China’s big policies moves | Why the 70:30 portfolio is back | Bonds to watch out for | Inflation outlook
The super-high inflation battle of 2022 may be won, but the outcome of the war is still uncertain says Pendal’s head of government bond strategies TIM HEXT.
THE market had been looking for US inflation to moderate for several months.
Forward indicators of goods prices had pointed this way since Q3.
Last week the US Consumer Price Index finally delivered a much slower pace of increase than expected.
Stocks surged, which was surprising given it wasn’t entirely unexpected.
Then again, markets were looking for any relief from this year’s constant inflation woes to jump on a positive narrative.
Doers this start an ongoing trend? Or will this month’s CPI join earlier false dawns such as July?
As always with inflation the breakdown is important.
Headline was 0.4% against consensus 0.6%. Core was 0.3%, below the consensus of 0.5%.
Leading the way down was used car prices, which fell 2.4%. Leading indicators show further weakness ahead. After a Covid-led 68% rise there is plenty of room to fall.
Apparel prices fell 0.7%. Inventory overhangs in a number of retail areas may see further discounting ahead.
The surprise contributor to lower inflation was health insurance.
This had been increasing by 2% per month for the past year. It fell 4% in October — and the way it’s calculated means it will keep falling for the next year.
Find out about
Pendal’s Income and Fixed Interest funds
Finally, rents showed some slowing in the pace of rises. They were still up 0.6%, but it was the smallest increase in six months. Again, forward indicators point to continued moderation in rent (and owner equivalent rent) in the CPI.
These changes all point to further moderation in the months ahead.
Although not entirely unexpected, lower inflation will continue to provide some encouragement to markets that the Fed can slow the pace of hikes.
December still seems a lock for a hike of 50 percentage points. But in 2023 they could moderate to 25 points or even none.
What’s next
So the super-high inflation battle of 2022 may be won. But the outcome of the war is still uncertain.
Getting from 9% to 4% next year will be the easy part.
The globe is a now a different place post-pandemic.
A combination of commodity shocks from Russia and tight labour markets globally will likely see inflation get sticky around 4%. Any rate cuts by then may be wishful thinking.
Unless we tip into a steep recession the US Fed will remain wary about calling victory on inflation any time soon.
Investors should continue to view any decent rallies as an opportunity to de-risk portfolios for the challenges ahead.
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
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.
Chinese policy has shifted in recent few weeks, impacting emerging markets investors. Pendal’s JAMES SYME outlines how our EM team is responding
This is a monthly insight from James Syme, Paul Wimborne and Ada Chan, co-managers of Pendal’s Global Emerging Markets Opportunities Fund
- China’s economy has lots of potential to recover but has been constrained by extremely negative policies in key areas.
- Chinese stocks steadily sold off as investors became more pessimistic about the prospects for more market-friendly policies.
- This month Beijing made major policy moves on Covid re-opening and real estate industry debt. Investors should broadly see this as a buying opportunity for the best-positioned Chinese companies. We have very significantly reduced our underweight position in China.
- Some parts of China’s equity market remain unattractive, include state-owned banks, private-sector real estate developers and tech giants with very poor corporate governance.
ONE of the characteristics of emerging markets is volatility.
Things can turn very quickly — positively or negatively.
Our investment process is designed to accommodate this. We are constantly alert to market drivers, change and trend, positive and negative surprises and changing forecasts and surveys.
The past two weeks have seen significant shifts in Chinese policy, which put some market drivers into a new context.
Our process emphasises a disciplined and repeatable country-based analytical process.
As always, we follow our core five-point framework in reviewing the outlook for Chinese equities (in USD terms) over the next two years.
These are:
- Growth
- Liquidity and credit environment
- Currency
- Management and politics
- Valuation
Here is our latest thinking on these market drivers in relation to China:
1. Growth
Growth in China is weak by historic standards, with strong exports offset by very weak domestic investment and consumption.
Third-quarter GDP was up 3% year-on-year. Industrial production lifted 6.3% and exports grew 10.7%.
But retail sales were up only 2.5% and property sales (for the 31 main listed players) lost 29%.
The crippling effect of the Three Red Lines restriction on lending to property developers continues to have a devastating effect on the sector. Meanwhile ongoing Covid lockdowns hurt confidence-hit consumers.
The outlook does not seem to be improving either. PMI surveys for October weakened to 48.7 for non-manufacturing and 49.2 for manufacturing.
Can fiscal policy drive growth?
Next month’s Central Economic Work Conference can shift the emphasis of fiscal policy while keeping to agreed policy parameters.
Probably the most effective change would be to directly support households, given the current downturn in domestic consumption.
