Keep a close eye on government | Why ESG wins in the long term | How Indonesia is attracting investors | Assessing stocks for cyber security

Government policy is an increasing risk factor for investors, argues Pendal head of equities CRISPIN MURRAY

• Government policy an increasing risk factor for investors
• Resource and energy companies at risk
• Find out about Pendal Focus Australian Share fund

GOVERNMENT policy is an increasing risk factor for investors, particularly in the resources and energy sectors, says our head of equities, Crispin Murray.

“As an investor, you really need to have conviction — and part of that comes from your ability to understand all the risks within an investment case,” Murray says.

“You are always worried about unpredictable events, and this is where the influence of government becomes a bigger issue, particularly around unpredictable policy.”

Murray, speaking at The Australian Financial Review Live conference, says sovereign risk can be more unpredictable than competitor risk.

“Competitors are largely focused on returns, so you can anticipate what they’re likely to do.

“But governments overlaying policy agendas can create more unpredictable outcomes.”

“Largely speaking, competitors are focused on returns — so you can anticipate what they’re likely to do.

“If you have governments with other policy agendas overlaying, that can create quite unpredictable risks.”

Murray uses the recently introduced federal safeguard mechanism in Australia as an example.

The safeguard mechanism effectively regulates the emissions of Australia’s 215 biggest polluters, including many fossil fuel companies, forcing them to reduce carbon output.

It comes into effect from July.

“They are still negotiating on details, but it means we’re asking mining companies, as an example, to quickly cut their scope one emissions,” Murray says.

“That means cutting diesel emissions over the next seven years – and there’s no proven commercial solution to that.

“That creates an extra cost and is going to deter investment.

“In isolation that is not going to be a huge issue. But when you add a few other things in — new taxes and things like that — it can very quickly start weighing on the market.”

Resource and energy companies are hit hardest.

“Where you have an unpredictable fiscal environment where the rules can change, retrospectively … that ultimately deters capital from wanting to be deployed,” Murray explains.

“Maybe as a society we are saying we don’t want capital deployed in the resources or energy sectors anymore, but that is the sort of example that will ultimately have an impact on society.”

Companies and investors will need to work into financial models the cost of carbon — even though in Australia there is no mandated carbon price — because under the safeguard mechanism many companies will have to purchase carbon offsets.

“I think we will see carbon price go up more than people realise,” says Murray.

“And it’s not beyond the realms of possibility that we will see a carbon price by the end of the decade.”

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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

Here are the main factors driving the ASX this week according to portfolio manager Jim Taylor. Reported by portfolio specialist Chris Adams

MOST eyes were on a generally positive US reporting season last week, with the S&P 500 up 0.89% while the S&P/ASX 300 fell 0.28%.

US economic data was mixed, but did little to change the current narrative of slowing economic growth.

In Australia the headline consumer price index (CPI) for Q1 2023 was a little ahead of consensus expectations, but lower than Q4 2022.

The market is now expecting the RBA to maintain current rates at its May meeting.  

Elsewhere, quarterly production reports from the miners have been generally disappointing, with higher costs and lower volumes, for a variety of reasons.

Australian inflation

Headline CPI came in at 1.38% for Q1 2023.

While this was above consensus expectations of 1.30%, it was well below the 1.90% of Q4 2022.

Annual growth is running at 7.0% versus 7.8% in Q4 2022.

Measures of underlying inflation were marginally softer than expected.

The trimmed-mean CPI rose 1.2%, down from 1.7% in Q4 2022 and below the 1.4% consensus expectation.

It is also 0.2% lower than the RBA estimate in February’s Statement on Monetary Policy.

The breadth of the inflation impulse continues to diminish.

The share of items in the CPI basket rising more than 3% year-on-year fell to 60%, from 76% in the previous quarter. 

The moderation in inflation is driven by goods, with year-on-year growth falling from 9.5% to 7.6%.

Price discounting by retailers saw falls across furniture (-4.6 per cent), major and small appliances (-3.8 per cent and -3.6 per cent) and clothing (-3.2 per cent).

Services inflation accelerated from 5.5% to 6.1% year-on-year. Rental prices increased 4.9% within the basket, the largest annual rise since 2010.

US Economic data

There were some mixed messages from economic data last week, but on balance seems enough to lock in a 25bp hike from the Fed for May.

Inflation
The core Personal Consumption Expenditure (PCE) deflator rose 0.3% month-on-month for March, in line with consensus.

