Pendal Sustainable Balanced Fund – Class G (APIR: PDL4756AU, ARSN: 637 429 237)
Pendal Sustainable Balanced Fund – Class R (APIR: BTA0122AU, ARSN: 637 429 237)
Pendal Sustainable Balanced Fund – Class Z (APIR: PDL0478AU, ARSN: 637 429 237)
Pendal Sustainable Conservative Fund (APIR: RFA0811AU, ARSN: 090 651 924)

(the ‘Funds’).

Effective 8 June 2023, some of the exclusionary screens for the Funds’ Australian fixed interest component will be changing. Broadly, the changes apply:

1. stricter screening definitions for fossil fuels by limiting the Funds’ exposure to issuers specifically involved in the exploration, extraction or refinement of coal, oil and gas; and
2. stricter gross revenue thresholds by reducing the gross revenue threshold from 10% to 5% for issuers involved in the following business activities:
   • Alcohol
   • Gaming Facilities
   • Non-controversial Weapons
   • Pornography
   • Uranium
   • Fossil Fuels.

Why are we making the changes?

The changes ensure that the Funds remain true to label and are more closely aligned with investor expectations in relation to responsible investment funds where the market is moving towards stricter exclusionary screens.

What will stay the same?

Importantly, the stricter exclusionary screens do not impact the way in which we manage the Funds. 

The Funds’ investment return objective remains unchanged.

Additionally, there is no change to the Funds’ management fee.

Funds’ exclusionary screens – Australian Fixed Interest

Effective 8 June 2023, the exclusionary screens for each Fund will be as follows:

The Fund’s Australian fixed interest investments will not invest in issuers directly involved in either of the following activities:

• tobacco production (including e-cigarettes and inhalers); or
• controversial weapons manufacture (including cluster munitions, landmines, biological or chemical weapons, nuclear weapons, depleted uranium weapons, blinding laser weapons, incendiary weapons, and/or non-detectable fragments).

The Fund’s Australian fixed interest investments will also not invest in issuers directly involved in any of the following activities, where such activities account for 5% or more of an issuer’s gross revenue:

• exploration, extraction or refinement of fossil fuels (specifically coal, oil and gas); or
• the production of alcohol; or
• manufacture or provision of gaming facilities; or
• manufacture of non-controversial weapons or armaments; or
• manufacture or distribution of pornography; or
• direct mining of uranium for the purpose of weapons manufacturing.

What do you need to do?

No action is required. You will be able to continue to invest and withdraw from the Funds.

Updated Product Disclosure Statement (PDS)

An updated PDS for each Fund issued on 8 June 2023 along with our contact details should you have any questions is now available on www.pendalgroup.com.

Pendal Sustainable Australian Fixed Interest Fund – Class R (APIR: BTA0507AU, ARSN: 612 664 730)

Pendal Sustainable Australian Fixed Interest Fund – Class W (APIR: PDL3438AU, ARSN: 612 664 730)

(the “Fund”)                                                                                                                   

Effective 8 June 2023, some of the Fund’s exclusionary screens will be changing. Broadly, the changes apply:

1. stricter screening definitions for fossil fuels by limiting the Fund’s exposure to issuers specifically involved in the exploration, extraction or refinement of coal, oil and gas; and
2. stricter gross revenue thresholds by reducing the gross revenue threshold from 10% to 5% for issuers involved in the following business activities:
   • Alcohol
   • Gaming Facilities
   • Non-controversial Weapons
   • Pornography
   • Uranium
   • Fossil Fuels.

Why are we making the changes?

The changes ensure that the Fund remains true to label and is more closely aligned with investor expectations in relation to responsible investment funds where the market is moving towards stricter exclusionary screens.

What will stay the same?

Importantly, the stricter exclusionary screens do not impact the way in which we manage the Fund.

The Fund’s investment return objective remains unchanged and the Fund will continue to aim to provide a return (before fees, costs and taxes) that exceeds the Bloomberg AusBond Composite 0+Yr Index by 0.75% p.a. over rolling 3 year periods.

Additionally, there is no change to the Fund’s management fee.

Fund exclusionary screens

Effective 8 June 2023, the Fund’s exclusionary screens will be as follows:

The Fund will not invest in issuers directly involved in either of the following activities:

• tobacco production (including e-cigarettes and inhalers); or
• controversial weapons manufacture (including cluster munitions, landmines, biological or chemical weapons, nuclear weapons, depleted uranium weapons, blinding laser weapons, incendiary weapons, and/or non-detectable fragments).

