Should we be concerned about the knock-on effects of the Silicon Valley Bank collapse? Pendal’s AMY XIE PATRICK explains

• Find out about Pendal fixed interest funds

COCKROACH theory refers to the belief that problems affecting one company may indicate similar problems with other similar companies.

After the collapse of California’s Silicon Valley Bank (SVB), the market and the media are on the lookout for more cockroaches.

The good news is that SVB was an unusual cockroach. The bad news is that other creepy crawlies lie in wait.

Two main issues led to SVB’s fall.

The first was an unusual decision not to hedge interest rate exposure or mismatch between its assets (long-dated fixed income instruments) and liabilities (deposits).

Most banks face this mismatch. Few would leave it unhedged.

Bloomberg’s US Treasury index returned -12.3% in 2022. This gives an indication of the mark-to-market damage that would have hit SVB’s long-dated fixed income assets.

The second factor was the concentration risk in its customer base.

The Silicon Valley tech sector formed almost the entirety of the bank’s borrower and depositor base.

Ultra-low interest rates going into and coming out of the pandemic were a huge boon to this sector.

At the time, money was virtually free and poured into high-growth sectors hungry for returns. But by the end of 2022 – after 425 basis points of interest rate hikes – that was no longer the case.

Higher discount rates needed to be applied to potentially speculative future earnings in the sector.

All at once, SVB found its customers calling on their deposits.

The need to satisfy these liquidity demands caused SVB to start realising some of those steep mark-to-market losses in their assets.

SVB is the 16^th largest lender in America, but its $200 billion of assets still sat below the $250 billion threshold at which banks need to report unrealised losses.

This helped hide the stress before a classic run on deposits in early March.

Are there more cockroaches?

There could be other lending institutions with similar red flags, but the bank’s problems were largely self-made.

Many regional US banks go under every year.

Most often, it is due to the poor quality of their loan books. Not because of poor risk management.

That is perhaps the most heartening takeaway from the SVB crisis.

Unfortunately, other risks have been uncovered by the bank’s collapse.

Here are the main lessons:

1. Easy money a thing of the past

The first is that easy money is a thing of the past.

The SVB crisis reminds us that the promise-heavy tech sector needs much more diligence now that money-good T-bills pay between 4.5% and 5%.

Similarly, in Australia cash and near-cash investments yield 4% or more.

This naturally pushes up the bar for going further out along the risk curve and down the liquidity ladder.

When money was virtually free, illiquid and opaque investments such as private debt and equity seemed attractive.

Just as had been the case with SVB until now, unrealised losses within these investments have yet to come to light. That flood of money is reversing.

2. Hurdles for mortgage-backed securities

A second risk is highlighted by the mortgage-backed securities (MBS) losses on SVB’s asset portfolio.

Mortgage-backed securities allow investors to own part of a bundle of home loans that have been packaged together.

Interest rates were not the only blame factor here. So was the quality of the underlying assets.

Like clockwork, a global synchronised housing downturn is following the synchronised global rate hiking cycle.

Australian credit portfolios heavily invested in illiquid residential mortgage-backed securities (RMBS) face significant hurdles this year.

The value of RMBS portfolios will be affected by the house price correction we’re already experiencing, as well as payment delays from stressed borrowers.

In addition, the RMBS issued by non-major banks are of poorer quality, leading to more accidents waiting to happen.

As Pendal’s senior credit analyst, Terry Yuan, says: “Set-and-forget credit portfolios often rely on the AAA rating of RMBS to raise the average portfolio rating of their holdings, giving them more room to veer into the low-BBB space.

“Both ends of the ratings spectrum will experience a lack of liquidity should something go wrong”.

That is not what true fixed income is supposed to feel like for the end investor.

3. The information factor

The third risk unveiled by the SVB crisis is that of information. Unlike the GFC, and thanks to technology, rumours can become truths in the space of a few tweets.

The reality is that SVB depositors are likely to be made whole. The shame is they could have got there without going through this mess first.

Faced with panic, with fear spreading like wildfire, it was individually rational to “sell first and ask questions later”.

This will happen to other institutions as well, leaving the biggest and safest of lending institutions to benefit from the fall-out.