Upward revisions to the result for January and February mean the annualised number came in at 4.9%, above the 4.7% expected by consensus.

The Core PCE services ex-housing figure, which is closely watched by the Fed, came in at 0.24% month-on-month. This is the lowest reading since July last year and down on the 0.36% result for February and the 0.44% average increase over the prior three months.

Consumer inflation expectations as measured by the Conference Board continue to be contained. The median inflation expectation for twelve months hence fell from 5.5% in March to 5.3% in April. This is the lowest level since April 2021.

Wages and employment

While inflation trends are reassuring, strength in employment costs seems enough to keep the Fed on track for a rate hike this month.

The Q1 2023 Employment Cost Index (ECI) rose 1.2% versus consensus expectations of 1.1%. It is up 4.9% year-on-year.

Within this, private sector wages-ex-incentives rose 1.3%, or 5.2% annualised, which is an increase from the 4.3% recording in Q4 2022.

While this is a break in the trend of slowing wage growth, data from Bank of America which looks at consumer deposit data to measure after-tax wage and salaries, suggests that the three month moving average has fallen to 2.0% annualised. This is down from the peak of 8.0% by the same measure in Q2 2022.

Elsewhere, weekly jobless claims fell from 1,868k to 1,858k. This is fewer claims than consensus expected and underscores the notion of a resilient labour market.

However layoffs continue and are broadening out from the tech sector. The largest layoff announcements for April are from David’s Bridal (9,000 jobs), 3M (4,000 jobs) and EY (3,000 jobs).

US GDP

US GDP grew by 1.1% quarter-on-quarter in Q1 2024. This is down from 2.6% in Q4 2022 and below consensus estimates of 1.9%.

Consumer spending remains robust, up 3.7% quarter-on-quarter versus 1.0% in Q4 2022. However this was more than offset by weaker inventory investment, which took 2.3% off Q1 growth.

Housing also dragged, with residential investment taking 0.17% off growth.

That said, this was less than the 1.4% and 1.2% drag form the third and fourth quarters of 2022, respectively.

New home sales have proved stronger than expected. Sales increased 9.6% to an annualized 683,000 pace in March.

There is an argument this is driven by low turnover in the existing homes markets, with owners unwilling to sell and re-finance at higher rates.

Markets

The air-pocket in US earnings that some feared has not materialised in this quarter.

Aggregate earnings for the S&P 500 have fallen 3.7% in Q1, versus expectations of 6.7% as at the end of March. Aggregate revenue has grown 2.9%.

Of the 53% of companies that have reported, 79% are ahead of consensus EPS expectations, versus a five year average of 77%. 74% have beaten consensus revenue expectations, versus a 69% five year average.

In aggregate, earnings are 6.9% above expectations, below the five-year average of 8.4%.

Some key takeaways:

• UPS: Noted that parcel volume trends deteriorated over the quarter, with US domestic volumes down in the high single-digits year-on year in March, versus low single digits in January.
• Microsoft: Revenue was up 7% and net income ahead of expectations. Management noted that customers are exercising some caution.
• Amazon: The market liked the strength in the international business, however reacted negatively to management’s observation that the cloud-based business is seeing slower growth as customers become more prudent in spending.

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About Jim Taylor and Pendal Focus Australian Share Fund

Drawing on more than 25 years of experience investing in top-performing Australian companies and a background in accounting, Jim manages our Long/Short Fund and co-manages our Imputation Fund. He is a Chartered Accountant with membership of the Australian Institute of Chartered Accountants.

Pendal Focus Australian Share Fund is managed by Crispin Murray. The fund has beaten its benchmark in 14 years of its 18-year history (after fees), across a range of market conditions. Find out more about Pendal Focus Australian Share Fund here.

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

As ‘stewards of capital’ Pendal undertook 562 ESG engagements on behalf of investors in 2022. Here, CEO Richard Brandweiner explains why this is important

• Download Pendal’s Responsible Investment and Stewardship Annual Report (2022)

THE concept of responsible investing has evolved hugely over the past decade, and the pace of change is accelerating.

Not necessarily in clear directions, however. 

We’ve reached a point where there wouldn’t be many boards or management of major Australian listed companies not taking Environmental, Social and Governance (ESG) risks seriously. 

A cursory glance at MSCI ESG ratings shows an improvement in scores across the market in recent years.

As one of the leading sustainable investors in the country, Pendal has played an important role in this transition, driving companies to change.

This is something we are very proud of. 

