel agents and those exposed to hotel bookings (e.g. Flight Centre (FLT), Webjet (WEB), Corporate Travel Management (CTD) and Siteminder (SDR)). On the other hand, Qantas (QAN), continues to trade well.

Our property team of Peter Davison and Julia Forrest note the following regarding the REIT space:

• REITs have broadly seen better rent growth (up 4.1%), with malls particularly strong (up 5.8%) and office still the weakest sub-sector (up 2%). 
• Nearly every REIT is highlighting far better credit conditions, longer tenor and lower margins.
• Debt costs, as measured by the three-year swap rate, have fallen by almost 60-80bps in the past two months – boding well for leveraged names and property fund managers.
• Regional malls are all trading well, with positive leasing spreads, low occupancy and very good demand for regional mall space. Importantly, buying interest for larger property assets is now reaching larger-scale mall assets. There has been very good demand for recent unlisted offerings by Scentre Group for its Tea Tree and Westlakes mall assets in Adelaide. This is a meaningful change in market dynamics.
• Melbourne is the weakest residential market, while Brisbane, Perth and Adelaide are very strong. Retirement living (land-lease communities) is also very weak in Melbourne.
• Apartment markets are all very weak on delivery concerns and affordability issues. Only luxury apartments are making money.
• Industrial assets are still recording high rent growth (about 4.6%).
• Office is still the weakest sector, with 2% rent growth.

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About Elise McKay and Pendal Australian share funds

Elise is an investment analyst and portfolio manager with Pendal’s Australian equities team. Elise previously worked as an investment analyst for US fund manager Cartica where she covered a variety of emerging market companies.

She has also worked in investment banking and corporate finance at JP Morgan and Ernst & Young.

Pendal Horizon Sustainable Australian Share Fund is a concentrated portfolio aligned with the transition to a more sustainable, future economy.

Pendal Focus Australian Share Fund is a high-conviction equity fund with a 16-year track record of strong performance in a range of market conditions. The Fund is rated at the highest level by Lonsec, Morningstar and Zenith.

Pendal is an independent, global investment management business focused on delivering superior investment returns for our clients through active management. 

Contact a Pendal key account manager here

We have updated and reissued the Product Disclosure Statements (PDSs) for the following funds effective on and from Monday, 2 September 2024. 

• Barrow Hanley Concentrated Global Share Fund
• Barrow Hanley Concentrated Global Share Fund No. 2
• Barrow Hanley Concentrated Global Share Fund No. 3

(each a Fund, together the Funds).

The following is a summary of the key changes reflected in the PDS for each Fund.

Updates to significant risks disclosure

Each Fund’s investment strategy involves specific risks.

We have updated the significant risks disclosure applicable to each Fund to ensure that our disclosure continues to align with the nature and risk profile of each Fund and the current economic and operating environment.

Updates to ongoing annual fees and costs disclosure

The estimated ongoing annual fees and costs for each Fund have been updated to reflect financial year 2024 fees and costs. These include changes to estimated management costs and estimated transaction costs.

We now also disclose the maximum management fee we are entitled to charge under each Fund’s constitution.

Updates to restrictions on withdrawals

We have updated the disclosure on restrictions on withdrawal to align closer to what is in each Fund’s constitution.

Updates to our complaints handling process

We have provided additional details about our complaints handling process and the Australian Financial Complaints Authority.

We have updated and reissued the Product Disclosure Statements (PDSs) for the following classes of units in the Regnan Global Equity Impact Solutions Fund (the Fund), effective on and from Monday, 2 September 2024: 

• Regnan Global Equity Impact Solutions Fund – Class R
• Regnan Global Equity Impact Solutions Fund – Class W

The following is a summary of the key changes to the PDSs.

Labour, Environmental, Social, Governance and Ethical (ESG) disclosure

We have enhanced our ESG disclosure to describe the Fund’s impact objective and the eight impact themes targeted by the Fund.