What we can learn from SVB

SVB’s failure reinforces our investment views for 2023.

We thought this year’s set-up for bonds looked good even before this most recent crisis surfaced.

The trend of cooling inflation will continue to play through.

The SVB collapse highlights the need to hold a true-to-label fixed income allocation in your portfolios – if only for insurance.

Over the past week, 10-year Commonwealth government bonds rose in value by more than 2.25%.

Portfolios exposed to that move would have felt cushioned against a 2.5% hit to Australian equities over the same period.

Our patience on credit should be rewarded.

Since the third quarter of 2021, we have held a defensive stance in our credit and income portfolios, favouring quality and liquidity over stretching for that extra bit of yield or spread.

We have also been long-time abstainers from RMBS.

Their valuations did not reward us when money was near-free, and the illiquidity they face does not make them attractive now that cash rates are approaching 4% in Australia.

Floating rate senior unsecured paper from our major banks, on the other hand, are a safe place to bias our credit allocations towards.

Rates, US recession risk, Chinese growth and government intervention will set the underlying economic picture for Aussie stocks this year, says Pendal’s CRISPIN MURRAY

• Aussie equities remarkably defensive
• Four issues will drive the underlying economic picture
• Find out about Pendal Focus Australian Share fund

AUSSIE equities have proven remarkably defensive over the past 12 months compared to global shares and other asset classes — delivering a 6.5 per cent return in the year to February, says Pendal’s head of equities Crispin Murray.

The recent ASX reporting season delivered an earnings revisions distribution — the ratio of upgrades to downgrades — in line with long-term averages as a post-Covid sales boost dissipated.

Earnings are on track for 2 per cent growth in 2023 and 1 per cent in 2024, Murray says in his new biannual Beyond The Numbers webinar.

That means a material decline in shares is unlikely over the course of 2023, he says.

“However, if we do get the RBA forced to hike rates far higher than the economy can absorb — and we do get a downturn — then we’re going to see much more material downgrades.

“That is the risk scenario for the market. But that is not the scenario we expect.”

Remarkably defensive

Why have Australian companies proven relatively defensive over the past year?

Partly it’s structural, he says.

The Australian share market skews to financials and resources. Banks have benefited from higher interest rates and commodity prices have buoyed the mining companies.

But a more important underlying explanation is the rise in company earnings that has meant that even as stock valuations fall in the face of higher interest rates, stock prices have been largely unaffected.

“What we’ve actually been able to achieve in Australia is a derating of the market without the actual market having to drop because earnings revisions were positive and these were positive across all parts of the market,” says Murray.

“Even the industrials really haven’t been exposed to an economic slowdown and they were bouncing back from impacts of the pandemic.

“Where we are sitting today, we’re quite comfortable with the overall rating of the market.”

Four key issues

Four key issues will drive the underlying economic picture for Australian companies, Murray says:

1. The risk of a US recession

The US economy is proving more resilient than many people thought, Murray says.

“There has been a material change in US interest rates and for a lot of people that was inevitably going to lead to a recession — but it so far has not.

“There is clearly now a school of thought saying that the US economy is more resilient.”

He says some measures of monetary tightening suggest the worst has past, setting the US up for soft landing.

On the flipside, a “very negative” yield curve and the biggest ever one year decline money supply growth since the 1930s indicates tough times ahead.

“As we stand today, we would expect perhaps a mild recession — we’d still be somewhat cautious.

And that’s why we believe that you still need to be very careful about what you’re paying for certain companies in this market environment.”

2. The outlook for Chinese growth

The growth of China is a significant factor in the success of Australian corporations.

Murray says the key question for investors is how much Chinese growth can accelerate out of the zero COVID period.

“China dealt with COVID very differently to the rest of the world.

“They did not throw anywhere near as much stimulus at their consumers so they saw consumer spend falling well below trend for an extended period.

“So the first thing that will underpin Chinese is growth is a return to that trend level of consumption and that in itself can add 2 per cent to 3 per cent to growth over the next couple of years.”

Growth could be even stronger if Chinese consumers dip into the money they have saved like their counterparts in the US and Australia.

“There is a big debate about whether this will happen,” says Murray, noting Chinese people are typically quite cautious in terms of their saving to protect themselves and their families’ health care and education.