It’s also reasonable to believe that the potential alpha available from targeting “box-ticking sustainability improvers” has eroded over time. 

Curiously, companies that are deprived of capital as a result of poor ESG behaviours may well have higher expected returns, at least over shorter time periods. 

This reflects their higher risk and lower multiples. Certainly, higher fossil fuel prices over the past year made excess returns very challenging for sustainable investors. 

Nevertheless, we know that changing consumer preferences, increasing transparency and a significant shift in the direction of policy settings are real.

These will demand ever more vigilance on behalf of corporates to stay on top of their sustainability agenda. 

Box-ticking increasingly unhelpful

So, what does this new ESG environment look like? 

Firstly, box ticking will become increasingly less helpful.

The challenge for investors is identifying authentic leadership that can leverage non-financial factors to generate real economic value. 

Since many of the basic hygiene factors are already considered, it will become particularly difficult for systematic processes like those used by the mainstream ESG score providers to assess this.

It is here that Pendal’s deep fundamental research resources will be well placed. 

Secondly, the next horizon is one of impact.

What are the externalities created by a company? To what extent is a company, through its product and services, making the world a better or worse place? 

Many see this as the third axis of investing.

The first was return, the second was risk — and the third is impact.

Notoriously difficult to measure, full of unintended consequences and spurious correlations, impact is nevertheless a real component of allocating capital.

It is the “so what” of owning a business and holding management accountable. 

In 2023, the Federal treasurer has started asking sincere questions of the role of financial markets in impacting our society as whole.

The influence that we have on our system as stewards of capital has never been lost on us. 

This report aims to highlight how we have carried out this responsibility. 

Look to mid-caps for battery metals | Take care with Korea and Taiwan | Time to consider liquid alternatives | No more hikes, but don’t expect cuts | Global equities opportunities

It’s been a busy time for fixed-interest investors. In this bumper edition, our head of government bond strategies TIM HEXT outlines his views on the latest inflation data, the RBA review and YFYS reforms

• Find out about Pendal fixed interest funds

FIRST to the latest Australian inflation data for the March quarter.

Since the introduction of monthly inflation data we know about 70 per cent of the quarterly story ahead of time – and the latest data came in largely as expected.

Headline inflation was 1.4% (7% annual). Underlying, or trimmed mean inflation (the RBA’s preferred measure) was 1.2% (6.6% annual).

Inflation remained strong in housing at 1.9% for the quarter, though that was boosted by gas prices up 14%.

Health was strong at 3.8% led by pharmaceutical products and medical and hospital services.

Education was high at 5.3% for the quarter, but it is only measured annually in February.

Finally, insurance was up 1.9%.

This all led to non-tradable (ie services) inflation at 1.9%, not far off the 2.1% from last quarter.

The domestic economy is not really relenting.

Goods prices continued their fall to 7.6% as supply chains return to normal. Tradables inflation was just 0.3% for the quarter.

This week’s quarterly data showed goods inflation almost flat-lining as supply chains return to normal, while services inflation jumped to 6.1%.

Given it’s a one-third / two-thirds split between goods and services, this leaves the medium-term annual inflation pulse nearer 4%.

No more hikes, but don’t expect cuts

The RBA will be encouraged that inflation is falling. Their 4.75% forecast for 2023 looks too high and will likely be revised down in May.

This means no more rate hikes, with the fixed-rate cliff doing the work on the domestic economy for the rest of 2023.

However, those looking for rate cuts late this year or early next year will be disappointed.

The easier work on inflation is done.

The harder work of reining in services inflation and the domestic economy is very much a work in progress.

It will not be smooth or pretty and will require rates stuck at this level for the rest of this year.

Overall the latest data supports our duration-friendly view on markets, but as always levels will determine our risk.

The RBA Review

Plenty was written about the RBA review last week. Most recommendations look reasonable and a review was definitely overdue.

But two things stood out to me about the report and its recommendations:

1. What about fiscal policy?

The report perpetuated the view that monetary policy is more important than fiscal policy

Most people still think monetary policy — not fiscal — is the most important lever in controlling inflation and activity.

They have elevated central banks, often with the help of central banks themselves, to a level of impact that just isn’t true.

Reading the dissection of RBA actions since 2016 must have been painful for Governor Phil Lowe, who I suspect — after being painted as the main culprit — wanted to cry out “but what about fiscal policy!”.

In fairness fiscal policy was not the focus of the report. It does occasionally reference fiscal policy, but when mentioned it’s given second billing.