The Fund will also not invest in issuers directly involved in any of the following activities, where such activities account for 5% or more of an issuer’s gross revenue:

• exploration, extraction or refinement of fossil fuels (specifically coal, oil and gas); or
• the production of alcohol; or
• manufacture or provision of gaming facilities; or
• manufacture of non-controversial weapons or armaments; or
• manufacture or distribution of pornography; or
• direct mining of uranium for the purpose of weapons manufacturing.

What do you need to do?

No action is required. You will be able to continue to invest and withdraw from the Fund.

Updated Product Disclosure Statement (PDS)

An updated PDS issued on 8 June 2023 along with our contact details should you have any questions is now available on www.pendalgroup.com.

With interest rates rising and the risk of a recession rising, it’s time to look for a safe harbour, says Pendal’s ANNA HONG 

• Rate rise risks triggering a recession
• Fixed income provides safe option

RECESSION talk increased in Australia this week after the RBA’s decision to lift rates for the 12th time in just over a year.

It means investors need to think about safer assets, argues Anna Hong, assistant portfolio manager with Pendal’s Income and Fixed Interest team. 

“That’s government bonds, cash and high-grade investment credit,” Hong explains. “But it’s important that it’s Australian fixed income and cash.” 

That’s because Australia is one of just a handful of countries to record a budget surplus this financial year and — not withstanding the threat of recession — the economy remains in very good shape, Hong says. 

“From an economic perspective, even if things go wrong, the government is in a good position to support the Australian economy.

“As a result assets within Australian shores should be safer than almost any other part of the world,” Hong says. 

The risk of recession in Australia is very real, Hong says.

While the government can tighten fiscal policy by increasing taxes, that often isn’t politically palatable.

It means much of the heavy lifting in controlling aggregate demand falls to the Reserve Bank. 

“The Reserve Bank hasn’t yet been able to reduce inflation enough with the interest rates increases they have already done,” Hong says.

“There are a lot of factors out of their control and they can only affect aggregate demand using interest rates.

“They are in a position where they almost have to break something to contain inflation, which they don’t really want to do.” 

The “something” is the economy.  It means investors should consider safer assets, she says. 

“Anything related to government — federal or state — is backstopped by the federal government and an investor will likely get their money back. 

“The RBA regards our major banks as ‘unquestionably strong’ and are well placed to weather any storms. This makes major bank credit a relatively safe place for investors.” 

“If you go into high-risk assets, even high-growth stocks, you might invest $100 today and not have $100 in six months because company outlooks can change very quickly now the risk of recession is higher.” 

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About Anna Hong and Pendal’s Income and Fixed Interest team

Anna Hong is an assistant portfolio manager with Pendal’s Income and Fixed Interest team.

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

With the goal of building the most defensive line of funds in Australia, the team oversees A$22 billion invested across income, composite, pure alpha, global and Australian government strategies.

Find out more about Pendal’s fixed interest strategies here

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About Pendal Group

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 are the main factors driving the ASX this week according to our head of equities CRISPIN MURRAY. Reported by portfolio specialist Chris Adams

• Find out about Pendal Focus Australian Share fund

US EQUITIES continue to grind higher following resolution of the debt ceiling issue and signals of economic resilience.

The market is buoyed by the possibility of resolving inflation without the Fed pushing the economy in to recession.

The S&P 500 gained 1.9% last week.

Fed governor Philip Jefferson (tipped to be the next Fed vice-chair), indicated that the rate-setting Federal Open Market Committee would hold rates steady in June despite higher CPI and a strong labour market.

Though he was quick to note this should not be seen as a signal that rates have peaked.

Australian equity market returns were more muted, with the S&P/ASX 300 essentially flat at -0.07% last week.

Here, the market was focused on wage increases from the Fair Work Commission, which at the margin pushed the odds of a rate rise tomorrow a bit higher.

There were also rumours of potential economic stimulus from Beijing late in the week.

Global bonds rallied early in the week helped by softer European inflation, Fed signals and a previously oversold position. Though stronger employment data saw the week’s rally reverse by half.

Equity investors remain cautiously positioned in aggregate. Many have been caught out by the recent upswing and the shift to catch up is helping underpin the rally.

The S&P 500 has broken through the 4200 resistance level, which represents the high of February and a 50% retracement of the 2022 bear market.

It is now testing 4300, which was the high of last August.

Market bulls argue that successfully breaching resistance at 4300 will see the market rise to 4600.

Bears counter that a weaking economy will ultimately see the market fail to breach 4300 and sell off. 

