Investors are advised of the following change to the March 2023 distributions.

The Funds set out below will pay their distribution (if any) for the March quarter on or around 31 March 2023 for the period ending 24 March 2023. This change will be for March 2023 only.

Investors will receive distribution statements in accordance with our usual process.

Please call our Investor Services Team on 1300 346 821 if you have any questions.

Pendal funds impacted if paying a March distribution

Fund Name	APIR Code	ARSN
Pendal Australian Share Fund	RFA0818AU	089 935 964
Pendal Fixed Interest Fund	RFA0813AU	089 939 542
Pendal Property Securities Fund	BTA0061AU	087 593 584
Pendal Sustainable Balanced Fund – Class G	PDL4756AU	637 429 237
Pendal Sustainable Balanced Fund – Class R	BTA0122AU	637 429 237
Pendal Sustainable Conservative Fund	RFA0811AU	090 651 924

This Important Update has been prepared by Pendal Fund Services Limited (PFSL) ABN 13 161 249 332, AFSL No 431426 and the information contained within is current as at 7 February 20230. It is not to be published, or otherwise made available to any person other than the party to whom it is provided.

PFSL is the responsible entity and issuer of units in the Pendal funds specified in this Important Update. A PDS or IM is available for the funds and can be obtained by calling 1800 346 821 or visiting www.pendalgroup.com. You should obtain and consider the PDS or IM before deciding whether to acquire, continue to hold or dispose of units in the funds. An investment in the funds is subject to investment risk, including possible delays in repayment of withdrawal proceeds and loss of income and principal invested.

This Important Update is for general information purposes only. It should not be considered as a comprehensive statement on any matter and should not be relied upon as such. It has been prepared without taking into account any recipient’s personal objectives, financial situation or needs. Because of this, before acting on this information recipients should consider its appropriateness having regard to their individual objectives, financial situation and needs. This information is not to be regarded as a securities recommendation.

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

STRONG US payroll data and consumer expectation surveys last week painted a picture of an economy that continues to hold up well.

Bond yields rose in response and equities gave back some of their recent gains.

US two-year government bond yields rose 23bps and saw the largest spike since September. At 4.52%, the two-year yield is 46bp above the January lows and is 21bp off its cycle highs.

This led to rotation away from yield-sensitive technology and REIT stocks.

The S&P 500 fell 1.7% last week and the NASDAQ lost 2.4%. They remain up 6.7% and 12% for the year, respectively.

The sell-down was not broad-based and looks more like a consolidation than start of a sharp reversal.

In Australia we saw a sharper reversal in the short end of the bond curve. Two-year government bond yields were up 41bps, as the RBA pushed a more hawkish line on inflation than expected.

The S&P/ASX 300 fell 1.7% and is up 5.6% for the year.

Trends and potential scenarios

It’s too early in reporting season to identify trends, though domestic stocks appear to be holding up better so far. This year’s rally has been driven by signs of inflation and wages easing without a sharp economic slowdown.

This “soft landing” (or ”narrow path” or ”immaculate disinflation”) scenario is the most bullish of the three broad outcomes.

The market likes the idea of a limited earnings downturn combined with falling rates.

There are two other, more bearish, scenarios:

• Structural inflation: Some combination of limited commodity supply, structural constraints on labour, re-arming of nations, re-shoring of supply chains and de-carbonising power and energy infrastructure all contribute to inflation remaining higher for longer.
• Policy is already too tight: A lagged effect – currently hidden – will prompt a recession in the second half of 2023. 

We are in a better place than we were three months ago, but material risks remain.

We need to regularly gauge the scale and direction of economic data to get a better read on which scenario is playing out. 

US Economics and Policy

Rates

A strong labour market – plus signs of housing pressures easing and improvement in consumer sentiment – contributed to the market adding back in an expected rate hike.

This takes the peak to between 5% and 5.25% and means a pause after the May hike, rather than March.

Revisions to historic CPI (following the annual recalculation of seasonal adjustment factors) show the decline in core services inflation (excluding housing) may not have been as material as originally reported.

