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

MOUNTING fears of stagflation — higher inflation and slowing growth — weighed on equity markets last week.

The S&P/ASX 300 fell 2.12% and the S&P 500 was off 2.19%.

Several factors are driving concern. These include persistent supply chain bottlenecks, the potential impact on export volumes from Chinese power shortages and a more hawkish tone on inflation from Fed Chair Powell.

OPEC’s decision not to add any additional supply to the oil market beyond already-planned increases — despite evidence demand is re-accelerating as the Delta Covid wave fades — added fuel to this fire.

In response to stagflation fears, equities and bonds have sold off, while commodity prices have risen.

In equity markets, higher bond yields have prompted a rotation away from growth stocks towards re-opening plays and companies offering protection against inflation.

At this point we don’t expect this issue to de-rail markets. But we wouldn’t be surprised to see the rotation away from growth continue.

Powell’s hawkish turn

After a relatively dovish tone on inflation at Jackson Hole, Powell was slightly more cautious in the September Fed meeting. He was more hawkish still in his presentation to the European Central Bank’s (ECB) Sintra conference last week.

This reflects inflationary data persistently coming in higher than expected and evidence that its drivers are shifting away from short-term factors.

In particular, the Fed Chair noted tension between the Fed’s goals on inflation and employment. He also noted “transitory” inflation may last longer than expected.

Powell later moved to soften the message, but the market is dwelling on the uncertain outlook.

The sub-plot is Powell’s likelihood of a second term.

Some suggest this is in question due to the recent Committee trading scandal — and that the narrative has as a result shifted to the inflation risks to be addressed, rather than the story of growth.

Powell is regarded as one of the more hawkish potential leaders of the Fed.

Any shift at the top of the Federal Open Market Committee will reinforce market expectations that inflationary pressures will be accommodated.

The inflation question

The Fed’s favoured inflation measure — US Core personal consumption expenditures (PCE) — rose 0.3% for the month and is running at 3.6% year-on-year.

Notably, some of the “Covid bounce-back” categories are no longer big drivers. This is evident in the quarterly annualised growth of 2.7% in the Core PCE — the highest since 2008.

There are two broad forms of inflation to consider:

1. Cost pressures building from input prices and shortages, as we are seeing now. This usually resolves itself via reduced demand as prices rise or products are unavailable. But through this process we have a period of higher inflation and lower growth, which is not a good combination for equities.
   
2. Expectations of inflation translating into rising real wages as workers leverage labour shortages. This enables higher spending which reinforces inflationary pressure. This is a far more sustained inflation — the wage-price spiral — which ends only when central banks slam on the brakes.

At this point we are witnessing the first form of inflation.

The hope is that it fades quickly as supply chains are restored and demand is fulfilled, easing inflationary pressure without any impact on growth.

The concern is that if supply chain issues persist too long and we get significant energy price spikes in the Northern hemisphere winter, it will drive a more severe impact on the global economy.

An additional fear is that current labour shortages in a number of countries — combined with central banks maintaining their current aim of higher real wages — would see inflation entrenched via wages.

For example the current wage negotiations at US equipment manufacturer Deere & Co will be worth watching, with employees threatening their first strike since 1986.

There is a long way to go, but risks have risen.

This all puts central banks in a tough position.

Either they react through tightening policy as we are seeing in countries such as South Korea and potentially New Zealand.

Or they hold the line as the US is doing, which risks fuelling continued strong demand, exacerbating the issue.

China’s inflation impact

The market has been focused on China’s role in the inflation question. The focus last week was power outages which have led to curtailed output in some industries.

There are three factors at play here:

1. The most significant factor is Beijing’s policy of less energy-intensive growth – ie electricity consumption growing slower than GDP. Nine provinces have missed targets for electricity consumption, prompting those governments to limit power supply. This is a self-inflicted issue, but tied to a signature policy for China’s leadership.
   
2. The shortage of coal supply. This is partly driven by the ban on Australian exports and compounded by Covid-linked supply issues with Mongolia and Indonesia. Environmental policies are limiting efforts to ramp up domestic supply.
   