Targeted fiscal measures have been successfully used to support consumption in previous downturns. Examples include subsidies for rural purchasers of home appliance in 2008 and support for car buyers in 2014-15.
But given the weight of real estate and adjacent sectors in the economy, this is unlikely to do more than help specific industries.
2. Liquidity and credit environment
The liquidity and credit environment will need to do some of the lifting.
But monetary stimulus is constrained by weak private credit demand and concerns about the exchange rate.
The capacity certainly exists. Despite global inflationary pressures the Chinese economy is heading into deflation.
PPI inflation dropped into negative territory in October after a September print of just +0.9%. Household and corporate excess deposits continue to collect in the commercial banking system.
The liquidity and credit metrics we track look very promising.
Total outstanding credit grew 10.5% in the year to October, while M2 money supply growth in October was 11.8%.
These represent a continuing pick-up in credit and money growth and a return to the more stimulative measures of early 2020 and in 2016-2017.
However deeper changes are needed for this to work.
There are two reasons:
Firstly, private sector credit demand is extremely weak. Simply making it cheaper and more available is unlikely to change that.
This is a classic crisis of confidence in which the central bank can end up “pushing on a string”.
Either policies change to create confidence or fiscal policy must do the work. Secondly, while the three red lines restrictions on private sector property developers are still in place, the key sector that isn’t borrowing will remain unable to do so.
Find out about
Pendal Global Emerging Markets Opportunities Fund
3. Currency
Thecurrency was at its all-time real effective exchange rate in the first quarter of 2022.
Though it is notionally supported by net exports — and protected by capital controls — it is likely to weaken relative to the US dollar.
This is partly because of interest rate differentials and partly because policymakers among east-Asian exporters must keep their currencies reasonably in-line with the depreciating Japanese yen.
4. Management and politics
The previous drivers are important, but management and politics are the key.
This month President Xi Jinping was appointed for an unprecedented third term.
In an overhaul of the Politburo Standing Committee, market-friendly reformers (including Premier Li Keqiang) were removed and replaced with Xi loyalists.
State media have begun referring to Xi Jinping as “Core” leader and establishing his political views (“Xi Jinping Thought”) as doctrine.
This marks a move away from the “Collective Leadership” system of Chinese politics which has been in place since the 11th Party Congress in 1978.
The economic focus on technology and quality of life adopted at the 2017 Congress remains in place.
The main changes at this congress were around governance and national security, with emphases on international relations, geopolitics and reunification with Taiwan.
What does this mean for the economy, and for a market looking for some political and policy relief?
The policies that have dramatically undermined growth — real estate restrictions and zero Covid — remain key.
As do the political developments that have hugely increased investor perception of risk in China — clampdown on tech companies, support for Russia, cold conflict with the West.
We essentially believe China’s policy choices in the past two years have broken its economy and equity market. We may now be seeing the beginning of changes that are needed to fix this.
On November 11, the People’s Bank of China and the banking regulator extended the end-of-2022 deadline for banks to limit their property and mortgage loans.
This major step is likely to substantially ease a credit crisis in the Chinese real estate sector.
Leading banks must reduce the share of total loans made to property companies to 40% and the share made to mortgages to 32.5%. But the deadline has been indefinitely extended.
This is likely to restore confidence in the property sector — particularly for homebuyers — though the most leveraged developers still face a difficult future.
On the same day we saw changes in China’s Covid policies — though officials stressed these were a refinement, not a relaxation.
The 20 new Covid policies include shorter compulsory quarantines, reduced testing and less latitude for local officials to impose their own restrictions.
Rising cases suggest this is not likely to lead to a rapid full re-opening of the economy.
But Beijing’s health commission said the government would keep advancing “in small steps”.
Markets have taken these steps as a sign that the Chinese economy — and Chinese companies — are on a path to the same post-lockdown, mini-booms we saw in other economies.
Then on November 14 President Xi met President Biden in Indonesia.
Officials from both sides said substantial differences remained between the two.
But the face-to-face meeting appeared cordial. The discussions are a sign that China is not Russia.
5. Valuation
Valuation is the only one of these five factors that are unambiguously supportive.
But valuation alone is not a buy case.
For any market, ongoing economic growth and corporate earnings disappointments undermine the fundamentals to which valuation multiples are applied.
Worsening liquidity conditions justify lower valuation multiples. A poor currency outlook will reduce expected US dollar returns.
Most significantly, the downside to valuation multiples when politics goes bad is always much, much more than you think.
The MSCI China forward price/earnings ratio (based on consensus 12-month forward estimates) has declined from a peak of 18.5x in February 2021 to 8.3x at the end of October.