From the section of the report dissecting events in the low inflation period of 2016-2019:

Some people consulted by the Review pointed to fiscal policy and the role it was playing in Australia.

During this period, fiscal consolidation weighed more heavily on domestic demand than the RBA had expected.

Prior to the outbreak of the COVID-19 pandemic, the 2019–20 Budget projected a balanced fiscal position for the financial year. At the same time, the cash rate was at historic lows.

The review heard from some that fiscal settings should have been looser to assist monetary policy to bring inflation closer to its target and boost employment.

This is quite soft language.

In reality it was absurd to try to balance the budget as some sort of fiscal bravado when there was clearly excess capacity in the economy and inflation wasn’t a problem.

From the section on the overshoot in inflation since 2021:

For example, while the Review (and many consulted by the Review) considers the strong and rapid fiscal and monetary policy response at the onset of the pandemic to be appropriate given the threat to lives and livelihoods, the cumulative effects of the measures over time contributed to the overshoot of inflation in Australia.

Indeed, Murphy (2022) found that, combined, the fiscal and monetary stimulus added 3.0 percentage points to inflation during 2022.

Of this, 0.6 percentage points were attributable to monetary policy being more accommodative than would normally be the case given prevailing economic conditions.

This suggests 80% of the overshoot problem was fiscal not monetary. Yet reading the report you’d think the opposite.

Maybe a major inquiry into fiscal actions through Covid should follow the RBA report.

Ultimately it would be more important for future episodes of massive disruption.

The report does reference closer coordination between fiscal and monetary policy but actual actions were outside its remit. It should not sit outside of the remit of those who pursue efficient public policy.

2. “Give me a one-handed Economist. All my economists say ‘on one hand…’, then ‘but on the other…”   — President Harry Truman

Monetary policy will be more volatile, not less.

Will decisions be wiser under the new RBA plan? Policy is an art not a science.

A separate monetary policy board, and likely more pressure to return to targets sooner, will lead to more rate volatility. There is likely to be less patience on over-shooting or under-shooting targets.

Inflation has spent more time outside the 2-3% range than inside since the target was introduced in 1993. Yet the average is almost exactly 2.5%.

Ultimately, the RBA has been generally correct in its patience.

The RBA will now only have two of nine votes on cash rates (three if the Treasury Secretary is included).

This would not be welcomed by the RBA, despite a brave face.

I suspect the governor will work behind the scenes to persuade voting members of the RBA view prior to a vote.

But the independent members — who will love having a seat at the most important economics table in town — are not there to rubber stamp.

Encouraged to be opinionated, they will not always play ball with the RBA view.

The report celebrates a diversity of views, believing “a stronger culture of constructive challenge and openness to diverse views” is vital.

This sounds good and is important. But as anyone who has been in a decision-making seat before will testify, democracy has its challenges.

Unfortunately, we will not see why the dissenters dissented. Only the vote, not the reasons, will be disclosed.

The votes also will not be attributed, leaving us guessing, at least in the short term.

The report also does not go back 30 years to analyse the times the market got it very wrong. Let’s face it, the independent board members will often be heavily influenced by markets and the media’s running commentary.

As someone who has been making market calls for more than 30 years, I am perhaps more honest (and dare I say humble?) than many commentators.

Remember 2011 to 2014?

Markets were very slow and sceptical on RBA rate cuts, believing inflation was still a post-GFC problem when central banks didn’t.

I suspect among the six independents the market’s view would have found some favour and made the appropriate cuts less likely.

What about 2008?

Despite worsening global problems the market had hikes, not cuts, priced in right up to June 2008.

The only major episodes I can think of where markets were right and central banks were asleep at the wheel is 1994 and 2021.

Unfortunately for the RBA there is a massive recency bias.

Benchmark Reform for Your Future Your Super (YFYS)

Earlier this month Australian Treasury released a draft report for benchmark reform under Your Future Your Super (YFYS).

The benchmarks are extremely important as the performance measure for MySuper products when conducting tests.

As 13 of the 76 MySuper products discovered in 2021, underperformance against benchmark of more than 0.5% for two years in a row could be catastrophic, as new flows are halted.

Therefore when reforms are suggested to fixed income benchmarks were are very interested, since it’ss safe to assume MySuper products will adjust holdings to more closely match the new benchmark.

Among many proposed changes across asset classes, there is a change in the default Australian fixed income benchmark from the Bloomberg Ausbond Composite 0+ Index to the Bloomberg Ausbond Master 0+ Index.