This means the three-month seasonally adjusted annual rate over the last three months is 3.5% rather than 2.6%. This helped support a shift higher in expected rates.

Labour markets and the economy

Economic contradictions are evident in a number of areas. Lead indicators such as the Conference Board Leading Economic Index (LEI) suggest forthcoming recession.

Meanwhile jobless claims are at historical lows.

The number of employed people is above pre-Covid levels, while the number of job openings is far higher. This all highlights the strength of the labour market.

The Fed is focused on the labour market becoming more entrenched as the transmission mechanism for inflation.

One possible reason for its ongoing resilience – and that of the economy more broadly – is that the lagged effect of tightening is longer in this instance.

Another is that other factors such as “labour hoarding” are working against the traditional transmission mechanism.

There have been a lot of headlines about job cuts in the US.

Last week Disney announced 7000 job cuts, NewsCorp 1250, Yahoo 1600, Dell 3500, Boeing 2000, Zoom 1300 and Affirm 485. 

However aggregate data indicates overall layoffs are still relatively limited and well below levels consistent with recession.

Job cuts are concentrated in the technology sector, where average employee numbers have risen by 40% in recent years. Jobless claims data suggest people are still able to find roles elsewhere.

All this begs the question whether the recent down-trend in wages will continue.

The US economy remains strong. The latest Atlanta Fed GDPNow signal is well above consensus market forecasts for Q1.

Consumption remains a key driver.

Aggregate excess household savings are running down at a rate of $80-90 billion per month. But with $1.1 trillion remaining it could support the economy for another five to six months.

That said, there are some negative signals on the economy:

• The yield curve hit new lows in terms of inversion last week. History suggests a recession within 12 months of yield curve inversion. 
• Money supply is running at -7.8% year-on-year in January.

The risk of recession remains. But history indicates that once rates peak they reverse relatively quickly.

Whether that happens this time depends on the stickiness of inflation. 

Australia

There was an important shift in the RBA’s stance last week. The messaging became more hawkish, in response to December’s stronger-than-expected inflation data.

 

This led to a step up in short-term rate expectations. Rates are now expected to peak around 4%. 

The RBA has noted that while housing construction and house prices have reacted as expected to higher rates, consumption and investment are holding up more than expected.

The reason why is critical to the path of rates – and whether we see only another 50bps to 75bps of hikes, or if a more sizeable increase is required.

The benign case is that strong consumption reflected a one-off “celebration Christmas” post-Covid and that spending falls away quickly.

As it stands there is no data supporting this theory. However the impending step-up in rates for those with fixed mortgages may quickly change that.

The RBA is indicating it needs to jolt consumers into worrying more about the future. This would help contain consumption and would mean fewer rate increases.

The challenge is the RBA’s policy setting is looser than other central banks.

There are several reasons why this may not be logical:

1. Inflation in Australia is still rising, even in durable goods. There is hope that the latter reverses sharply.
2. Unlike the US, rents here are still rising thanks to immigration. Household formation rose through the pandemic. The RBA will be looking for this to reverse to ease pressure.  
3. We need to hope that Australia’s current terms of trade boost does not translate into more investment spend. So far it has not.
4. We need the government’s support for inflation-linked wage increases for low-paid workers not to flow through into higher income groups.

There is a lot on the line.

In the near term the market gets the benefit of earnings holding up better than feared.

The risk will be if this ends up requiring much tighter policy.

Markets

The US equity market is not giving the same signals we saw in April, August and November last year, which led to more significant corrections.

The Australian market saw weakness in REITs and technology, which had been leading the market in 2023. Thematic rotation continued to play a major role in stock performance, but stock specifics also started to come through as results begin.

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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

Why it’s time to consider long-duration bonds | ASX reporting season preview | US earnings overview | US law drives sustainable opportunities | Protectionist Indonesia looks attractive

The RBA’s hawkish tone could mean a hard landing with a fast turnaround on rates later this year. That means fixed interest investors should be eyeing longer-dated bonds.