This compares to a recent average of 11.3x.
Other valuation metrics have similar patterns. Cheap, but cheap alone is not enough.
Remain alert to opportunities
Our investment process has a monthly review of the key top-down drivers of USD equity return for all countries.
We take no strategic views. No market is an automatic overweight and no market is automatically excluded.
We do not think Chinese equities — whether A-shares, H-shares or overseas listings — are “uninvestable”. We remain alert to opportunities.
Some parts of the Chinese equity market do look very difficult to invest in.
Public sector banks remain mere policy tools and investor mistrust here is very high.
The more leveraged private sector developers are still unlikely to survive their debts coming due.
Corporate governance at some big technology companies — most notably Alibaba — is very poor and hard to look past.
Some Chinese state-owned companies remain sanctioned by the US Treasury and are literally uninvestable for most foreign investors.
But China is a huge market. It is the biggest emerging market by market capitalisation and by number of listed securities.
Since the end of October we have very significantly reduced our Chinese underweight.
The great bulk of this move happened before the policy changes were announced. Since those announcements, Chinese assets have moved sharply higher.
We will continue to follow our process and react to both the level of these market drivers — as well as change, trend, surprise, forecasts and surveys.
A mix of positive and negative drivers continue to influence China.
But the outlook is much better than a month ago.
And it is always a mistake in emerging market investing to assume that any trend — up or down — will continue forever.
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 an independent, global investment management business focused on delivering superior investment returns for our clients through active management.
Here are the main factors driving the ASX this week according to Pendal investment analyst Elise McKay. Reported by portfolio specialist Chris Adams
Find out about Pendal Focus Australian Share Fund
Find out about Pendal Horizon Sustainable Australian Share Fund
THERE was a lot of thudding last week as valuations fell back to earth in a number of sectors.
- Used car prices fell in the US, pushing core goods into deflationary territory
- Bitcoin hit its lowest price in two years as the crypto market reeled after the collapse of the FTX exchange. There is no contagion to other asset classes at this point, but we are watching closely.
- The tech sector is in recession
- The freight sector came under pressure with container shipping rates 75% off their peak and volumes on a downward trajectory
Most importantly, softer lead indicators have started to show up in US CPI data.
One month does not make a trend. But there is now a strong argument for the Fed to slow to a 50bp hike in December and 25bps in February, reducing the risk of overtightening.
Does this renew hope of a soft landing?
Broader data such as jobless claims — which remain flat — support this argument.
However we see very different trends in different parts of the economy.
Technology, freight and crypto are clearly in decline, while the broader labour market remains strong so far.
It is encouraging that core services (excluding shelter) rose only 0.23% in October.
But over any longer period core services inflation and wages are still running at levels more consistent with inflation at 3.5% to 4%, rather than the Fed’s 2% target.
The case for a softer landing may have risen with the latest CPI data, but it is off a very low base.
We still need to see signs of consumer demand and labour markets slowing in coming months to give the Fed the confidence that a decline in inflation is sustainable.
Pendal Focus Australian Share Fund
Now rated at the highest level by Lonsec, Morningstar and Zenith
We also saw a 50bp easing in Morgan Stanley’s Total Financial Conditions measure on the day of the CPI release — its biggest move this year.
This may also motivate some participants in the Fed’s Federal Open Market Committee to lean against the market move in the near term.
US inflation
Downwards pressure on inflation had been visible everywhere except in the actual inflation data.
This has now changed.
Headline CPI came in at 0.44% for October (consensus 0.6%) while core CPI rose 0.27% on the month (consensus +0.5%).
On a yearly basis, headline inflation declined to 7.7% from 8.2% in September, while core inflation declined to 6.3% from 6.6%.
Core goods were deflationary (-0.38% month on month) while services inflation decelerated (0.5% versus an average of 0.6% in the third quarter).
The biggest drag on core goods came from a 2.4% decline in the used car price component, which surged in 2021 due to chip shortages which reduced supply of new cars.
Rental firms needed to rebuild fleets, which stimulated demand and pushed used car prices up about 68% from their pre-Covid level to a January 2022 peak.
Supply and demand have now rebalanced and used car prices are dropping.
Apparel (-0.7%) and household furnishing (-0.2%) also declined, showing the impact of easing supply chain pressures.
On the services front, the big stories were a decline in medical services and rents.
Medical services stepped down from +1% in September to -0.6% in October.
This was driven by health insurance costs, which are estimated based on annual data on retained earnings of insurance companies.
The refreshed methodology means these low insurance readings will continue for the next 11 months until the next annual data refresh in October 2023.