While recent conditions have been positive, we are mindful that the range of potential outcomes for the economy and markets remains very wide by historical standards. 

This reflects the combination of:

1. The scale of rate hikes
2. Economic distortions created by the pandemic
3. A range of structural themes such as energy transition, artificial intelligence and rising geopolitical fissures

These factors all remain in play and demand careful management of portfolio risk.

The interplay of these issues is manifesting in a series of contradictions:         

1. Continued resilient economic growth despite a rise in rates and inverted yield curves
2. Strong equity market performance despite broad-based expectations of a recession
3. Divergent equity performance between big tech and the balance of the market
4. Continued strength in services while manufacturing remains weak
5. Rising house prices despite a continued increase in mortgage rates
6. Stubborn inflation despite falling commodity prices
7. Subdued recovery in China post re-opening

The implication of these contradictions is that circumstances and conditions can change quickly.

This emphasises a need to manage thematic and macro risk carefully in our portfolio construction.

US debt ceiling

The debt ceiling has been resolved in a far more bipartisan and benign way than most in the market expected.

The deal’s impact is relatively limited in the near term, with US$30 billion of additional spending cuts in FY24 equivalent to only 0.1% of GDP.

This is only half the effect of resumed student loan payments, with the payment “pause” expected to lapse and drive a more material fiscal headwind. 

The deal also achieved minimal reform on environmental permitting.

This deal slaps some patches on key issues for two years. Both sides are betting they will be better placed to get their preferred outcomes then.

The more interesting point is that the market was positioned bearishly, expecting a far more damaging and protracted negotiation.

A rotation to less defensive exposure can help underpin the equity market at these levels.

The liquidity impact is also important to remember. Treasury needs to fund about US$500 billion in spending in the next couple of months, which may check any rally in bonds as new supply comes to the market.

US jobs and economic data

US non-farm payrolls for May rose 339k, well ahead of 195k expected. There were also net revisions of +93k to previous months.

Payroll growth is running at +2.8% year-on-year.

This is still too strong for the Fed’s comfort in regard to inflation.

It also indicates there is no imminent sign of recession despite the banking crisis, which to date has had no discernible impact on the economy.

That said, the picture is complex and there were a number of mitigating data points to offset too bearish a read on the data:

1. The Household Survey, another measure of jobs growth, saw a drop of 310k jobs. This gap has been widening for some time, but this is one of the biggest divergences in recent times. The reason is causing debate. But a shift from self-employment to working as a paid employee seems to be playing a role. The key point is that both sides of the argument around jobs growth can draw something from this month’s data. 
2. The unemployment rate rose from 3.4% to 3.7%, due to the drop in the Household Survey. This is the highest rate since October.
3. There is a rise on permanent unemployed, as opposes to temporary layoffs. This is seen historically as a lead indicator of recession. 
4. Average weekly hours worked fell to 34.3 and has now fallen in three of last four months. This suggests employers are cutting back hours rather than laying off workers.
5. Average hourly earnings growth slowed to 0.3% month-on-month and 4.3% year-on-year which compares to 6.4% annualised at the start of the year

Employment, hours worked and average hourly earnings combined provide a proxy for income — which has slowed to +0.2% monthly for May, but is still high at 6.2% year-on-year.

The US Job Openings and Labor Turnover Survey (JOLTS) came in stronger than expected in April. Job openings increased 358k to 10.1m, pushing the ratio of openings to unemployed back up to 1.8.

This has been regarded as a lead indicator of any loosening in the labour market which could alleviate wage pressures — but it continues to hold up more than expected.

One more helpful signal was a decline in the “Quits” rate (a proxy for employee confidence in finding a job) which could signal a decline in the employment cost index.

US monthly job layoff data has also plateaued after rising in late 2022 and early 2023. 

The May ISM manufacturing index (a survey of purchasing managers at US manufacturing firms), dipped to 46.9 from 47.1.

The decline was due to fewer new orders, which fell 3.1 points to 42.6 as inventories fell for the fifth straight month (by 0.5 points to 45.8).

This is now in-line with the Covid low and highlights that manufacturing remains soft.

It also gave a clear indication that inflationary pressures in goods are easing and should help reduce overall inflation further.

Our current conclusion from all this is that the US economy is holding up better than most thought. It seems clear that most companies remain reluctant to lay-off works at scale.

This underpins income growth, which helps to hold up the economy.

There is also evidence that inflationary pressures are falling, which means the potential for wage growth to normalise without a dramatic increase in unemployment remains a viable option. This is constructive for markets.

The bear case is contingent on an accelerated economic downturn affecting earnings. There remains little evidence yet that this is set to happen.