”But clearly, China is in a far better position today than it was six or 12 months ago.”

3. Interest rates and their impact on the Australian economy

Closer to home, the trajectory of the Australian economy is a critical driver of corporate earnings and an important factor in determining which parts of the market to invest in.

The key to the economy is interest rates.

Mortgage repayments in Australian households as a percentage of disposable income have risen in line with rates, but there has been a change in mix — as people pay more interest they are cut back on principal payments.

This is a reversal of the recent past, when low interest rates allowed higher principal repayments.

“This probably explains why we haven’t necessarily seen any real effect on consumption — as those interest payments are going up, we’re just compressing the principal repayments.”

Murray says that, as a proportion of household income, interest repayments are unlikely to reach the heights of the GFC and should remain below the levels of the early 1990s.

“This doesn’t mean we won’t still see a material consumer slowdown, because the rate of change is material. But it’s not as bad as perhaps it is perceived. In my view, we will not get a recession here.”

4. The growing influence of Australian government policy

A growing trend towards government policy intervention is becoming an issue, says Murray.

Partly, this is evident in the recent regulation of the gas industry and the stepping up of Australia’s carbon reduction pathway.

Murray says he is also hearing from banks that they are concerned about the potential for more regulation on deposit rates.

Companies with a high share of labour costs could also be impacted by the government’s push for real wage increases.

Overall outlook

Overall, 2023 will be a good year for investors with deep insight into individual companies, Murray believes.

“Today reminds me of 2012 going into 2013, where the markets were very thematic — and that’s creating a lot of stock opportunities.

“We are seeing this as a great time to identify opportunities and really differentiate and get some insights into the stock.

“We’re very confident on the outlook.”

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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 Pendal portfolio manager JULIA FORREST. Reported by portfolio specialist Chris Adams.

• Find out about Pendal Focus Australian Share fund

THE odds of a 50bp US rate hike next week increased markedly after hawkish comments by Fed chair Jay Powell – but that didn’t last long.

Powell last week told US Congress that if the data indicated faster tightening was warranted, “we would be prepared to increase the pace of rate hikes”.

Stronger-than-expected data suggested “the ultimate level of interest rates is likely to be higher than previously anticipated”, he said.

The comments drove two-year US Treasury yields above 5% for the first time since 2007.

The spread between two-year and 10-year bond yields inverted to -107bp – the biggest inversion since 1980 when then Fed chair Paul Volcker was trying to kill inflation.

However, all this was reversed after the collapse of Silicon Valley Bank (SVB) late in the week, which saw yields fall.

Market expectations for next Wednesday’s decision quickly dropped back to a 25bp hike.

Equities continued to sell off. The S&P 500 fell 4.5% and the S&P/ASX 300 shed 1.2%.

US labour markets and SVB

On Friday we saw a strong US payrolls number with 311,000 additional jobs versus 225,000 expected.

This followed a very strong January number.

February average hourly earnings were up 0.2% M/M and +4.6% Y/Y, slightly below consensus (+4.7%).

In normal circumstances the labour numbers would have realised the Fed’s worst fears about labour market resilience – and we would have seen bond yields spike.

But rates collapsed across the curve in response to the failure of SVB, the 16^th biggest bank in the US.

The sudden failure does not appear to be a systemic issue.

The failure was tied to the specific and concentrated nature of SVB’s depositors in the venture capital and cryptocurrency sectors. Deposits attributable to digital currency customers account for 82% of the deposit base.

It appears cash drain from the cryptocurrency fallout and cash burn on venture capital starts-ups led to cash withdrawals.

This forced SVB to sell $11.4 billion of its “available for sale” securities, including Treasuries, mortgage-backed securities and municipal bonds.

After the recent sell-off in fixed income markets, this crystalised a $1.8 billion loss.

Bank stocks were sold off on Thursday and Friday with investors concerned about the quality of bank balance sheets and outlook for net interest margins.

It’s difficult to know if this will be an ongoing issue, since most bank investment portfolios are held to maturity and not forced to mark to market.

There appears to be no issue with deposits in the US banking system.

This episode demonstrates that banks need to offer competitive rates to retail and business depositors, since they are now competing with Treasury bills that offer over 5% and money market funds that offer 4.5% to 5%.