The slowdown in housing inflation was one of the biggest surprises. Owners’ Equivalent Rent (OER) slowed to 0.61% from 0.81% in September. Rents of primary residence slowed to 0.69% from 0.84%.
The transition from falling market rents to CPI is gradual. It’s hoped this is the start of a clear softening in the data, in line with forward indicators.
Perhaps most interestingly, core services excluding shelter came in at 0.23% month-on-month (annualised 2.76%).
This is a leading indicator of where inflation may be in 18-24 months, perhaps suggesting wage pass-through pressures are less acute than thought.
This is supported by Evercore surveys of temporary and permanent employment agencies, which show further signs of wage pressure easing this week.
Adviser Sam is invested
in making our world
A better place.
Watch as Sam meets a
mum rebuilding her life
thanks to responsible
investing
Certain industries are in significant pain. But is the broader US economy still heading for recession? Or could we end up with a soft landing?
The risk of persistently hot inflation — and over-tightening by the Fed — has perhaps receded with this inflation print.
But we still need to see how severe the economic impact will be.
The chance of a soft landing has increased — but still remains quite low.
The Fed will need to see further signs of softer consumer demand and labour markets in coming months.
The inflation data was great for the stock market, pushing the S&P 500 ahead 4% and Nasdaq 5.6% on Thursday.
But it doesn’t help the Fed’s cause with Morgan Stanley’s Total Financial Conditions measure easing 50bps on the day of the CPI release.
This compares with a tightening of 375bps so far in 2022.
The Fed does not target a specific level of financial conditions. But the size of the move (particularly in real rates) may motivate some FOMC participants to talk down the market’s move in the near term.
US economy
Initial jobless claims rose to 225,000 from 218,000. Consensus was 220,000.
This is in line with the existing flattish trend.
We are seeing some industries such as tech cut headcount. But the broader trend is a slow-down in hiring rather than laying off staff.
Nevertheless there is stress in certain pockets of the economy.
Rising interest rates have led to real pain in the technology industry. November is on track for the worst month this year in terms of lay-offs. Open job ads have halved from the peak earlier this year.
There is a long-term positive. We should see increased discipline on return on investment (ROI) for capital deployed across the tech sector.
This should also allow tech workers to move into other parts of the economy (eg financials, industrials) where they have been in short supply in recent years.
The freight industry is also under pressure.
Global container trade volumes declined 8.6% in the year to September. The third quarter was down 3.9%.
Global freight rates have fallen 75% from their peak (though they are still above pre-Covid levels). There are indications this could deteriorate further.
FTX, the world’s second-biggest cryptocurrency exchange filed for bankruptcy after a liquidity crunch caused by a bank-run-style exodus.
This was triggered by claims that the balance sheet of Alameda (a crypto hedge fund owned by FTX’s founder Sam Bankman-Fried) held billions of dollars of FTX’s own cryptocurrency and had been using it to collateralise further loans.
The liquidity crunch morphed into solvency issues with an estimated $US8 billion shortfall.
The crypto market’s entire value reached a peak of $US3 trillion in November 2021. It is now worth about $800 billion.
So far this has not led to contagion into other asset classes. Though the risk — and that of a financial crisis — needs to be watched.
Find out about
Pendal Horizon Sustainable Australian Share Fund
The FTX collapse caused pain among venture capital (VC) investors who are facing losses and write-downs in crypto-related investments.
VC investors (including the biggest and most respected institutions) had invested $1.8 billion in FTX’s fundraising rounds over the past two years, with the first write-offs to zero being flagged.
Expect more pain to come in other crypto-related organisations.
UK heads for recession
The US not clearly in recession, but it is a different case in the UK.
British GDP contracted by 0.2% in the September quarter. This is expected to be the start of a lengthy recession, though the decline was less than expected.
China Covid pivot
Beijing is finally easing Covid-related restrictions, but has stopped short of declaring an end to the zero-Covid model.
More than 4 million people remained locked down in Guangzhou.
China announced 20 measures including shorter quarantine times for close contacts and travellers, plus efforts to improve vaccination rates and medical treatment.
This sparked big moves in commodities last week, including iron ore (+4.7%), copper (+2.6%), alumina (+5.9%), nickel (+3.9%) and Brent crude (+2.4%).
The AUD gained 4.1% against the USD for the week.
The Hang Seng gained 7.7% on Friday.
US politics
An expected red wave did not materialise in the US mid-term elections.
The Democrats retained control of the Senate. The Republicans look on track to take the House majority with a tighter margin than expected.
The most likely outcome on the economy is more of the same, though it reduces the tail risk of some more extreme and destabilising policy measures.
The real winner is perhaps Ron DeSantis, who has emerged as the de-facto leader of the Republican party.