Expectations around rates are shifting as a result, with less easing now priced in for the end of the year.

Rest of the world

Eurozone HICP Inflation data came in weaker than expected, prompting a more moderate outlook for rate hikes and providing support for bonds.

Friday saw some chatter about a policy reboot and more economic stimulus from Beijing.

This remains speculation for the moment, but did help sentiment in the resource sector, which had been very weak.

Australia

We saw the long-awaited Fair Work Commission wage recommendations last week.

The outcome is a 5.75% increase in award wages, which benefits 20.5% of workers. There is also an 8.65% increase for the national minimum wage, which affects 0.7% of all workers.

There is an additional 4% of workers on enterprise bargaining agreements and individual agreements tied to this.

So the net effect of all this is about a quarter of the workforce getting an average wage increase of 5.8%, versus 4.6% last year.

This was broadly in line with expectations, though there is a view the Reserve Bank may have baked a little less into its figures, which therefore raises the odds of a rate rise on Tuesday.

This will also flow through into the September quarter wage price index, which is likely to accelerate to a rate over 4% annualised.

At a corporate level, the greatest impact will be felt by supermarkets and retail. Even though the outcome was close to expectations, these sectors underperformed for the week.

One specific issue that may lead to sustained high inflation is the rise in unit labour costs (ULCs), which historically have had a strong link to services inflation.

The RBA is focused here, concerned that productivity remains low and therefore the impact of wage increases may prove more inflationary.

ULC data will be updated for the March quarter with next week’s GDP data.

To date they have been high, reflecting the ability of Australian workers to grow overall wage income well above the level implied by the wage price index, once bonuses, role changes and the extra income from additional jobs is factored in.

All these factors allow households to supplement income and explains the resilience in the economy.

The growing number of hours worked is reducing GDP per hour worked, implying reduced productivity.

 

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About Crispin Murray and 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

Emerging markets can offer diversification and stronger growth, but it’s important to take a country-by-country approach, argues Pendal’s JAMES SYME

• Find out about Pendal Global Emerging Markets Opportunities fund
• Watch a short Emerging Markets overview webinar with James Syme

AS AN asset class, the emerging markets are 24 countries across Latin America, eastern and southern Europe, Africa and Asia that — often contrary to popular belief — are largely well-run democracies with successful economies and large, growing middle classes.

EMs often deliver higher returns than developed markets, though performance sometimes comes at the cost of higher volatility.

“One of the attractors for Australian investors is that emerging markets offer some diversification,” says Syme, who co-manages Pendal Global Emerging Markets Opportunities fund.

“The risks they have are different to the risks in developed markets and there are periods when they can outperform developed markets.

“So for Australian investors who are making an international allocation, having some emerging markets can help diversify some of that risk.

“These are also markets that have generally stronger trend growth rates, so the fundamental growth opportunity you’re buying is often stronger in the emerging world than in the developed world.”

Syme was speaking at a Pendal on-demand webinar, Get ready for emerging markets to re-emerge.

He says there is a common misconception that emerging markets countries are dysfunctional, war torn or burdened with significant health or security issues.

“But they’re generally not that different from us — they just haven’t progressed as far down the path of economic development.

“It’s important to understand that while they’re never the perfect investment opportunity, they are usually not excessively risky or chaotic.”

Origins of Emerging Markets investing

Emerging markets stocks were once difficult to access and generally ignored by foreign investors.

In the 1980s, a World Bank push to promote the asset class encouraged investment and helped finance development.

Since then, the asset class has undergone significant changes.

“The history of emerging markets as an asset class is one of booms, slowdowns and recoveries. It’s important to be positioned in individual countries that offer the better opportunities,” says Syme.

“For example, the size of China has changed beyond recognition. It was about the size of Poland when it originally came in, and now it’s by far the largest market in the asset class.

“There’s also been markets like Argentina that seem to promise a lot but struggle in the longer term.

“And Greece has been an interesting story — promoted to be a developed market, but subsequently had the crisis in 2011 and came back to us.”

Pendal’s emerging markets team employs a country-by-country approach, emphasizing a comprehensive understanding of the economic and political conditions of each individual market.

This approach allows the team to navigate the mixed fortunes of emerging markets.

“It’s a very technical, consistent approach based on getting a clear-eyed view of what’s happening in the economy, principally through the data releases that come out,” says Syme.

“You buy emerging markets for growth, and you buy equities for growth, and so what’s happening the growth environment is a core consideration.