This will squeeze net interest margins or possibly impact the amount of credit in the system. 

We have seen signs of credit tightening in response to the cycle.

But we don’t know if financial conditions are tight enough to dampen inflation enough to get back towards “normal”. 

Rate-tightening cycles normally work their way through the economy via housing, manufacturing orders, corporate profits and then employment – in that order.

The housing market reflects higher rates, as do new orders, which look bleak.

At this point sales have started to retreat but operating margins in the US remain elevated and profits resilient.

Employment remains strong, though history shows that when employment starts to deteriorate, it does so quickly.

Labour markets tend to be tight until they are not – then central banks realise they have over-tightened.

Australia

As expected, the RBA hiked rates 25bps to 3.6% last week.

The tone was less hawkish and markets are pricing a terminal rate of 4.14% in November 2023.

We are yet to see a meaningful slowdown in consumer data, though sentiment remains soft.

This is puzzling given some 17% of households borrowed at trough rates and 35% face higher rents.

Hiking rates is the only policy tool available to the RBA, though this only affects about half of households.

The other half remain cashed-up, while negative “real rates” on savings encourage continued consumption.

It’s no surprise that luxury goods and international travel spending remain strong.

 

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Why fiscal policy matters for investors | The ‘no landing’ scenario | Aussie recession unlikely | US set for growth

Monetary policy gets the headlines — but investors would be wise to pay more attention to fiscal policy, argues Pendal’s TIM HEXT

• Budget decisions dwarf rate changes
• Fiscal policy to dictate if going into recession.
• Find out about Pendal fixed interest funds

WHILE Australia focused on the RBA’s 10th rate rise in a row this month, Team Albanese was working in the background on the May federal budget.

The March rate rise added about $7.5 billion to repayment schedules across the nation.

By comparison, the May Budget will include hundreds of billions of dollars in spending initiatives and cuts, impacting all parts of the economy.

Why does monetary policy get so much attention?

Which is more important for investors: monetary or fiscal policy?

“We’ve built a whole system around monetary policy and the wisdom of the independent central bank,” says Tim Hext, head of government bond strategies at Pendal.

“But fiscal policy doesn’t get enough attention.

“Fiscal policy is more likely to determine whether or not Australia is going to have a recession,” he adds.

Monetary policy – movements by the Reserve Bank in the official cash rate, which is used as a basis for other lending rates – is conveyed regularly, normally 11 times a year after central bank board meetings.

Fiscal policy – the government’s spending policies – normally has only two spotlight events.

The first is the annual budget on the second Tuesday of May, and the second is the mid-year economic and fiscal outlook (MYEFO) about six months later.

The power of monetary policy comes less from the actual movement in interest rates, and more from the secondary round impact on asset prices, Hext says.

“The direct impact of monetary policy might not be that huge, but if it causes a boom in asset prices, such as people’s homes, it’s going to make people feel wealthier,” Hext says.

There is about $3 trillion of debt in the economy, Hext says.  About $1.2 trillion is held by foreigners and the rest is local – Australians lending to Australians.

Therefore the net impact of a one per cent rate hike on the economy is only $12 billion. The other $18 billion of payments are between Australians.  

“After 3.5 percentage points of hikes we are $42 billion a year worse off,” Hext explains.

Fiscal policy the main game

“The government spent $250 billion during Covid. Fiscal policy remains the main game for people’s pockets and the economy.

“It explains why the Australian economy is proving more resilient to rate hikes, at least for now.”

Hext says in a world of four per cent wage growth, bracket creep means fiscal policy is tightening.

Bracket creep occurs when income growth causes individuals to pay higher average income tax each year.

Stage 3 tax cuts, legislated for the middle of next year, will reverse bracket creep, assuming they go ahead.

“Tight fiscal and monetary policy will be a major headwind through 2023 and the Federal Budget in May should confirm this,” he says.

“In essence, fiscal policy just doesn’t get enough attention.”

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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 our head of equities Crispin Murray. Reported by portfolio specialist Chris Adams.

• Find out about Pendal Focus Australian Share fund

EQUITIES remain range bound, having absorbed a material rise in bond yields without breaking down through technical support levels.