Markets
Market were buoyed last week by the positive surprise on inflation.
The S&P 500 gained 5.9%.US ten-year bond yields dropped 35bps, which helped the NASDAQ gain 8.1%.
More than 90 per cent of the S&P 500 market cap has now reported third-quarter results with overall sales growth of +11.6% (2.5% beat) and earnings of +2.4% (1.6% beat).
Despite this, the average stock fell 0.3% post results with significantly more pain than usual on the downside.
The inflation data supported a strong move in the trade-weighted US dollar index (DXY) which was down 4% for the week and triggered a 4.7% gain in gold.
Heading into the CPI print, hedge funds were the most under-weight in info-tech stocks versus the S&P500 in many years. This resulted in tech ripping on Thursday.
In Australia, weekly performance was driven by macro themes. All sectors were up for the week except energy.
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.
How to read the rally | The signal that will end rate hikes | Lessons from US earnings season
Inflation should soon start to fall — but not as much as some expect. Inflation-linked bonds could be a good option, argues Pendal’s head of government bonds TIM HEXT
“The sun is shining, the weather is sweet, yeah|
Bob Marley
Make you wanna move your dancing feet”
A LONG overdue spell of warm and sunny weather has lifted spirits here in Sydney.
For the first time in three years everyone is out and about and looking forward to celebrating Christmas. Party invitations are issued and fingers are crossed on the health front.
However, the tone in markets is more sombre.
Cumulative central bank tightenings are starting to hit hip pockets and liquidity is worsening.
In simple terms a decade of low rates — and the associated investment structures built up around them — are starting to unravel. It’s increasingly looking partly structural not just cyclical.
This is what central banks intend to happen.
For years one of our major themes was the chase for yield. Now it is the chase for inflation protection — though too many remain stuck in the mindset of the last decade.
The ultimate aim of the superannuation industry should be to protect the spending power of their members —who defer consumption today for their retirement.
If the economy is productive, hopefully that money can grow a little faster than inflation to increase the standard of living.
A decade of low inflation and falling interest rates made that look easy.
Find out about
Pendal’s Income and Fixed Interest funds
In 2022 with super funds down on average 5% and inflation close to 8%, the spending power of members has gone backwards by 13%. Not so easy now.
Inflation could settle at 3-4%
We expect US inflation will fall soon and Australia will follow by mid-2023.
“Risk markets may take some encouragement from this, but inflation is likely to remain around 3-4%.
“Goods prices may fall — or even go negative — but inflation on services will remain stubbornly high.
The markets may look for rate cuts, but inflation could prevent that. At least rates will stop rising. “
In this environment investors need the defensiveness of bonds, which have now restored their insurance credentials after this year’s hits, says Hext.
“My recommendation would be to buy inflation-linked bonds.
Returns from inflation-linked bonds are adjusted for inflation, allowing investors to protect real returns.
They’re not popular in Australia, which is something of a mystery to Hext.
“The mainstream investment community seems to prefer standard, nominal bonds — as evidenced by the nominal-only benchmark proposed for bonds in the Your Future Your Super guidelines.
“In my view this is poor policy, overlooking the benefit that inflation-linked bonds provide for retirees or those near retirement.”
While we enjoy summer in Australia, the wintertime blues of an energy-constrained northern hemisphere will mean summertime blues for markets in Australia.
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
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.
FOR a while now our attention has been focused on the timing of a central bank pivot.
That’s the much-anticipated moment when central banks change course and stop hiking rates.
But perhaps the more important pivot is in the hands of consumers — reining in our spending.
Our pivot needs to occur before central banks’ pivot.
The RBA is hiking rates to fight inflation which is driven by our desire to keep spending in an economy doesn’t have capacity to absorb that spending.
Most observers are surprised at how well retail sales are holding up even though consumer confidence is at recession levels.
This demonstrates the power of fiscal policy when stimulus is delivered to consumers versus the trickle-down impact of government spending through infrastructure projects.
The JobKeeper and JobSeeker schemes preserved (and in many cases improved) Australian household balance sheets and cash flows.
Once the lockdowns ended, pent-up consumption allowed a business boom that fed into record low unemployment.
That’s the main driver of a divergence in consumer confidence and retail spending.
We all have jobs — and though our purchasing power has diminished, having a pay cheque goes a long way.
The SEEK.com table below demonstrates the incredible growth in demand for labour in industries catering to consumer spending. It also highlights the difficulty those industries have had in filling vacancies without the international students and work holiday visa flow.
It’s unlikely that consumers will stop now, with the first fully open Christmas in three years just around the corner.
With Sydney-Melbourne return flights costing more than $1000 maybe bus transport will experience a revival. Time to put up those prices.