3. At the margin, a dryer-than-usual wet season has reduced hydro-electric generation.

Power shortages are flowing through to higher prices in inputs such as cement and aluminium.

They are also limiting output in a number of processing industries and retail suppliers, exacerbating supply shortages.

Beyond the role this plays in potential inflation, we need to be mindful of Australian companies with exposure to Chinese supply chains.

The current situation limits China’s ability to stimulate in response to slowing growth, with potential implications for the ASX’s miners.

Covid and vaccines

Delta seems to be waning as a market issue. New daily case trends are improving in developed and emerging markets. This is flowing through to better activity levels in countries affected by restrictions.

The main news was the approval of the Merck / Ridgeback oral antiviral pill which roughly halved hospitalisation and morbidity rates among Covid patients in trials.

Ease of use and manufacturing scalability make this a real potential tool in the response to Covid.

A similar product from Roche / Atea and also from Pfizer due to report trial results soon.

Markets

US 10-year bond yields were only 1bp higher last week, but rose 18bps over the course of September.

Commodities continued to climb higher. Brent crude was up 1.5% and iron ore 4.4%. Even without a material shift in yields, this was enough to support the continued rotation away from growth stocks.

As a result technology (-5.94%) and healthcare (-5.62%) underperformed. Concerns over China weighed on the miners, but the energy sector (+4.48%) showed signs of life on the back of a stronger oil price.

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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 here.  

Contact a Pendal key account manager here.

Shareholder-initiated resolutions will be a standout feature of this year’s AGMs as investors step up activism on ESG issues such as climate change and executive pay, says Regnan’s Susheela Peres da Costa

• Shareholder-initiated resolutions again a feature of AGMs
• Boards more willing to lend support
• Find out about Regnan’s impact investing solutions

ACTIVISM has long been a feature of annual general meetings held by ASX-listed companies

But an increasing sophistication in the way resolutions are prepared and drafted is leading to more engagement from shareholders and boards.

There are even recommendations from some companies that shareholders vote in favour of activist proposals, says Susheela Peres da Costa, head of advisory at Regnan, a leader in impact investing and ESG (Environmental, Social and Governance).

It’s a major development — and it highlights how portfolios can deliver real results on climate change and other ESG issues when holding companies in portfolios instead of divesting, says Peres da Costa.

“There’s a few reasons for this seismic shift,” she says.

“One is that the advocacy groups have become more sophisticated in understanding the language of shareholders and have a greater appreciation for what is actually within companies’ powers to do.

“But also, investors have become more comfortable about casting their votes based on the substance of the resolution before them — rather than fearing it will be seen as a protest.

“Having a company like BHP recommend that shareholders support a resolution brought by an advocacy group turns that kind of thinking on its head.”

At BHP’s upcoming annual meeting, activists have proposed the mining giant rethink its membership of industry associations that do not support the Paris Agreement’s climate goals. The BHP board agrees and has recommended shareholders pass the resolution.

“That was unthinkable just a few years ago,” says Peres da Costa

A similar resolution has been put to miner South32 which has also recommended shareholders vote in favour.

In the past, activist resolutions were often dismissed by companies and institutional shareholders declined to take proposals from activists seriously.

“Investors have also changed their approach,” says Peres da Costa.

“Big institutions are increasingly recognising that using their votes in a principled way can communicate their position more clearly and transparently than relying only on private meetings behind closed doors.”

In Australia, successful shareholder resolutions are often drafted by non-government organisations with roots in the not-for-profit sector.

Campaigner Market Forces grew out of the Friends of the Earth climate group. Researcher and shareholder advocate Australasian Centre for Corporate Responsibility is partly funded by industry super funds.

Resolutions may have started as way for activists to make a protest, but increasingly institutional shareholders are co-sponsoring shareholder resolutions being put to boards.

The lesson for investors?

“Stewardship does drive change. It is working, and success breeds further success,” says Peres da Costa.