“Right now, we see a number of key emerging markets that have over the last five or seven years had slowdowns in their economies, but we’re now seeing very clear signs of strong acceleration.”

Syme names India, Mexico and Indonesia as the stand-out performers, but cautions that past winners like South Korea and Taiwan are facing a slowdown in their key export markets.

And China? “We have a neutral position. There clearly is going to be a rebound in the Chinese economy because of post COVID opening and because the most unfriendly policies that the administration was pursuing have eased off.

“But without a real estate recovery, it’s hard to see how China can get the economy back to where it was in 2015-16.”

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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

Despite higher-than-expected monthly data, the outlook for inflation should be mildly friendly over the next few months, says Pendal’s TIM HEXT

• Why bonds, why now? Pendal’s income and fixed interest experts explain
• Browse Pendal’s fixed interest funds

IF forecasting inflation was already complicated, the move to monthly numbers last year added further complexity.

The latest monthly Consumer Price Index from the Bureau of Statistics — which compares prices in April 2023 and April 2022 — shows an annual rise of 6.8%, versus an expected 6.4%.

On the surface this should worry the Reserve Bank and markets — and increase the chance of another rate hike in June.

But under the hood, the May number looks like it will be closer to 5.5%, which means the RBA should be able to hang on till August and reassess then.

How can we tell? This is where it gets a little complicated.

The monthly inflation numbers are published as year-on-year outcomes, and you must back-solve to gain a sense of the monthly pace.

In this case, monthly was up 0.7% versus an expected 0.4%.

There is no underlying inflation data yet.

Also, for now only half of items are updated every month. (Another 10% are updated annually (council rates, health, education) and the remaining 40% are updated quarterly, spread across the three months).

This will change in the future. The Bureau has been given extra resources and funding to introduce an accurate monthly series, similar to other countries.

Impact of subsidies

The other detail inflation forecasters need to stay on top of is the impact of subsidies, which exploded in scope and breadth with Covid and energy shocks.

CPI measures the price a consumer pays, so a subsidy will reduce that.

But a rebate does not reduce the headline price, and is not counted.

These subsidies appear and disappear regularly now and must be kept track of.

The Morrison government’s HomeBuilder scheme was the big one in 2021 and 2022, but now it’s all about utility prices.

The subsidy detail for this April number — which the ABS reminded us of — is that in April 2022 the Morrison government cut fuel excise in half as prices surged post the Ukraine invasion.

This relief was removed in October. This means that — despite falls in the price of crude oil — the price we are paying at the pump is higher than this time last year.

Beyond fuel, there were modest upside surprises across clothing, furnishings, food and holiday travel.

These would be uncomfortable for the RBA, though not likely enough to warrant another rise in June.

However, with the market pricing in only a 35 per cent chance of a hike, these are not odds we will take on.

What it means for investors

The implication for bonds is muted.

As mentioned, the outlook for inflation here and in the US should be mildly friendly over the next few months.

Beyond that time will tell. Risk markets should come under some moderate pressure, though, as it’s a reminder of the long and hard road ahead.

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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

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

• Find out about Pendal Focus Australian Share fund

WE remain in a stock-picker’s market, after emerging from the largely macro-driven environment of the pandemic.

This is emphasised by the still-clouded outlook for the economic cycle and interest rates on one hand — and the extraordinary AI-driven uplift in revenue guidance from chip-maker NVIDIA on the other. 

The outlook for US rates remains uncertain. Fed-speak remains mixed.

Last week Christopher Waller — a member of the rate-setting Federal Open Market Committee (FOMC) — suggested a pause may be appropriate while tighter credit conditions continued to dampen inflation.

But April’s Personal Consumption Expenditure index — a measure of US inflation — came in hotter than expected, increasing the chance of another hike in June.

Other economic data from last week suggests the US outlook is stronger than expected, while much of the rest of the world looks weaker.

China is not contributing as much as expected and Germany is now in technical recession.

We saw a positive development on the US debt ceiling. The Biden administration and House speaker Kevin McCarthy over the weekend agreed to raise the debt limit and cap federal spending until after the 2024 election.

A lack of visibility in the macro narrative compares with high levels of market conviction in the emerging micro-narrative of AI.

NVIDIA reported a blow-out quarter. Its second-quarter revenue guidance was more than 50% ahead of consensus expectations on the back of AI-related demand for its GPU (graphics processing unit) chips, driving huge bottom-line upgrades. 

This drove a 2.5% gain in the NASDAQ, despite two-year US bond yields rising 30bps.

The S&P500 rose a more subdued 0.35%, while the S&P/ASX 300 was down 1.74%.