This may well be peak exuberance and it will come through in the January CPI numbers. It could be a very different story in 2023, with consumers staring at empty wallets.
Find out about
Pendal’s Income and Fixed Interest funds
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. In 2020 the team won the Australian Fixed Interest category in the Zenith awards.
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
About Pendal Group
Pendal is an independent, global investment management business focused on delivering superior investment returns for our clients through active management.
Here are the main factors driving the ASX this week according to our head of equities Crispin Murray. Reported by portfolio specialist Chris Adams.
CHAIR Jerome Powell’s hawkish tone after the Fed’s 75bp rate hike weighed on markets last week.
Though signs that Beijing may getting ready to roll back zero-Covid by March prompted a Friday rebound, helping contain the damage.
In Australia the RBA reinforced its more dovish rate path, choosing to take a risk on inflation to avoid triggering a damaging recession.
The S&P 500 fell 3.3% last week and is trading in the middle of the 3500-3900 range.
There was substantial rotation as growth and technology stocks suffered on the rate outlook. But cyclicals — and particularly metals and energy — did well on the signals from China.
Other global equity markets fared better, given a more cyclical skew.
The S&P/ASX 300 rose 1.6%. It is down 4.2% for 2022, versus -19.8% for the S&P 500 and -32.6% for the NASDAQ.
The medium-term outlook still depends on the degree of economic downturn and its impact on earnings.
There is some debate about the degree of leverage earnings will have to the downturn.
Historically, recessions have led to an average 20 per cent fall in earnings. Though this is often in a low-inflation environment, when nominal GDP (a proxy for corporate revenue) is low.
Sustainable and
Responsible Investments
Fund Manager of the Year
In this instance the bulls argue that three factors may mitigate earnings decline:
- Companies will benefit from higher nominal growth, supporting revenue and helping cover fixed costs
- Materials and energy companies will see continued strong earnings, given lack of supply
- The potential re-opening of China may offset weakness in Europe and the US
The Fed
The Fed’s initial press release indicated a coming deceleration in the pace of rate hikes and an extension of the hiking cycle.
But Powell ensured this was not interpreted as the longed-for dovish pivot. The peak in rates would likely be higher than previous forecasts, he noted in a press conference.
This is expected to be released in December’s quarterly “dot plot” — likely 5% to 5.25% by the end of 2023.
This is 50bps higher than the September indication and 25bps more than consensus forecasts.
Two-year US government note yields rose 24bps and 10-year bond yields were up 14bps for the week in response.
Higher rates and a further hawkishness put a nail in the “pivot” trade and saw growth stocks underperform.
US economic data
October’s payroll data showed 261,000 new jobs, versus 193,000 expected.
This strong print was somewhat mitigated by a weaker household survey, which showed a decline in employment of 328,000 and an increase in unemployment from 3.5% to 3.7%.
Less helpfully, the participation rate for the “prime” age cohort fell from 82.7% to 82.5%.
Average hourly earnings were stronger than expected at 0.4% month-on-month versus consensus of 0.3%.
However this series has been softening. The three-month moving average is now down to 3.9% annualised, well below the annual rate of 4.7%.
All wage data series are rolling over, but growth is still too high at around 5%. It needs to fall to 4%.
Earlier in the week we saw job-opening data reverse the previous month’s decline.
A range of indicators show the labour market softening and lay-offs picking up. But the data is still too strong for the Fed to feel comfortable on inflation.
Finally, manufacturing data (the ISM index) weakened more than expected, though not enough to indicate a recession.
China
The week’s most significant surprise came from China with rumours of a shift in thinking on zero-Covid.
We saw:
- Rumours of a “re-opening committee” meeting
- People’s Daily articles dispelling concerns on long Covid
- German chancellor Olaf Scholz — on a visit with President Xi — speaking of an agreement to supply the Pfizer / BioNTech vaccine to foreign nationals living in China
- Rumours that Li Qiang, the next PM, supported mRNA vaccines which could be rolled out in the next 2-4 months
- A Chinese epidemiologist say Chinese mRNA vaccines are as effective as Western versions and express confidence in inhalable vaccines
Some of these stories were walked back at the weekend — especially after a surge in Covid cases, particularly in Guangzhou.
We are careful not to extrapolate too much from this. There is a view that it would make more sense for Beijing to roll back zero-Covid once the northern hemisphere winter has passed.
But the market reaction highlights how far consensus positioning was caught out by a shift in sentiment on China.
Chinese stocks moved about 18 per cent on the week. Resources stocks and the Australian dollar also moved sharply on Friday. There were moves in resources with oil and copper up.