The difference is that the Master Index includes everything in the composite plus inflation bonds and credit Floating Rate Notes (FRNs). 

This increases the outstanding universe from $1.4 trillion to $1.65 trillion as $60 billion of inflation bonds and almost $200bn of credit FRNs are included

You can see a summary of the differences below:

It’s estimated that more than $900 billion of Australia’s $3 trillion of super money is invested in MySuper products.

Some 60% of all super accounts are in these products. The majority sit in industry funds, but retail funds are also big providers.

Data from the Australian Super Funds Association (see below) suggests as of late last year almost $100 billion sat in Australian fixed interest, consistent with a 10-15% allocation.

Of course there are also non-MySuper products that reference the Composite Bond Index, which may seek to match the change or are indirectly captured by YFYS.

The Composite bond index spent its first 20 years, after starting in 1989, as roughly 70 per cent government and 30 per cent credit.

A massive government issuance since the GFC (and now Covid) has seen credit diluted down to 17%, of which supranationals are over half.

Introducing more Australian credit vias FRNs will see genuine credit (non-supras) almost double from 9% to 17%.

Inflation should also have a home in default products.

It could be argued that protecting purchasing power should be the first requirement of any investment, so 4% of the Master Index is far too low in my view.

However, at least it is a start in the right direction.

Market Impact of YFYS reforms

The YFYS changes are likely to be introduced in August, though fund providers will likely seek to adjust prior to that date, possibly from July 1.

We must also recognise that part of the reason for the proposed change is that some funds already have holdings closer to the new benchmark than the old.

Holding some inflation and credit FRNs and topping up duration with derivatives (mainly government bond futures) is a smart and commonplace strategy.

Ultimately, investors benefit from this.

Though the performance test has never been about optimal portfolios, but rather performance against benchmark. This will reduce tracking error for many funds.

There will still need to be some important changes.

The reduction of 0.4 years of duration is very large.

This may be worth around 15-20 basis points if we use the recent large index lengthening (March 31) of 0.2 years as a guide.

We can also reference the recent $14 billion AOFM 2034 issue that cheapened the market by around 10 basis points.

Demand for credit FRNs, which are predominately Australian banks, should be strong.

Fortunately, as the Term Funding Facility unwinds, banks will have plenty of issuance to do. This will still provide a decent tailwind for bank spreads.

Finally, inflation should see net demand.

For a small and at times challenged liquidity market — where $150m tenders can move the market 5 basis points — any large shifts will have a decent impact.

Physical inflation bonds have always enjoyed a decent discount to Inflation Zero Coupon Swaps (ZCS), since ZCS has been the favoured inflation hedge of super funds so they can deploy capital elsewhere.

This discount should narrow quite quickly and we recommend funds invest in physical bonds until the gap is closed.

Conclusion

We are increasingly factoring these changes in to our investment decision-making in the next few months.

We are also keen to hear from investors whether there is appetite for a fixed income product or unit trust based off the Master index.

We do not currently plan to change the benchmark of our two flagship funds (Pendal Fixed Interest and Sustainable Australian Fixed Interest) but look forward to an active dialogue with investors if their needs change.

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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

Pendal’s JAMES SYME warns investors to take care before jumping into South Korea or Taiwan on the back of bullish semi-conductor export expectations

• Taiwan, South Korea exports historically weak
• Look instead to the likes of Mexico
• Find out about Pendal Global Emerging Markets Opportunities fund

EMERGING MARKETS investors will be aware that media and analysts have recently been weighing up the prospects of a return to growth for key Asian tech hardware export markets.

But Pendal’s James Syme warns investors to take care before jumping into South Korea and Taiwan on the back of bullish semi-conductor export expectations.

Expectations that South Korea and Taiwan can lead an emerging markets recovery are overdone as both countries continue to face historically weak conditions in their key semi-conductor and electronics export industries, argues Syme.

An analysis of economic conditions and export data shows little evidence of recovery, with some key metrics as weak as they were during past global recessions like the tech wreck of 2001 and the financial crisis of 2008.

“We’ve seen a lot of a lot of investors go back to the playbook of what worked for the last couple of years — Chinese Internet stocks and Korean and Taiwanese tech hardware names,” says Syme, who co-manages Pendal Global Emerging Markets Opportunities Fund.

“But when we look at the data, we see no evidence of that at all.”

South Korean exports of semiconductors were down 42.5 per cent year on year in February. Taiwanese electronics exports fell 22 per cent for the same period.