Fed speak

We continued to receive mixed communications from the Fed, with no clear direction. This overshadowed the release of May’s FOMC meeting minutes. 

While inflation remains too high, concerns continue over the impact from tightening credit conditions due to stress in the banking system.

The question is whether this will do some of the work that further rate hikes would otherwise do.

Governor Waller gave a “Hike, Skip or Pause” speech on Wednesday, focusing on the case for “skipping” a rate-hike in June and increasing the odds for another rise in July.

“If lending does slow, this can obviate the need for at least some monetary policy tightening,” he said. “It is important to account for this other form of tightening in setting the stance of monetary policy.

“If not considered appropriately, the Fed could tighten too much and needlessly raise the risk of a recession.”

The market saw this as a more hawkish signal than Chair Powell’s comments from the previous week.  

Fed-fund futures are pricing a 69% probability of a June-rate hike and markets are shifting expectations to rates remaining higher for longer.

US inflation and economic data

The PCE – the Fed’s preferred inflation indicator – was released on Friday, with core PCE prices rising 0.38% in April versus 0.30% consensus expectations. It is running at 4.7% year-on-year, up from 4.6% in March. 

This print was higher than expected and represents a stall from its downward trajectory, further complicating the debate regarding a rate rise in June. 

PCE Core services ex-rent rose 0.42%, the biggest increase in 3 months, suggesting stickiness and disappointingly limiting the break to the downside. 

This measure has shown no meaningful improvement since Fed officials started to highlight it late last year. 

Consumer spending rose 0.8% in April, up from 0.1% increases in both February and March. 

This was largely driven by vehicles and financial services. 

Motor vehicle consumption surged 3.8% and remains a lumpy category with pent-up demand and low inventories supporting pricing. Used car prices have rolled over again, which should be supportive to the downside in future months. 

Elsewhere economic data in the US has been coming in stronger than expected, including the Purchasing Manager’s Index (PMI) last week where the Composite index is at 54.5 versus consensus at 53.0 and the Services index at 55.1 versus 52.5 expected.

US debt ceiling

President Biden and House Speaker McCarthy reached an “in-principle” agreement over the weekend to raise the US debt ceiling and increase the borrowing limit for two years.

US equities rallied on Friday on the expectation this would eventuate, ending fears of a default on US government debt and any potential flow-through impact on the global economy. 

Spending levels should remain roughly flat for the next two years, which should minimise fiscal headwinds to the economy. 

Republican demands for tightened handouts were met through a temporary increase to the top-age threshold for the Supplemental Nutrition Assistance Program (“SNAP”). 

This now means that low-income adults without dependents or disabilities between ages of 18-54 (previously 18-49) can only receive benefits for up to three months in a three year period unless they are working or enrolled in a work program. 

Internal Revenue Service (IRS) funding will also be reduced, which was intended to boost tax enforcement and modernise technology. 

The agreement still needs to move through the House and Senate by the 5^th of June to ensure the government does not run out of money to pay its bills. 

Rest of the world

UK inflation surprised to the upside at 8.7% year-on-year, 50bps above consensus and with core inflation 60bps higher than expected at 6.8% YoY. 

There is pressure on the Bank of England, with the market pricing 90bps of tightening over the next three meetings. 

Germany officially entered recession with GDP -0.3% in 1Q23, following a 0.5% decline in 4Q22. 

The Reserve Bank of New Zealand (RBNZ) hiked interest rates for the twelfth consecutive time, this time raising by 25bps to 5.50% – the highest level since 2008. 

The Board also suggested that the interest rate hiking cycle is done, with the view that rates are sufficiently contractionary to lower demand, but may stay higher for longer.

The market had been expecting one further hike to 5.75%

Generative AI and accelerated computing

The NVIDIA result was a standout, adding US$200bn of market cap (+28%) following a blow-out guidance upgrade for 2Q23. 

This was followed up by Marvell Technology, which was up +32% after signalling a strong outlook.

This underpinned by rapid adoption of accelerated computing to support generative AI.

NVIDIA’s guidance for revenue gains of 53% quarter-on-quarter to $11bn was well above consensus expectations of $7.2bn.

It implies sales of graphics processing unit (GPU) microchips to data centres almost doubling quarter-on-quarter as they rapidly gain share over central processing units (CPU) chips.

GPUs process data several orders of magnitude faster than CPUs, making them better suited to generative AI applications. 

Marvell Technology also guided for AI revenue to more than double in FY24 (from ~$200m in FY23) and more than double again in FY25. 