This highlights the issue that Chinese re-opening could renew inflationary pressure.
Finally, Beijing also sent a message to Russia cautioning against the threat of nuclear weapons.
This was seen as an important attempt to reduce geopolitical tensions.
Australia
As expected, the RBA raised rates 25bp to 2.85% last week.
The message remains far more benign than the Fed. This is seeing a divergence in outlooks for domestic and internally-focused stocks within the ASX.
The RBA expects rates to peak at 3.5%, versus 5% to 5.25% in the US. Inflation is expected to peak at 8% this quarter and fall to 4.7% a year later, with GDP slowing to 1.4% in 2023.
The risk is inflation does not drop so quickly, given this level of growth.
Markets
The combination of a hawkish Fed and hope on Chinese re-opening led to a major rotation in the market last week.
There was a 9% relative move in the S&P 500 mining sector and 8% in the S&P 500 energy sector versus the NASDAQ.
Adviser Sam is invested
in making our world
A better place.
Watch as Sam meets a
mum rebuilding her life
thanks to responsible
investing
US earnings season deteriorated to below long-term averages in term of beats and above in terms of misses.
Most telling was the poor performance of the technology mega caps, where there was a second wave down. As always, it seems “the generals are the last ones to be shot” in a bear market.
Apple unwound all the previous week’s performance.
Atlassian fell 28% post result and is now down 73% from its peak 12 months ago. Twilio fell 34% on its result, taking the decline from its Feb peak to 93%.
Both these companies are leveraged to the tech sector as service providers, so their slowdowns are compounded.
The rotation is also reflected in earnings.
Exxon quarterly earnings have now caught up to Microsoft. Though the energy sector’s proportion of the S&P 500 is back only to 2019 levels — still well below its highs of a decade ago. The Australian market’s sector mix and skew to resources/energy and financials continued to provide resilience.
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.
Our Emerging Markets team always starts with a top-down, country-level investing framework. Here’s how their framework applies to China right now.
This is a monthly insight from James Syme, Paul Wimborne and Ada Chan, co-managers of Pendal’s Global Emerging Markets Opportunities Fund
CHINA has undergone major political change recently with the consolidation of Xi Jinping’s power in his third term as leader.
Chinese equities have also aggressively de-rated in valuation terms this year.
As emerging markets investors, how has our view on China changed?
Our investment process is designed to be alert not just to market drivers — but also to changes and trends, surprises (positive and negative) and forecasts and surveys.
The philosophy behind that process emphasises a disciplined and repeatable country analytical process.
When reviewing recent develoment in China, we stick to our core five-point framework in reviewing the outlook for Chinese equities in USD terms over the next two years.
Here’s what that tells us.
What the data says
Growth in China is weak by historic standards. Strong exports are offset by very weak domestic investment and consumption.
Third-quarter GDP was up 3% year-on-year, with industrial production up 6.3% and exports up 10.7%.
But retail sales were up only 2.5% and property sales (for the 31 main listed players) were down 29% (all to September).
The crippling effect of China’s “Three Red Lines” restrictions on lending to property developers continues to have a devastating effect on the sector. Meanwhile ongoing Covid lockdowns hurt confidence-hit consumers.
The outlook does not seem to be improving either. October PMI surveys weakened to 48.7 for non-manufacturing and 49.2 for manufacturing.
Can fiscal policy drive growth?
This December’s Central Economic Work Conference can shift the emphasis of fiscal policy while keeping to agreed policy parameters.
Probably the most effective change would be to directly support for households, given the downturn in domestic consumption.
Find out about
Pendal Global Emerging Markets Opportunities Fund
Targeted fiscal measures to support consumption have been successfully used in previous downturns — for example subsidies for rural purchasers of home appliance in 2008, or support for car-buyers in 2014-15.
But given the weight of real estate and adjacent sectors in the economy, this is unlikely to do more than help specific industries.
The liquidity and credit environment will need to do some of the lifting. But the ability to enact monetary stimulus is constrained by weak private credit demand and concerns about the exchange rate.
The capacity certainly exists. Despite global inflationary pressures the Chinese economy is heading into deflation.
PPI inflation trackers dropped into negative territory in October (after a September print of just +0.9%). Household and corporate excess deposits continue to collect in the commercial banking system.
This is likely to eventually lead to increases in credit quotas and cuts in interest rates.
But these are unlikely to work for two reasons.
Dual challenges
Firstly, private sector credit demand is extremely weak. Simply making it cheaper and more available is unlikely to change that.
This is a classic crisis of confidence, in which the central bank can end up “pushing on a string”. Either policies change to create confidence, or fiscal policy must do the work.