The S&P 500 gained 1.96% last week, helped by stabilising bond yields and a weaker US dollar.

The S&P/ASX 300 was flat (-0.03%). Gains in the resource and energy sectors offset a decline in REITs and domestic cyclicals.

Weak results in discretionary retail and concern over impending rate hikes weighed on the latter. 

There was limited news in the wake of reporting season and the market remains braced for further signals from central banks.

Fed chair Jay Powell provides his semi-annual Monetary Policy Report to Congress this week.

The decline in equity markets this year has helped tighten the “Total Financial Conditions” index – a measure of changes in key indicators such as mortgage rates, credit spreads, equity markets and currency moves – possibly allowing the Fed to be more balanced in its comments.

This suggests the market should be reasonably well supported for now, as long as growth and inflation don’t continue to surprise to the upside.

Elsewhere, resource and commodity prices have been stronger in hope of positive statement from the Chinese National People’s Congress. Though the signals indicate less stimulus for growth than many anticipated.

Economics and policy

China

The National People’s Congress, which officially starts Xi’s third term and introduces many new faces at top posts, announced a target of 5% GDP growth for this year.

This is down on last year’s 5.5% target – though up from the 3% that was actually achieved.

There had been hope of a higher target – somewhere near 6% – to reflect the re-opening of China’s economy.

The 5% target – despite an environment of potentially strong “revenge spending” by Chinese consumers – suggests Beijing is not planning material policy changes to stimulate growth, particularly in housing and infrastructure.

This may be prompted by fears around inflation.

This is consistent with local government bond quotas, which are traditionally used to fund investment and are lower than last year.

Beijing is targeting employment stability, with a goal of maintaining unemployment at 5.5%.

US

The latest Institute for Supply Management’s (ISM) Services PMI came in at 55.1 for February, versus 55.2 in January and 54.5 expected.

The new orders component was particularly strong, though the price outlook fell (which is a positive).

This puts paid to theories that the strong reading in January data was an aberration.

It reinforces the issue that the US economy remains too strong to enable inflation to slow sufficiently at the current rate setting.

Service sector resilience is supported by other surveys which note continued strength in restaurant spending.

Anecdotes from home builders suggest the year has got off to a better-than-expected start, despite continued high mortgage rates.

The ISM manufacturing index came in at 47.7 versus 47.4 in January – and below an expected 48.

This suggests manufacturing remains weak but is not deteriorating. New orders are improving and there are no signs yet of significant impending job losses.

US Non-farm business output per hour data – a measure of productivity – continues to decline as we see the pandemic boost unwind.

The economy continues to recover employment without driving additional growth. This potentially signals labour hoarding. It may also indicate job growth in lower-productivity sectors.

Central bank action

The market is locked in on a 25bp from the US Fed.

While economic data has been stronger since last meeting there are emerging signs of easing labour market pressure.

This should encourage the Fed to be patient and stick to the plan of 25bp hikes – while focusing more on the duration of rates at higher levels to deal with lingering inflation pressure.

The European Central Bank is in a greater bind, since inflation data has been materially worse than expected.

European core inflation expectations have risen from 5.2% to 5.6% with the release of regional data, leading to a step-up in inflation and rate expectations.

A 50bp hike is the likely outcome and the tone of comments will probably be quite hawkish given the fear of inflationary pressure on wage negotiations.

The market expects another 50bp in May.

The Reserve Bank of Australia is expected to hike 25bps on Tuesday.

We are watching to see whether it eases back on recent hawkish rhetoric. The RBA may be able to point to some early anecdotal signs of a softening economy, though these are limited and not yet sufficient to offset an apparent strong economic momentum.

While we’re seeing a significant rise in household interest payments, the total as a share of household income is still well below that seen in the GFC, given the growth in income in recent years.

This suggests a soft landing is possible.

But it may also signal the need for rates to rise beyond market expectations.

Markets

The S&P 500 bounced off its 200-day moving average last week, which is a significant support level.

The sell-off this year has not been marked by higher volatility and breadth has been narrower, which is constructive.

The Australian market continues to be resilient.

The domestic and rate-sensitive part of the market was down last week after a signal of inventory building in the Harvey Norman (ASX:HVN) result.