“It may not get the cut-through that divestment does, but shareholder engagement and voting can really change things in the world.  Changes that companies make after a successful shareholder resolution are proof.”

It looks like we’re approaching peak pessimism on China — which could mean it’s time to lift portfolio exposure to Asian shares, argues Pendal’s SAMIR MEHTA

• China’s economy drives Asia’s markets
• Maximum pessimism reached
• Find out about Pendal Asian Share Fund

SIGNS that investors are approaching maximum pessimism on the Chinese economy could indicate it’s time to lift portfolio exposure to Asian shares, argues Pendal’s Samir Mehta.

Most of Asia’s sharemarkets have fallen heavily over the past 12 months on a combination of rising interest rates, higher inflation and escalating geopolitical concerns.

China’s economic outlook has also been a key cause of the declines across the region, as Beijing takes steps to strengthen regulations governing the property sector and lift oversight of the operations of its big technology companies, says Mehta, who manages Pendal’s Asian Shares Fund.

“Pessimism is now embedded in stock prices, and that’s why I’m turning a little bit more positive on Asia, because if China does well, you could start to see things turn up for the region,”

Mehta says this kind of contrarian view on Asia has the potential to deliver gains even if global markets fall, echoing this year’s sudden reversal of fortunes for coal and gas companies as the rest of markets struggled.

“The simple tagline is that China is like another ‘anti-ESG’ portfolio. Back in 2021, ESG was so entrenched that ‘anti-ESG’ stocks like fossil fuels became very cheap and investors were bidding up anything ESG compliant no matter the valuation and no matter the future risks.

“Those risks became manifest in 2022 — everything that was ‘anti ESG’ had a really big bounce, energy and commodities in particular.

“My sense is that China is at a similar stage with negativity now manifest.”

Three positive signs for China

Mehta says three signs indicate China’s economic prospects may be on the mend.

First, the recent profit season saw improving fortunes for bellwether companies. Food delivery giant Meituan posted better than expected earnings while results at gaming giant Netease were good.

On the other hand, poor results are not being treated with big sell-offs — restaurant chain Haidilao has suffered from COVID lockdowns, but its stock rose after weak results on a plan to reorganise the business and reduce restaurants and staffing.

“So, we have results that are not meeting expectations, yet the stocks are higher. And we have some results that are better than expected. These are the initial stages of what looks like sellers’ fatigue.”

Mehta says there are also hints that President Xi Jinping might loosen up on COVID restrictions once he is confirmed for another term in October, using Hong Kong as a test case.

“I don’t have a crystal ball but there are rumblings around Hong Kong where leaders are talking to the neighbouring provinces as to how do they work with opening up a little bit more.”

Mehta says a signal for investors will be if Xi personally attends November’s G20 meeting in Indonesia.

“Xi leaving the country would be a big statement,” he says.

Mehta says a third positive for investors could be a shift in government policy to stimulate the economy.

“There’s a big rise in youth unemployment in China and social stability for the Chinese is going to be a very important point for Xi after he becomes president for a third term.

“There are real issues that the economy is facing, and therefore his motivation will turn away from cementing power to trying to make sure that they don’t have to deal with social problems.”

And finally, investors’ concerns about tension in Taiwan might be overstated, at least in the short term, says Mehta.

“The experts think that the Chinese navy is just not ready for an invasion by sea that would be multiples of the complexity of the Normandy landing — the Taiwan strait is significantly larger than the English channel.”

Instead, Mehta says investors should consider the prospect of Xi biding his time for a decade or more.

So, what are the risks?

Mehta says the US dollar will remain strong as the US Federal Reserve battles inflation, creating capital outflows that put pressure on Asia’s economies. High commodity and oil prices are also a structural headwind for Asia.

“But barring a real accident, which is possible, the negativity is now manifest in China and the rest of Asia. That means it makes strategic sense to start to allocate capital to Asia.”