We have also provided clarification that the Fund may hold cash and may use derivatives from time to time and that exclusionary screens are not applied to the Fund’s investments in cash or derivatives. The use of derivatives may result in the Fund having indirect exposure to the excluded companies.

There has been no change to the Fund’s investment approach, or the exclusionary screens employed by the Fund.

Updates to significant risks disclosure

The Fund’s investment strategy involves specific risks.

We have updated the significant risks disclosure applicable to the Fund to ensure that our disclosure continues to align with the nature and risk profile of the Fund and the current economic and operating environment.

Updates to ongoing annual fees and costs disclosure

The estimated ongoing annual fees and costs for the Fund has been updated to reflect financial year 2024 fees and costs. These include changes to estimated management costs and estimated transaction costs.

We now also disclose the maximum management fee we are entitled to charge under the Fund’s constitution.

Updates to restrictions on withdrawals

We have updated the disclosure on restrictions on withdrawal to align closer to what is in each Fund’s constitution.

Additional information on how to apply for direct retail investors

We have provided additional information for non-advised retail investors (retail investors without a financial adviser) investing directly in Class R units of the Fund who may also be required to complete a series of questions as part of their online Application, to assist us in understanding whether they are likely to be within the target market for a Fund.

Updates to our complaints handling process

We have provided additional details about our complaints handling process and the Australian Financial Complaints Authority.

We have updated and reissued the Product Disclosure Statements (PDSs) for the following classes of units in the Barrow Hanley Concentrated Global Share Fund Hedged (the Fund), effective on and from Monday, 2 September 2024: 

• Barrow Hanley Concentrated Global Share Fund Hedged – Class R
• Barrow Hanley Concentrated Global Share Fund Hedged – Class Z

The following is a summary of the key changes to the PDSs.

Updates to significant risks disclosure

The Fund’s investment strategy involves specific risks.

We have updated the significant risks disclosure applicable to the Fund to ensure that our disclosure continues to align with the nature and risk profile of the Fund and the current economic and operating environment.

Updates to ongoing annual fees and costs disclosure

The estimated ongoing annual fees and costs for the Fund has been updated to reflect financial year 2024 fees and costs. These include changes to estimated management costs and estimated transaction costs.

We now also disclose the maximum management fee we are entitled to charge under the Fund’s Constitution.

Updates to restrictions on withdrawals

We have updated the disclosure on restrictions on withdrawal to align closer to what is in each Fund’s constitution.

Updates to our complaints handling process

We have provided additional details about our complaints handling process and the Australian Financial Complaints Authority.

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

• US economy slows, but no signs of a recession yet
• Green light confirmed for a series of rate cuts in the US
• Find out about Pendal Focus Australian Share fund
• Coming soon: register to join Crispin’s Beyond the Numbers webinar

MARKETS continued trailing back toward their July highs last week, driven by commentary from Federal Reserve Chairman Jay Powell.

Powell expressed confidence that a soft landing is achievable and said that the Fed would focus on keeping the labour market strong as it makes progress towards its inflation target.

The “Fed put” is back in terms of monetary policy, providing important insurance against recession risk.

US bonds rallied and the market is now pricing in a roughly 50% chance of a 50 basis point (bp) rate cut in September.

The US Dollar weakened, which is supportive for risk assets, and crypto rallied, indicating that liquidity is coming back to markets.

The S&P 500 gained 1.47%, while the S&P/ASX 300 finished up 0.90%.

The main check on equities is the fear of September, which is seasonally the weakest month.

Local earnings results remain supportive, albeit with some pockets of weakness which tend to reflect specific industry issues rather than broader economic malaise

US economy: green light confirmed for a series of rate cuts

Two years ago, Powell used his Jackson Hole address to signal that the Fed would risk recession to restore price stability.

His speech at the same venue last week was as close as you get in central bank world to a declaration of victory.

The message was the labour market will not be a source of inflationary pressure. Instead, it is cooling – and the Fed does not want it to cool any further.

Powell noted that “the time has come for policy to adjust” and that “the direction of travel is clear, and the timing and pace of rate cuts will depend on incoming data, the evolving outlook and the balance of risks”.