The question is whether recent market moves reflect the start of a multi-year bull-cycle on the back of AI-driven efficiency gains.

Or are we reaching bubble territory with just seven US mega cap tech names (Apple, Microsoft, Alphabet, Amazon, NVIDIA, Meta and Tesla) up 70% in 2023 and driving the majority of the 24% NASDAQ rally YTD, leaving us at risk of a pullback?

We do note that valuation metrics for this group do not seem stretched given they are growing, are making efficiency gains, have strong balance sheets and are buying back stock, and may be moving into a more favourable macro / interest rate backdrop.

There is a bigger conversation around what generative AI means for the economy in terms of productivity, jobs, and wages.

Politicians and the business community must also grapple with the implications in terms of accuracy, regulation, ethical considerations, privacy issues, IP protection and data ownership — with no straightforward answers apparent.

Accelerated computing and storage infrastructure also still needs to be built to support mass usage of generative AI at scale. 

Markets

Commodities continued to weaken over the week and have been the worst performing asset class in 2023, after topping the charts in both 2021 and 2022. Oil bucked the trend last week, with Brent crude up 1.8%. 

The US dollar (measured by the DXY) bounced with US economic strength relative to weakening China and Europe data. 

In Australia, technology stocks tended to outperform.

While Technology One (TNE, +9.90%) delivered a decent result and was the best performer in the ASX 100, the other leaders such as Altium (ALU, +7.91%), NextDC (NXT, +6.8%) and Wisetech (WTC, +5.20%) were largely driven by the broader tech thematic. 

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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

Latest on recession risk | Regnan biodiversity guide | A tool for analysing rates | EM impact of Turkish and Thai elections

Awareness is growing among investors about risks associated with biodiversity loss. Regnan’s OSHADEE SIYAGUNA has authored a set of recommendations in a new report, Beyond Biodiversity

• Investor focus turns to biodiversity
• Download Regnan’s Beyond Biodiversity guide
• Find out about Regnan Global Equity Impact Solutions fund
• Find out about Regnan Credit Impact Trust

BIODIVERSITY is fast emerging as a big concern for investors, as the world’s financial institutions grapple with how to measure and manage the ecological systems underpinning the planet’s economic stability.

Biodiversity — sometimes referred to as a “twin crisis” along with climate change — refers to the variety and variability of living organisms in an ecosystem.

Biodiversity provides us with food, water and other resources. It helps regulate the climate, protect us from natural disasters and provides us with new medicines and other products.

The United Nations regards land degradation and biodiversity loss as among “the most pressing environmental challenges facing humanity.

“Land degradation has reduced the productivity of nearly one-quarter of the global land surface, impacted the wellbeing of about 3.2 billion people and cost about 10% of annual global gross domestic product in lost ecosystem services,” the UN said in its 2019 Land Degradation Neutrality for Biodiversity Conservation report.

Most of the world’s GDP is dependent in some way on nature.

But historically, efforts at protecting biodiversity, nature and ecosystems have repeatedly failed to achieve their goals.

The acceleration in the loss of biodiversity and the deterioration of natural systems undermines the stability of our economic, social and political systems, says Oshadee Siyaguna, a thematic investing analyst at Regnan.

“We have a biodiversity crisis — but we also have a problem with how we’ve been approaching conservation,” says Siyaguna.

“The planet doesn’t care how it survives — but we care because we have to live on it. We want a stable natural system, a stable social system and a stable economic system.

“The fewer disruptions there are to business operations and socioeconomic conditions, the better and more predictable the outcomes. And that essentially should be the focus  — to have all these systems operating within productive thresholds.”

Siyaguna says that while biodiversity is something all investors are starting to grapple with, it is of particular importance to universal investors like pension and sovereign wealth funds whose investment outcomes are dependent upon the health of the overall global economy.

He says investors considering biodiversity need to think of nature as a series of interconnected systems where everything interacts with everything else, and that humans have been modifying the environment for thousands of years.

Part of the problem investors face is that biodiversity is still emerging as an investment theme.

Siyaguna points to the increasing sophistication of climate change investing in recent decades, saying biodiversity will potentially go through the same curve — a feedback loop of articulating problems and triggering companies to search for solutions.

“The world’s biggest asset managers and asset owners are seriously looking at this but the approach is still embryonic.

“But these are just growing pains. We’ve been through this with climate change, we understand the playbook, it’s just a matter of how we progress it.”

Articulate the problem

The starting point is being able to articulate the problem properly, says Siyaguna.

“If you don’t understand the nature of the problem, then you’ll be addressing something that is completely different.