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About Samir Mehta and Pendal Asian Share Fund

Samir manages Penda’s Asian Share Fund, an actively managed portfolio of Asian shares excluding Japan and Australia. Samir is a senior fund manager at UK-based J O Hambro, which is part of Pendal Group.

Pendal Asian Share Fund aims to provide a return (before fees, costs and taxes) that exceeds the MSCI AC Asia ex Japan (Standard) Index (Net Dividends) in AUD over the medium-to-long term.

Find out about Pendal Asian Share Fund

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.

Want to understand the outlook for China? Look to Japan’s 1990s stagnation experience, says Pendal Asian equities manager SAMIR MEHTA

• Even in low-growth periods, some companies stand out
• Cashflow, pricing power and market structure the key
• Find out about Samir Mehta’s Pendal Asian Share fund

INVESTORS looking for clues as to how China’s economic future will pan out should examine Japan’s performance after the 1980s boom, says Pendal’s Samir Mehta.

China faces enormous uncertainty about its economic outlook after decades of faster-than-normal growth culminated in a slowdown on the back of Covid-lockdowns, a real estate crunch and regulatory tightening in tech and education.

As the rest of the world wrestles with supply constraints, runaway inflation and rising interest rates in 2022, China instead faces lacklustre growth, rising unemployment and the real prospect of deflation.

“It’s almost diametrically opposite to what the rest of the world is facing,” says Mehta, who manages Pendal’s Asian Share Fund.

“What we are seeing at the moment in China is reminiscent of what happened in the Japanese economy when their bubble burst in the 1990s — for the next three decades Japan’s economy was mostly hobbled.”

Mehta says the key to Japan’s long-term troubles lay in the fact that its banks refused to recognise non-performing loans (NPLs), take write-offs, recapitalise and move on to lubricate economic growth via taking on risks on new projects.

“There are parallels with what we are seeing in Chinese banks. They are unlikely to recognise or write off their NPLs and they are not changing old business models.

“If you do not recognise the problem, then you risk a massive balance sheet recession and deflation.”

Another parallel to Japan is policy mistakes prolonging the downturn.

In the 1990s the Bank of Japan went too far with interest rate rises while increases in indirect taxes were poorly executed.

Similarly, Beijing seems to be making policy mistakes such as its strict zero COVID policy. Just last month authorities locked down a million people in Wuhan.

Mehta says an extended period of low growth should change the way investors approach China.

“Remember that in Japan’s case there were always some very good companies that were globally competitive — Toyota, Sony, Nintendo, some of their speciality chemical and semi-conductor companies.

“It’s not as if there weren’t good businesses but those businesses typically relied on export orientation because the domestic economy was going through a very challenging period of disinflation and deflation.

“I want to keep that precedent in mind for China and look for similar opportunities.”

Mehta cautions that the geopolitical environment is different. While Japan did cause resentment in the US in the 1980s because of its economic power, it was never a military threat.

“So be careful – the same export markets that were open to the Japanese might not be open to the Chinese.”

But the broad characteristics of companies that will thrive in a slow growth, deflationary domestic environment should be similar.

“The companies that stood out had shared characteristics.

“They were companies with high pricing power, they had an industry structure with few irrational competitors, and they were able to generate very strong cash flows.

“When you have a disinflationary or deflationary environment, cash is a fantastic asset to own.

“Inflation is the enemy of holding cash as value, whereas in a deflationary environment, cash is king.

“In my portfolio in China, I am gravitating towards these kinds of businesses – export-oriented champions or domestic champions with pricing power and cash flow.”

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About Samir Mehta and Pendal Asian Share Fund

Samir manages Penda’s Asian Share Fund, an actively managed portfolio of Asian shares excluding Japan and Australia. Samir is a senior fund manager at UK-based J O Hambro, which is part of Pendal Group.

Pendal Asian Share Fund aims to provide a return (before fees, costs and taxes) that exceeds the MSCI AC Asia ex Japan (Standard) Index (Net Dividends) in AUD over the medium-to-long term.

Find out about Pendal Asian Share Fund

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.