In Pendal’s latest webinar, Commbank chief economist STEPHEN HALMARICK reviews the latest economic data while Pendal head of bond strategies TIM HEXT outlines the impact on fixed interest investors. Here’s a summary.

WITH higher rates on their minds, Aussies have begun reining in spending in the past two weeks, says Commbank chief economist Stephen Halmarick in a new Pendal webinar.

Halmarick, who has a unique, real-time view of the spending habits of CBA’s 16 million customers, says consumer spending continued during the summer holidays, but is now slowing down.

The economist was speaking alongside Pendal’s head of bonds Tim Hext in Wednesday’s Why bonds, why now? webinar. (You can watch a replay here).

“People were saying: ‘I know interest rates are going up and I know inflation is high, but what the heck, I need to have a holiday’,” says Halmarick.

“That was pretty clear in the data. Things like eating out and recreation and travel were very strong.

“In the first week of February, things have definitely softened again.

“I’ve seen a turn-down in spending in the last two weeks on the CBA credit and debit cards.” (Halmarick stresses the data analysis is anonymous).

That will be good news for the RBA, but it’s unlikely to change its hawkish approach to inflation in coming months.

That’s partly because of strong wage growth – another area Halmarick has excellent real-time insights via the salaries deposited into savings accounts.

“The annual rate of wages growth is heading towards 3.5 per cent,” he says. That’s against official ABS data showing 3.1 per cent growth.

“If it gets too much north of 3.5 per cent towards 4 per cent, the RBA will be quite worried about the inflationary impact of that and then maybe you get more rate hikes.

“So, we’re definitely watching wages go up very closely.”

Odds increase on hard landing

While a soft landing is still likely, the chance of a hard landing in Australia is rising as the RBA takes a more aggressive approach to inflation, Halmarick says.

The strong tone taken by the RBA this week has narrowed the path for the bank to get control of inflation, with the official cash rate now expected to hit 3.85 per cent by April, up from 3.35 per cent today.

“We would describe that as very restrictive monetary policy,” he says.

“The RBA has been talking about a narrow path forward to get inflation back towards target while also having the economy grow.

“I think that path is getting narrower and narrower. The risks of a hard landing are growing.”

A short cycle?

Halmarick reckons the cycle will be short and rates could still fall this year.

He is forecasting “inflation declining at a much faster rate than the Reserve Bank’s forecasts”.

That means rates are likely to peak this year, he says.

“We’re currently forecasting GDP growth this calendar year of 1.6 per cent but the risks are now on the downside for that.

“We think the RBA will need to start cutting interest rates before the end of this year. So, we’ve got a fairly quick turnaround in that cycle.”

What it means for investors

The upshot for fixed interest investors?

Pendal’s Tim Hext says it’s time to consider longer-dated bonds as insurance while locking in a decent income.

Bonds play two important roles in a portfolio: acting as an insurance policy against a downturn and providing income.

“It’s certainly not a time to be underweight bonds,” says Hext. “A 3.7 per cent triple-A government guaranteed return for the next 10 years is pretty decent income.”

But investors need to consider the duration of bonds as the economic picture changes, he says.

Take care with bond duration

Duration is a measure of the sensitivity of a bond’s price to changes in interest rates.

The longer the duration of a bond (for example ten years compared to two years), the more sensitive the bond’s price is to changes in market interest rates.

“Duration is the period you are locking in current rates for,” says Hext.

“If you buy a 10-year bond, you’re locking in for 10 years. If you buy a two-year bond, it’s only for two years.

“Bond prices are far more sensitive to interest rate changes the further out you go.

“If you think rates are going up, you should keep your investments as short as possible so you can take advantage of the higher rates down the track.

“But if you think rates are going to fall, you want to lock them in for as long as possible.

“Our advice to clients is if you’ve got quite short duration, you should be looking to lengthen that.

“With 10-year bonds around 4 per cent, we don’t think cash rates are going to be able to get that high. If they do, they’ll only be there very briefly.

“Therefore, you’re going to get a better income locking in for a longer term.”