There was no specific lead on whether we see a 25bp or 50bp cut in September; this depends on employment data.

However, the key point is that we will see a series of cuts into next year.

This is supportive for equities as it reduces the tail risk of a recession. Should the economy slow quicker than expected, it will still affect the market – but the downside is limited, as it would be mitigated by more accelerated easing.

The more material tail risk is a re-acceleration of inflation as the economy cools, but this looks unlikely for now.

US economy: slowing but no signs of recession

There were a number of data points supporting the notion of an economy which is slowing, but not sliding into recession.

1. US payroll data saw its annual revisions and was adjusted down 818k for the year – this is much larger than normal and gives fuel to bearish arguments. It was expected, to some degree, given the gap between this data set and the Household Survey. The key observation is that the economy wasn’t as strong as previously thought and that cracks in the labour market started earlier. But this does not imply that the odds of recession have risen. We note this data is often revised again and the final estimate has been above the preliminary for the past five years.
2. Jobless claims data remained benign again last week
3. The Flash US composite Purchasing Managers’ Index (PMI) data was solid, falling to 54.1 versus 54.3 the previous month, but above the consensus of 53.2. Services rose to 55.2 from 55.0 and beat expectations of 54.0. Manufacturing was weaker at 48.0 versus 49.6 last month and the 49.5 expected. There was a drop in the employment component to 48.9 from 51.6, which highlights there are still risks to employment data.
4. New home sales were stronger than expected, which could signal that the impact of lower mortgage rates is beginning to flow through. This may help clear the inventory issue holding back new home construction.

The Atlanta Fed GDP Now measure is still hanging in there at 2.0% for Q3. It has dropped from just under 3%, which relates to home construction, which may turn soon.

Europe

Stronger PMI data was put down to a combination of the Euros, Olympics and Taylor Swift.

Underlying growth remains soft, with Germany quite bleak.

The European Central Bank’s (ECB) indicator of negotiated wages fell materially from 4.74% to 3.55%. This should remove one of the barriers to future ECB rate cuts.

Markets

Last week’s weakness in the US Dollar was interesting.

The US Dollar Index (DXY) fell 1.7% – just breaking down through a technical resistance level – and is down 4.9% in the quarter to date.

This reflects the more benign US inflation outlook, allowing the Fed to move faster on rate cuts.

A falling US Dollar, combined with weaker oil and lower bond yields, is typically helpful for equities.

The other potential positive is that a weaker US Dollar may allow Chinese policy to be more stimulative. This remains the key concern for global growth and has weighed on commodity prices and resource stocks.

The oil price is resting on technical support levels. Iraq is making noise about breaking its quotas, so the Saudi reaction will be interesting.

Australia

The ASX continues to grind higher.

Resources didn’t drag last week – the main sector moves were driven by stock-specific factors relating to results, notably Wisetech Global driving tech and Brambles lifting industrials.

Thus far, the take-outs from reporting season are:

• The market is looking for beta – any promise of upside is being enthusiastically embraced rather than being challenged, as seen in Wisetech last week and Pro Medicus the week before. 
• Good industry structures and capital discipline are being rewarded (e.g. insurance).
• Some signs of a turn in industrials which have been navigating a post-covid hangover (e.g. Brambles, Ansell and Reliance Worldwide)
• Consumers are receptive to product innovation and good value propositions (eg Breville Group and Super Retail)
• The steel industry is suffering as a result of China’s over-production and exports
• Earnings volatility and rising capital intensity are being penalised by the market (eg A2 Milk and Ampol).

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About Crispin Murray and the Pendal Focus Australian Share Fund

Crispin Murray is Pendal’s Head of Equities. He has more than 27 years of investment experience and leads one of the largest equities teams in Australia. Crispin’s Pendal Focus Australian Share Fund has beaten the benchmark in 12 years of its 16-year history (after fees), across a range of market conditions.

Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management. 

Find out more about Pendal Focus Australian Share Fund  

Contact a Pendal key account manager