“We’ve only seen those levels in 2008, 2001 and in 1990,” says Syme.

“It may or may not be the case that the global economy is tipped into recession by Fed interest rate hikes — but looking at the current state of the tech hardware industry, it looks and feels like there’s a major recession.

“It might be that we’re seeing the tail end of a drop off in the developed world before China recovers, but our process is based on looking at what’s happening, not imagining what might happen — and when we look at what’s happening, things are difficult.”

Syme says one key indicator — the number of days of inventory in the global semi-conductor industry — has “exploded higher, even to way above where it was in the bad days of ‘08”. That implies reduced demand while this inventory bulge is worked through.

Economic data from South Korea and Taiwan are important indicators of the state of the world economy. Both countries publish a good amount of data with long time series, which can be used as a benchmark for global demand.

South Korea is a major exporter of cars, machinery and steel. Taiwan is a leading exporter of semiconductors and electronics.

Overall exports for South Korea were down 7.5 per cent in the year to February, while Taiwan’s exports fell 17 per cent over the same timeframe.

Exports are not the only indicator of tough economic times.

Purchasing manager surveys in both countries show expectations of contraction. Korean industrial production in January showed a disappointing 12.7 per cent contraction, while Taiwan’s industrial production fell 10 per cent in February to be down 21 per cent year on year.

“It’s just a really weak set of data,” says Syme.

“Now, things could recover from here, but a lot of the mood around technology right now looks difficult.

“There’s a bit of hope that Artificial Intelligence products like ChatGPT will lead to demand for server hardware.

“But if you look at the start-up ecosystem, if you look at demand for tech hardware for crypto mining, and if you look at job moves from the global scale players like Amazon, Microsoft, Google and Netflix, it looks really difficult.”

Syme says earnings expectations for South Korea and Taiwan are now trending down after being some of the best-performing earnings markets during COVID.

“Despite a recovery in China and ongoing growth in other major economies like India or Indonesia, we think it’s far too soon to be looking for Taiwan and Korea to lead.”

Look to the likes of Mexico

Instead, Syme says investors should stick to the emerging markets that are suited to current global economic conditions.

“Mexico continues to deliver in terms of exports and remittances. And Poland, Hungary and Czech are looking a lot better than a year ago.

“So, you wouldn’t say that it’s all red lights in terms of the outlook for the global economy — it’s sector specific.

“There’s an enormous shortage of people in the United States who are able and willing to drive trucks and serve food and clean and build things — that it is an enormous opportunity for Mexico, which is a supplier of people who can do that.

“The developed world has a shortage of labour — but there’s no shortage of DRAM or NAND flash or CPUs or GPUs.”

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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

Pendal’s income and fixed interest team favours high-quality Australian assets likely to provide investors with a stable income and protection from the uncertainty ahead. Assistant portfolio ANNA HONG explains why

• Why bonds, why now? Find out more from Pendal’s income and fixed interest team

THE current rate hiking cycle may resume in Australia as soon as next month, after a short pause in April.

That’s the suggestion from the Reserve Bank’s latest meeting minutes, released yesterday.

Even though inflation has moderated, it is still higher than targets set by the central banks, because household spending remains resilient.

A fall in inflation from 8% to 4% is the easy part – the normalisation of goods supply chains has ensured that.

But getting back to the Reserve Bank’s 2% to 3% target range or US Federal Reserve’s 2% target will be a much tougher ask.

To get there, service inflation will need to moderate from the current 6% level back down to 3%, something that for now seems unlikely.

This is because monetary policy is a blunt tool that only impacts the demand side of inflation.

Meanwhile, the current inflation flare-up is shaped largely by supply: issues with supply chains, labour market tightness, energy constrictions and issues with housing stock lead the charge.

The persistence of inflation will drive future rate decisions.

Impact of rate hikes

Meanwhile, the impact of the rate hikes that have been already passed by central banks will continue to work its way through the system, increasing risks to global financial stability.

different story in 2023, with consumers staring at empty wallets.

Cracks were always going to appear after the ferocity of rate hikes in 2022-23.

The tightening of financial conditions led to the March madness that claimed the scalp of three regional banks in the United States and a 176-year Swiss bank. RIP Credit Suisse July 5 1856 – March 19, 2023.

Those events were a stark reminder that tightening conditions will have an impact on risky assets.

The RBA’s recent Financial Stability Review highlighted that knowing what assets you own is incredibly important, especially in light of the Silicon Valley Bank collapse.

Just like doing a regular health check and making sure your insurance is up to date.