Watch a short webinar with Stephen Halmarick and Tim Hext

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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 portfolio manager Brenton Saunders. Reported by portfolio specialist Chris Adams

MARKETS continue to rally hard, helped by dovish Fed commentary following last week’s 25bps rate rise in the US.

We’ve also seen notable US economic data.

The Nasdaq lifted 3.3% last week while the S&P500 was up 1.6%. The S&P/ASX 300 gained 1.1%.

The NYSE FANG+ index – which tracks tech companies such as Amazon, Google and Facebook-owner Meta – is up about 30 per cent this year. Meta jumped 23% last week.

US bond yields and the US dollar rose moderately by the week’s end. Most of the moves came on Friday in response to very strong non-farm payrolls data, which raises expectations for further rate increases.

A stronger US dollar weighed on most commodities, though iron ore continued to make good gains.

Elsewhere, the European Central Bank raised rates by 50 basis points. Another 50 points is likely in March.

Commentary suggested the ECB was heartened by falling inflation, helped by a mild winter and a fall in natural gas prices.

US economy and the Fed

The US economy is so strong that some are wondering if it’s less about a hard or soft landing – and more about whether there is a landing at all.

Inflation continues to cool in many areas. But strong labour markets are confounding the more bearish economic forecasts.

The Federal Open Market Committee – which is responsible for setting US monetary policy – raised rates 25 basis points to 4.75%, in line with expectations.

Fed chair Jay Powell noted greater optimism around inflation and the start of a disinflationary process.

However, he also said the FOMC “anticipates ongoing increases in the target range would be appropriate” and there was “more work to do” on raising rates.

If the US economy performed as the Fed expected, it would not be appropriate to cut rates in 2023, Powell noted. This is in keeping with recent signals.

But if inflation slowed faster than expected, this would be incorporated into their thinking, he said.

On balance, markets took this nod to data-dependency as dovish – particularly since Powell down-played improvement in total “financial conditions” in response to a question.

Financial conditions tries to capture the cost and availability of funding, which impacts spending, saving and investing for businesses and households. Indicators include corporate borrowing rates, US equities and even the US dollar.

While the language was softer, there is a risk that the market’s interpretation is overly dovish in the face of continued strength in the US economy and labour market.

The latter was emphasised by Friday’s non-farm payroll data.

By Friday the short end of the US yield curve had more than retraced a bond rally that came after the Fed’s press release.

Some analysts are raising the possibility that the Fed may be raising rates by 50 points in March or May, rather than the currently expected 25 points.

The market continues to price Fed rate cuts in late 2023. This expectation may have to shift if labour markets remain strong.

The market is also implying rate cuts in Australia by the end of the year, but from a high point of about 3.6%, versus about 5% in the US.

The US dollar is down about 10% from its late September high (as measured by the DXY).

Some degree of consolidation – or even reversal – is now likely, which may be a headwind to commodities and markets in the near term.

We are likely to see a partial reversal of the 70-point decline in US 10-year bond yields since October 2022, as the market digests the impact of strong jobs data on the interest rate trajectory. 

The yield curve remains inverted on most measures.

Bears still point to this as the most reliable recession predictor.

US employment data

The cost of employment – measured by the Employment Cost index (ECI) and Average Hourly Earnings – is trending in the right direction. But other employment data has been surprisingly strong in direction and magnitude.

The market was looking for 188,000 new jobs in the non-farm payrolls last week – and got 517,000 instead.

Unemployment fell to 3.4%, down from 3.5% and below a consensus expectation of 3.6%.

The return of 36,000 workers from strike – and seasonal effects such as relatively warm weather – played a role.

Nevertheless this was a strong print which may result in some re-thinking of the rates trajectory.

This strength was also reflected the latest Job Openings and Labor Turnover Survey and initial claims for unemployment insurance.

US quarterly earnings

Just over half the S&P 500 by number (and roughly two-thirds by weight) have now reported December-quarter earnings.

The proportion of companies beating eps estimates remains at 69% – below the long-term average.

Aggregate consensus earnings estimates for FY23 have bounced from their lows on February 1, but are still down 2.3% since the start of major earnings releases this season.