This was offset by a bounce-back in resource stocks after a weak February.

Overall, resources were weakest during reporting season, as sentiment on China faded and results showed an increase in costs.

Discretionary retail was weaker as market concerns around domestic interest rates rose.

This led to underperformance in the banks, which were also affected by fears of margins rolling over due to strong competition.

Earnings season winners tended to be companies where fears had built but did not eventuate in the result. Examples include:

• Medibank Private (MPL)– where the cyber-attack had minimal impact on customers
• Orora (ORA) – where no evidence of a US slowdown was evident
• QBE (QBE) – which delivered an in-line result with no new surprises and a clever reinsuring of the highest-risk part of its back-book
• Ampol (ALD) – which is seeing margins recover in its convenience retail business

 

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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 an independent, 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 big themes of ASX reporting season | Time to check your ‘duration’ settings | Why the government’s eyeing our Super | Where to look for innovative companies

Fixed interest investors should get their portfolio settings right now, before US inflation tops out and starts falling in the second half, says Pendal’s TIM HEXT

• Markets set to trade in narrow range
• Inflation to move quickly lower in second half
• Find out about Pendal fixed interest funds

FEELING moody? It’s understandable says our head of government bond strategies Tim Hext.

Right now, US inflation reports are resetting the mood of investment markets every month, says Hext.

“The mood runs for about a month or so until the next set of numbers.

“Central bank officials in the US and Australia come out and express concern if the numbers are too high. Then they warn they’ll have to do a lot more.”

On the other hand, when inflation data is lower – like late last year in the United States – investors start thinking the rising interest rate cycle is nearer the end.

“We’re going to be in this environment for the first half of this year and we are going to be range-trading as the narrative goes backwards and forwards,” Hext explains.

But the uncertainty won’t last – and investors should be ready, says Hext.

“By the second half of the year, we are going to get a much clearer picture and we are going to see that inflation hasn’t just topped out but is coming down.

“Inflation could head back towards central bank target ranges faster than they think.”

Inflation to fall this year

Pendal’s income and fixed interest team estimates inflation will fall towards 4 per cent by the end of 2023. That compares to the Reserve Bank’s forecast of 4.75 per cent.

“The Reserve Bank is going to be pleasantly surprised by inflation,” Hext says.

“In this current March quarter, the number will still be higher because of utility charges, but then in the second, third and fourth quarters, there’s a chance we get readings below one per cent.”

Goods inflation is weakening, in large part because supply chain disruptions during COVID is broadly over. Services inflation continues – about two-thirds of the way through, Hext says. That’s why the inflation data remains elevated, and choppy.

“Investors will start believing the soft landing story,” Hext says, whereby the economy slows bringing inflation down, but doesn’t go into a recession.

“There is a risk though. Central banks might feel they haven’t done enough, particularly the US Federal Reserve.”

Hext believes there will be a couple more interest rate hikes in Australia in coming months, starting next week at the Reserve Bank board meeting.

As to how far the official cash rate set by the Reserve Bank goes, Hext says ten-year bond rates normally top out around the same level as the cash rates peaks.

“That’s where we are now. We are around about 385 basis points for ten-year bonds.

“The big message is that investors have a bit of time on their hands now, but things will start to move quite quickly by the middle of the year.

“So investors should be getting their duration sorted.”

That means checking the duration of your fixed income investments and their sensitivity to interest rate changes.

“Investors should be getting back to at least where their model portfolios tells them they need to be in the medium-to-long term.”

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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

As markets absorb the impact of central bank tightening, it’s important to maintain a high-quality, balanced portfolio, says Pendal’s ANNA HONG

INVESTORS need two things in 2023 – protection and patience.

Today’s Australian monthly CPI shows the Reserve Bank’s tightening – which started in the second quarter of 2022 – is starting to have an impact.

The monthly CPI indicator rose 7.4% for the year to January – an easing from 8.4% in December.

Monetary policy works with a lag – but it does work.

This can be observed through the two key components of the CPI number: new dwelling prices and rents.

Compared to December, there is moderation in the growth of new dwelling prices and rents – which accounts for almost a fifth of the basket.

The January data also shows price increases have slowed more broadly.

We may have passed peak inflation.