The investment metrics that worked in a low interest rate world are no longer the right markers for profitable investing. Pendal’s SAMIR MEHTA explains

• Some investing metrics will stop working as rates rise
• Margins, asset turns and net profits are key
• Find out more about Samir Mehta’s Pendal Asian Share fund

HOW do you pick your way through tricky global markets?

As markets adapt to higher interest rates, companies with good margins, a high ratio of sales to assets and strong net profits are best placed to survive and thrive, says Pendal portfolio manager Samir Mehta.

The types of metrics that worked in low interest rate world — measuring total addressable market size; valuing stocks as a multiple of sales; and earnings measures that hide stock-based compensation expenses — are no longer the right markers for profitable investing, he says.

“This is a market with nowhere to hide — bonds, equities, private equity, crypto, whether growth or value,” says Mehta, who manages Pendal’s Asian Share Fund.

“The reasons are evident — the Fed is raising rates and they are going to start the process of quantitative tightening.”

Mehta says the effects of this will play out over the coming years. As interest rates rise, the US dollar strengthens, vulnerabilities in the financial system are exposed.

“The first fatalities are on display — cryptocurrencies, bonds of Chinese property companies and the Sri Lankan economy — but there will be more.

“If you look back in history — the savings and loan crisis, the tech bubble, the housing bubble — as we go through a tightening cycle something big could break.”

Opportunity for investors

The crisis will be challenging but he says the opportunity for investors is to look through the valley and identify the factors that will help companies survive the downturn and then grow as stability returns.

“In the last decade or more of this loose monetary policy environment, every entrepreneur, venture capitalist and most fund managers became focused on the concept of total addressable market.

“How big can this business become? How scalable can it be? Can you become the next Facebook or Google?

“Now, in trying to address a very large market, what became secondary, almost inconsequential, was the question of whether it was a profitable venture.”

Mehta says this explains the rapid growth of a whole raft of popular but unprofitable global tech companies.

“These companies were selling a $1 for 50c.

“If I was to stand on a street corner and hand out a $1 in exchange for 50c my turnover will go through the roof.

“But now, in the current environment, several of these companies could go bankrupt. Which will inflict pain on consumers accustomed to subsidies.

The reason is twofold.

“Not only is there little capital available for companies to give you those subsidies, but there are massive shortages in everything around us. Problems due to supply chain disruptions; even finding qualified labour has become very difficult.”

The job now for investors is to find those companies, which will survive the shake out and take advantage of the dislocation.

Mehta says investors should turn to time-honoured measures like margins (the ratio of earnings to sales), asset turn (sales to assets) and net profits (after all expenses).

“Let me put in an Australian context: it’s no longer ‘Tim TAM’ for Total Addressable Market.

“Now it’s ‘Tim MAN’ for Margins, Asset turn and Net profit.”

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About Samir Mehta and Pendal Asian Share Fund

Samir manages Penda’s Asian Share Fund, an actively managed portfolio of Asian shares excluding Japan and Australia. Samir is a senior fund manager at UK-based J O Hambro, which is part of Pendal Group.

Pendal Asian Share Fund aims to provide a return (before fees, costs and taxes) that exceeds the MSCI AC Asia ex Japan (Standard) Index (Net Dividends) in AUD over the medium-to-long term.

Find out about Pendal Asian Share Fund

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.

‘If you don’t own China today, you’re going to miss out,’ says Samir Mehta, manager of Pendal Asian Share Fund. Here’s why

• Stimulus could turn around faltering Chinese economy
• Policymakers have track record of rapid action
• Find out about Pendal Asian Share Fund

INVESTORS nervous about the outlook for China are not accounting for the fact that Beijing has a track record of rapid policy change — and could move quickly to bolster the faltering economy, says Pendal’s Samir Mehta.

A policy-led resurgence in Chinese growth could spark a rally in Chinese stocks battered by regulatory crackdowns, a slumping property market and the fight to suppress COVID outbreaks.

(Listen to this fast podcast from Pendal’s head of income strategies Amy Xie Patrick for a fixed interest perspective on China).