What it means for investors

Having a defensive allocation in a balanced portfolio insures against adverse market outcomes.

Among safe-haven assets, we favour Australian government bonds and very high-quality credit from well-capitalised Australian issuers, due to the strength of the Australian financial system.

Why?

Australia is one of the strongest AAA-rated sovereigns in the world.

Australia has a pathway to surplus that most developed nations can only hope for.

That’s anchored by the Budget outcome to January 2023, which was $13.6 billion better than expected, driven mainly by $8.5 billion of upside revenue surprise and $5.1 billion less spending than expected.

Australian banks are the best capitalised major institutions in the world allowing them to be the pillars of support for the Australian economy.

Hence, in Pendal’s income and fixed interest portfolios, we favour high-quality Australian assets likely to provide investors with a stable income and protection from the uncertainty ahead.

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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 some $20 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

THE market continues to grapple with the implications of stress in the US banking system.

There are two questions.

One is the extent to which this is a genuine crisis versus a more manageable, short-term shock.

The other is the degree to which credit growth will slow as an exodus of deposits constrains the ability of banks to lend.

At this point the market is swinging to the more benign view that credit tightening will shave somewhere in the vicinity of 0.5% off GDP growth.

This implies a lower peak in rates than expected before the Silicon Valley Bank collapse. But it also means the pace of subsequent cuts may not be as sharp as some have been looking for recently.

The market is pricing in an 80 per cent probability of one last hike in May — and then for rates to fall around 60bp through to year end.

The S&P 500 has rallied about 7% since its March 13 low after the Silicon Valley Bank collapse.

It has been trading in a range of 3600 to 4300 for almost a year.

The recent rally in the face of a financial shock has been driven by the prospect of US rates peaking, inflation softening and the economy remaining resilient, all combined with bearish positioning.

The market valuation discount rate effect from the prospect for lower rates has outweighed the negative impact from the financial sector.

This was bolstered last week by receding fears of a bank-induced credit shock, retail sales holding up better than expected, bank deposit outflows settling down and a better-than-expected start to US bank results.

The S&P 500 returned +0.82% for the week and US ten-year Treasury yields rose 21bps to 3.52%. The S&P/ASX 300 gained 2%.

There are two schools of thought for the economy and markets:

• The successful soft landing — potentially with a mild recession
• A sharper economic downturn, driven by a shock to the banking system or the need for rates to be held higher for longer as inflation remains sticky, leading to a more significant decline in corporate earnings.

The first scenario keeps the market at current levels with perhaps some upside to valuation rating.

The latter sees the market returning towards lows.

In the near-term, markets could remain benign as we enjoy a phase where inflation continues to ease while the economy holds up.

We also have the benefit of a reasonable liquidity environment. In this environment volatility stays muted and market focuses more on stock specifics.

Our view is that the risk increases as we approach the debt ceiling negotiations in July and August, which could coincide with emerging signs of the economy weakening more meaningfully.

Given this, we continue to balance the portfolio in terms of skew between cyclicals and defensives and focus on stocks with less exogenous risk and greater control over their outcomes.

US policy and economics

It’s worth reflecting on the contrasting views on some key questions facing markets:

1) How will the banking crisis affect growth?

Annual deposit growth in the US has very rarely been negative — as it is now. The scale of the decline is by far the largest on record.

Declining deposits constrict a bank’s ability to lend. The market is concerned about how large this impact will be.

This remains to be seen. But there are reasons why this financial shock may not be as bad as people fear.

These include:

1. We’re already in a cautious lending environment, so the change in credit availability may be more limited.
2. The funding issue mainly affects small and regional banks. While they are important providers of credit, this limits the scale of the issue, since bigger banks are less affected.
3. Alternate sources of capital are increasingly available, such as private credit where substantial capital remains to be deployed.
4. Bank balance sheets are far more secure since the GFC, therefore they are less vulnerable to shock.

The minutes from the last Federal Open Market Committee meeting released last week suggest the Fed staff were more fearful of a significant credit shock than the FOMC members.

Interestingly, more recent submissions indicate initial fear is dissipating, emphasising the dynamic nature of this issue. Friday’s US bank results were also supportive for sentiment around banking.

JPM and Citi both beat earnings expectations materially, driven by better-than-expected margins.

JPM’s CEO Jamie Dimon chose to be more constructive on the banking shock, noting it involved far fewer players and required fewer issues to be resolved.