This will be welcome news for the RBA.

But their job is not done.

While price rises are moderating, inflation can be sticky. That’s something the Reserve Bank is alert to.

Globally, we are still in a tightening cycle as central banks race to contain inflation by unwinding the easy money of the last couple of decades.

As the markets absorb the impact of coordinated central bank tightening, it’s important to maintain a high-quality, balanced portfolio.

Defensive assets can play an important role as a shock absorber when risk assets wobble.

The effects of central bank tightening will continue to flow into economies and markets in 2023.

Investors should add protection to their portfolio, but may need patience to reap rewards.

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

Contact a Pendal key account manager

Corporate Australia is looking robust as macro forces work their way through, says Pendal’s OLIVER RENTON

• Earnings season surprisingly conventional
• Five big themes in reporting season
• Find out about Pendal Focus Australian Share fund

ASX earnings season — which wound up at the end of February — delivered a more robust-than-expected picture of the economic backdrop.

Earnings upgrades and downgrades were broadly in line with historical averages despite higher inflation and a tight labour market.

But a closer look at the half-year results shows signs that increasing prices, higher rates and energy prices are at different stages of working their way through corporate Australia.

Investors should be a little wiser as to how this all plays out — without yet having the full picture. 

As always there are opportunities and risks over the remainder of 2023, says Oliver Renton, an analyst and co-portfolio manager with Pendal’s Australian equities team.

“If you look top-down at how the reporting season played out, it was pretty normal in terms of the mix of revisions, upgrades and downgrades,” says Renton.

“That’s illustrative, because it wasn’t expected to be a normal reporting season with all the fears around the consumer, home-owners, interest rates and macro-economic forces more broadly.

“So, to come out of the reporting season relatively unscathed in terms of earnings shows the economy is probably holding up better than was feared.”

Here are Renton’s five big themes from this reporting season:

Interest Rates

The effect of higher interest rates is generally well understood. There is a lag, however, as companies adjust decision making to reflect higher costs of capital, says Renton. 

Also, with some companies locked in to fixed rates or hedging, the impacts are yet to fully flow through company P&Ls.

“A few companies hit expectations at an operating level but missed at a net profit level.

Alot of that can be attributed to interest costs.”.

Labour cost pressures

Early signs of higher wages are starting to show in company results.

But the full effect could take to two-to-three years to flow through in countries like Australia, he says.

“Even as some of the heat comes out of the headline employment and wages statistics, we continue to be cautious on labour pressures coming through and pressuring margins.

“Labour pressures come through with a lag and we see that persisting for some companies over the forecast horizon.”

Inflation

“In an inflationary environment, we favour companies with a degree of pricing power, strong margins and control of their cost base.

“The online classifieds companies, CSL and COH have these attributes, for example, and they held up relatively robustly.”

Consumer confidence

The earnings season has not resolved concerns about the outlook for household spending and consumer confidence, says Renton.

“This was not the sort of reporting season that washed those concerns out.

“Ultimately, the economy does need to cool, rates probably need to go up or stay higher for longer and the outlook is for a more cautious consumer.”

Energy

This reporting season, energy stocks had exceptional periods for revenue off the back of high commodity prices.

That largely flowed through to bottom-line results and strong dividend outcomes.

“Ampol had revenue up 78 per cent, Viva was up 66 per cent, Santos was up 65 per cent and Woodside up 142 per cent boosted by the BHP transaction,” said Renton.

“Of course, if they’re making those sort of revenues, then that’s inflation which is coming through the rest of the economy.”

Share price performance

ASX-listed stocks dropped about 3 per cent over February through the company reporting season, giving back some of the strong gains in January.

“At a headline level reporting season appeared quite normal, but there is a lot going on under the surface and much-discussed macro drivers are only just starting to come through in actual company earnings,” says Renton.

“This reporting season was not a widespread cleansing event.

The same pressures we’ve been speaking about for the past 12 months are not in the rear-view mirror yet.

“The good thing is that the intersection of those macro forces with company specifics continues to create opportunities to add value.”

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About Oliver Renton and Pendal Focus Australian Share Fund

Oliver is an analyst and co-portfolio manager with Pendal’s Australian equities team. He has more than 15 years of industry experience.

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  

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