“A ‘let’s try to fix it quickly’ approach without really understanding the nature of the problem could have dire consequences.

“While this is an emergent theme in the investment industry, it is by no means a new issue — people have been wrestling with these issues for hundreds if not thousands of years. The very idea of conservation is more than 2500 years old.”

Oshadee Siyaguna’s paper Beyond Biodiversity sets out a framework for asset owners and managers to think about biodiversity and the stewardship of ecological and social systems.

Could the potential for political change in Turkey and Thailand offer opportunities for Emerging Markets investors? Here’s an opinion from senior fund manager JAMES SYME

• National elections are unfolding in Thailand and Turkey
• Investment case unlikely to change for now
• Find out about Pendal Global Emerging Markets Opportunities fund

OUR emerging markets team is known for its top-down, country-level approach to investing.

The team’s research suggests good investing conditions in countries such as Mexico, Indonesia, India and Brazil.

What about Turkey and Thailand, which have both undergone national elections this month?

Does the potential for political change alter the investment case? Below is a brief analysis from the team.

Turkey

In the first round of this month’s Turkish presidential elections, incumbent Recep Tayyip Erdogan won 49.5% of the vote – just short of the majority needed for victory.

Opposition leader Kemal Kılıçdaroğlu won 44.9%. A run-off vote is set for May 28.

Sinan Oğan, who came third with 5.17%, has since endorsed Erdogan.

Under Erdogan, Turkey has become increasingly less democratic, especially since the switch to a direct presidency in 2017.

The media have been repressed or sold to allies of President Erdogan, the court system has been stuffed with loyalists and parliament has functionally been replaced by presidential decree.

Of more importance to markets has been a drastic deterioration in economic and financial competence in government.

The central bank has lost its monetary independence and seen four governors in as many years, while at one point making his son-in-law the finance minister.

The most damaging part of economic policy, though, has been President Erodogan imposing on the country his personal view that high interest rates drive inflation.

Consequently, interest rates have been well below inflation in recent years. Current policy rates are 8.5% and trailing CPI inflation is 43.7%.

Because borrowing is so incredibly cheap in real terms, it must be rationed by the government, allowing the president to reward allies and family with cheap loans.

This unorthodox monetary policy has allowed economic growth to be relatively strong but has driven the economy to the brink of disaster.

As well as inflation, the current account deficit has expanded to 5.5% of GDP and the nation’s foreign exchange reserves have been exhausted in an impossible attempt to defend the Turkish Lira.

If the opposition coalition can win the election and manage to peacefully come to power (which is far from guaranteed – President Erdogan is unlikely to go quietly), they are committed to central bank independence.

That, though, is likely to lead to drastic interest rate hikes, a massive currency devaluation and a deep recession in the economy. And this is the best case for Turkish investors, as President Erdogan may well win the election.

Thailand

An eight-party coalition this week agreed to share power following Thailand’s general election on May 14.

The coalition is led by the Move Forward Party, which comfortably defeating conservative and military-backed parties

Thailand is in some ways – such as its compromised democracy – similar to Turkey. But in other ways – a stagnant and inefficient economy – it has the opposite problem.

The current political crisis followed the 2001-2006 government of reform-minded businessman Thaksin Shinawatra, which was deposed in a military coup in 2006.

The military and their conservative allies seized control of the political system through their power to appoint politicians and judges.

Shinawatara-aligned political parties have won every election since. But opposition prime-ministerial candidates need to win three times as many seats in the lower house as pro-military candidates to form a government.

As well as their outsized role in Thai politics, the army and its allies have had a huge and growing role in the economy.

The armed forces control businesses ranging from banks, airports and media to hotels and convenience stores.

Competition is severely repressed. For example, telecoms, beer, petrochemicals and cement are all cosy oligopolies keeping prices high and growth low.

Many leading companies have links to the crown, the armed forces, or their allies.

This political and economic set-up has kept growth weak in recent years, with reduced tourist arrivals and declining foreign direct investment.

Yet, even this weak growth rests on increasingly weak foundation, with the current account balance steadily moving from surplus to deficit and increasingly large fiscal deficits.

What it means for investors

Difficult political conditions in Thailand and Turkey have affected their financial markets and economies, which in turn have fed back into politics.

This process, and the country-specific way in which it plays out, are good examples of the country-level risks and opportunities that are the backbone of our investing approach to emerging markets.

Political change in each is uncertain from here and would still leave new governments with many economic challenges to overcome.

We remain alert for opportunities in Thailand and Turkey.

But we do not yet see a case to invest in either.

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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