Secondly, while the Three Red Lines restrictions on private sector property developers are still in place, the key sector that isn’t borrowing will remain unable to do so.
In fact, credit conditions continue to worsen for private sector developers. Bond yields are climbing steadily for even the highest-quality issuers, suggesting the situation will get worse before it gets better.
The currency was at its all-time real effective exchange rate in the first quarter of 2022.
Although it is notionally supported by net exports — and protected by capital controls — it is likely to weaken relative to the US dollar.
This is partly because of interest rate differentials, and partly because policy makers in East Asian exporters must keep their currencies reasonably in-line with the depreciating Japanese yen.
The Xi factor
Management and politics are the key, despite the previous three drivers.
President Xi Jinping has been appointed for an unprecedented third term. An overhaul of the Politburo Standing Committee saw market-friendly reformers (including Premier Li Keqiang) removed and replaced with members seen as Xi loyalists.
State media have begun referring to Xi Jinping as ‘Core’ leader while establishing his political views (Xi Jinping Thought) as doctrine.
This marks a move away from the ‘Collective Leadership’ system of Chinese politics that has been in place since the 11th Party Congress in 1978.
An economic focus on technology and quality of life adopted at the 2017 Congress remains in place.
The main changes at this Congress were on governance and national security, with emphases on international relations, geopolitics and reunification with Taiwan.
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 an independent, global investment management business focused on delivering superior investment returns for our clients through active management.
Investors should continue to find attractive opportunities in Brazil after the transition to a new government, argue James Syme, Paul Wimborne and Ada Chan, co-managers of Pendal’s Global Emerging Markets Opportunities Fund
BRAZIL has been one of our favourite emerging markets since late 2020.
Over that time it’s delivered strong USD total returns despite a significant negative return from the MSCI Emerging Markets Index.
October’s election has returned Luiz Inacio Lula da Silva (Lula) as the president, a position he held from 2002-2010.
Lula is from the left-wing PT party, which may raise concerns after recent, sharp negative market reactions to left-wing electoral successes in Chile, Colombia and Peru.
How has this affected our view on Brazil?
We remain very positive on Brazil in both absolute and emerging market-relative senses.
We do not see a Lula administration as a material risk to Brazil’s economy or financial markets. We continue to find attractive investment opportunities there.
Why are we sanguine about Brazil’s political shift to the left?
Here are four reasons:
Find out about
Pendal Global Emerging Markets Opportunities Fund
- The Brazilian economy remains in a relatively strong economic position, helped by commodity prices and recovery from the previous downturn.
These conditions are similar to when Lula previously was in power, which was a good period for equity investors. (During his previous presidency, MSCI Brazil returned an annualised 36.9% in USD terms. This is unlikely to be repeated, but it’s evidence that a left-wing president isn’t necessarily a problem).
Export prices and the trade balance remain strong in historical terms. This supports growth and the currency, while the domestic economy continues its recovery from the deep 2014-16 downturn (a recovery that is extended by the 2020 Covid-driven dip in activity).
PMI surveys show continued expansion in both manufacturing and non-manufacturing activities. - Brazil’s core institutions remain strong and market friendly. This will constrain the more populist desires of the incoming administration.
The central bank remains deeply orthodox regarding inflation-fighting, while the elections have skewed Congress and Senate towards centre and right-wing coalitions.
Right-leaning coalitions have seen their share of seats increased from 46% to 49% in the lower house and from 31% to 44% in the upper house.
The fiscal spending cap (which Lula has indicated he would like lifted) is a constitutional measure, so any reform would have to pass both houses. - Since the start of 2021 monetary policy has been aggressively employed to reduce inflation with policy interest rates lifted from 2% to 13.75%.
With reported inflation and inflation expectations trending down, 2023 should see Brazil become one of the first major countries to move into a rate-cutting cycle. This should support its economy and equity market. - Equity valuations in Brazil are attractive historically and compared to other similar-size emerging markets. The price/earnings ratio on 12-month forward consensus earnings of MSCI Brazil is just 6.6x.
This compares to a long-term average for Brazil of 11.2x and current levels of 21.6x for India, 14.6x for Saudi Arabia and 12.6x for Mexico. These levels seem to price in a lot of political and policy risk.
In an emerging market-relative sense — and even in a global sense — Brazil’s reasonably good conditions are extremely attractive.
Net energy exports, a central bank that seems to have got on top of inflation, fiscal orthodoxy, moderate economic growth and attractive market valuations are conditions enjoyed by few countries anywhere.
Given the above, we think investors can live with a more left-wing government in Brazil.
We certainly can.
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 an independent, global investment management business focused on delivering superior investment returns for our clients through active management.