This week we will see the Senior Loan Officers Opinion Survey (SLOOS) on credit conditions, which will be an important signal for the Fed.

2) How fast is inflation falling?

There are clearly more signs that the lead indicators of inflation are easing.

US import prices excluding food and fuel dropped 0.5% month-on-month in March and are running at -1.6% annualised, versus a peak of about 7% in 2022.

The Producer Price Index (PPI) readings are also slowing. The US Core PPI is running at 3.4% annualised in March, down from above 9% in 2022.

Historically, PPI measures have been a decent lead on broader inflation.

This is a constructive trend. But on the other hand, Fed officials continue to highlight the issue of tight labour markets and persistent inflation.

FOMC members Christopher Waller and Raphael Bostic emphasised this on Friday.

Waller noted core inflation had only moved sideways since the end of 2021 and said there was much work to be done.

This was reinforced by the latest Atlanta Fed wage tracker data, which did not support the recent average hourly earnings drop in wage growth.

3) The risk of recession

A high proportion of US economists are now expecting a recession, according to surveys.

It should be noted that the Fed themselves are now forecasting a mild recession.

The signals supporting this view are more ambiguous. Consumer spending is slowing but not more than anticipated by the market.

“Real-time” indicators of credit and debit card spending from Bank of America show spending is now flat year-on-year. The mix breakdown shows retail spend is deteriorating, while services growth may have peaked.

Last week’s revisions to jobless claims data revealed a more material rise in claims, which is more consistent with signals on job losses.

History suggests that once claims pick up they can break materially higher very sharply.

The counter to this is that real-time indicators of layoffs remain at normal levels, including notices to employees.

We are also seeing labour supply beginning to return, which should enable wages to slow without a significant rise in unemployment.

China

Sentiment improved last week, which was reflected in mining stocks performing well.

This was driven by lower inflation numbers and strong credit data.

This suggests the economy is seeing early signs of picking up post-winter, with improvements in the housing market and consumer spending.

Inflation is being held in check by production growth also ramping up along with consumer demand.

Markets

As concerns over the banking shock mellow, the implied Fed funds rate has crept higher.

However, it still suggests 60bps in cuts by the end of the year, which indicates caution over the economic outlook.

This is also reflected in consensus expectations for earnings as we go into US first-quarter 2023 reporting season. The market is expecting 7% annual decline in earnings in Q1 and 6% declines in Q2.

This is conservative and may have the potential to surprise on the upside.

The bigger issue is the expected recovery. The market has 9% annualised earnings growth in Q4 and 14% in Q1 2024. This seems inconsistent with the economic outlook.

Bears suggest that when earnings start to roll over, they can then plunge suddenly as companies throw in the towel and start to cut costs.

But it’s important to note that while this may have been the case in 2008 and 2020, you can also get extended periods of stagnant earnings, such as in 2014-15.

Australia

The S&P/ASX 300 has lagged the US in 2023, reflecting less skew to tech and the issues with banks.

Last week we saw some catch-up, mainly driven by resources after positive signals on China and less fear around US growth.

Banks lagged the market but did begin to see some price stability return.

Heading into bank reporting season, the key issue will be competition in mortgages where back-book re-pricing may be accelerating and the cost of deposits increasing.

 

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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

The Pendal Japanese Share Fund (Fund) will terminate with immediate effect on Wednesday, 5 April 2023.

Why is the Fund terminating?

The Fund’s small size means that it has high running costs and cannot be managed in a cost efficient way.

We also consider that the Fund has little prospect of significant growth in funds under management in the foreseeable future. If the Fund were to continue, the Fund’s size would result in higher management costs for investors, which would reduce their investment returns.

How this affects you?

We will terminate the Fund on Wednesday, 5 April 2023.

Any applications, transfers or withdrawal requests received after 4:00pm (Sydney time) on Wednesday, 5 April 2023 will not be accepted.

As soon as practicable after the Fund is terminated on Wednesday, 5 April 2023, we will begin winding up the Fund. The assets remaining in the Fund will be realised and the proceeds distributed to all investors in proportion to their unit holding.

What does this mean for you?

The cash proceeds from this termination will be paid directly to your nominated bank account on file during the week commencing Monday, 24 April 2023 or shortly thereafter.

We expect that termination of the Fund will result in a distribution of the net income of the Fund. Details of the distribution will be included in your distribution statement for the month of April 2023. You will also receive an annual tax statement following the end of the financial year.

Questions?  

If you have any questions, please contact our Investor Relations Team during business hours on 1300 346 821.