“When Xi Jinping came to power in 2013, he quickly changed the incentives in the system away from pure GDP growth to what he ultimately termed ‘common prosperity’ — reducing inequality, balancing growth and promoting fairness,” says Mehta, who manages Pendal Asian Share Fund.

“If that meant you had to take down the education sector, the internet sector and the property market, you do it. The incentives changed and society began to re-orient itself.

“Policies can change on a dime in China — and my sense is we are on the cusp of them doing something to ramp up economic growth.”

Under pressure

China’s gross domestic product rose by an annual 4.8% in the first quarter. The economy is under pressure from regulatory constraints on the real estate industry and lock downs as authorities struggle to contain Covid.

A quarter of China’s population lives in cities that are now under some form of pandemic lockdown.

The first clues that Beijing wants to re-start growth have come in reports that Xi is calling for a boost in infrastructure construction and a statement from last week’s Politburo meeting promising stimulus.

“We should waste no time in planning more policy tools and enhance the strength of adjustment in due course,” the Communist Party’s Politburo said Friday, according to a readout of a meeting of the leadership on state broadcaster China Central Television.

There have also been reports that Xi is meeting tech giants this month in a sign of easing regulatory pressures.

And newspapers last week reported Xi had told officials to ensure the country’s economic growth outpaced the US this year.

Expect stimulus

Mehta expects further policy effort to stimulate the economy is on the way.

“During lockdowns in the US, among many other schemes, the government handed out $600 additional monthly payments to households.

“What’s to stop the Chinese from doing something similar?”

Mehta expects fiscal action to dominate because monetary policy is more constrained by the global environment.

“In face of the rapid depreciation of the Japanese Yen, the Chinese renminbi has depreciated by almost 2.5% in the past week.

“The People’s Bank of China needs to be very careful about the externalities. The worst thing that could happen is if they loosen monetary policy in a big bang and are faced with capital outflows, which could result in a further weakening of the currency and have ramifications and unintended consequences.

“Monetary policy cannot be done in isolation, whereas fiscal policy can.”

Risk for investors

The risk for investors is that Chinese policy changes can come “at the drop of a hat”, says Mehta.

He points to the rapid reversal of Beijing’s climate commitments after last year’s UN climate conference.

“Chinese authorities said they were focused on not using fossil fuels and reducing coal consumption — and then the war in Ukraine exacerbated an energy crisis. Restrictions on fossil fuels have been shelved as a result.

“China’s coal consumption is back approaching all-time highs.”

Mehta says a change in policy on economic growth or zero-COVID will have profound impacts for investors.

“Charlie Munger said ‘show me the incentive and I’ll show you the outcome’ and China is all about incentives.

“For 30-plus years, there was just one incentive for everyone in government — GDP growth. What was surprising is that China achieved that GDP growth year-in, year-out.

“But incentives can change on a dime: one thing we know about the Chinese authorities is that when they want to do something, no one can stand in the way because it’s an authoritarian Leninist society, where there is no democratic process. It is rule by law (as defined by President Xi or the CCP), not rule of law.

“When they confront reality, they will have to look it in the eye.

“There seems to be almost universal revulsion at owning stocks in China for good reasons. Yet Chinese stocks today are the equivalent of the “anti-ESG portfolio” of 2021 and 2022.

“Every sector ignored by the market due to ESG compulsions roared back to life — and was in hindsight the only portfolio to own in 2021 and 2022.

“If you don’t own China today, you are going to miss out.”

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About Samir Mehta and Pendal Asian Share Fund

Samir manages Penda’s Asian Share Fund, an actively managed portfolio of Asian shares excluding Japan and Australia. Samir is a senior fund manager at UK-based J O Hambro, which is part of Pendal Group.

Pendal Asian Share Fund aims to provide a return (before fees, costs and taxes) that exceeds the MSCI AC Asia ex Japan (Standard) Index (Net Dividends) in AUD over the medium-to-long term.

Find out about Pendal Asian Share Fund

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.