Markets

The S&P 500 next-12-months (NTM) PE is 18.3x, up from lows of 15.5x. The market is forecasting 9% EPS growth for the NTM.

The ASX200 NTM PE is 14.9x, up from lows of 12.6x. The market is forecasting 1.8% EPS growth for the NTM. Technical indicators suggest the ASX 200 is fairly over-bought, with resistance at the 7600-7650 level.

What today’s Fed move means | How to invest in a recession | What’s driving the ASX run

Fed chair Jerome Powell today gave the green light to the market’s move to risk-on investing. But it may not last, writes Pendal’s TIM HEXT

JANUARY was a great month for risk. Equities and bonds had strong rallies. Credit spreads contracted.

As we entered February all eyes were on Jerome Powell and the US Fed to see if they would push back on the easing of “financial conditions”.

Here we’re talking about overall financial conditions for the real economy – not just where the Fed Funds rate is.

Financial conditions tries to capture the cost and availability of funding, which impacts spending, saving and investing for businesses and households. Indicators include corporate borrowing rates, US equities and even the US dollar.

Below you can see the Goldman Sachs US Financial Conditions Index, which suggests it’s becoming cheaper to access money or credit.

The Fed’s response?

This morning the US central bank announced a rate rise of 25 percentage points after a year of bigger hikes.

As always, we look to changes in phrasing in the official Fed statement. Today we saw the phrase “extent of future increases” replace “pace of future increases”.

This is interpreted as the debate shifting from last year’s theme of “25bp, 50bp or even 75bp” to “25bp or nothing”.

The Fed is keeping a few more hikes in its “dot plot”, but it’s now distinctly less hawkish.

All this was not unexpected.

Markets really did not react immediately after the statement.

Rather it was Powell’s press conference that saw equities and bonds get a boost.

The first question asked about the recent easing of financial conditions.

Many would have expected Powell to call this out as unwelcome in the fight against inflation.

He did not.

The Fed, like many central banks caught flat-footed a year ago, is now happy to react to data rather than predict it.

Of course, inflation is a lagging indicator meaning central banks, including the RBA, are happy to sit back and observe these long and variable lags.

Two of the three planks of high US inflation are now in a downtrend. Goods and rents price should ease further in the months ahead and disinflation will be the trend.

However, the third area of services prices remains high. Easing of wages and employment will be need to return to 2 per cent.

Overall though Powell has given the green light to January’s moves to risk-on investing.

February should see that trend continue although at a more modest rate given current levels.

By the middle of the year though, weakness in the economy and falling business margins may see pressures go the other way.

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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 portfolio manager Jim Taylor. Reported by portfolio specialist Chris Adams

THE market is still waiting for a clear indication of how much the global economy will slow this year.

Last week’s economic data didn’t provide a strong signal one way or the other.

European data continued to be better than many feared. US data told the story of moderating inflation and slowing consumer activity as higher rates began to bite.

US reporting season has been mixed from an earnings perspective.

About 100 S&P 500 companies report this week – including Apple, Amazon, Meta, Alphabet, McDonalds, Caterpillar, Merck and Exxon Mobil – which could provide a clearer picture.

Job cuts, which started in tech, have now spread to a broader cross-section of sectors.

The US Federal Reserve meets this week and is expected to hike 25bps, perhaps with some jawboning around “we are not done yet” to keep the bulls at bay.

The S&P 500 gained 2.48% last week. The NASDAQ was up 4.32% and the S&P/ASX 300 rose 0.56%.

North America macro and policy

The Bank of Canada became the first G10 nation to pause its hiking cycle after a 25bp increase to 4.5%.

The Canadians cited “growing evidence that restrictive monetary policy is slowing activity – especially household spending”.

Though they also noted economic growth was “stronger than expected and the economy remains in excess demand”. 

This bolstered a growing view that the risk of central banks dogmatically driving the economy into deep recession may have fallen. Instead, a growing chorus of voices suggest the US can achieve a soft landing – in stark contrast to consensus views just a couple of months ago.

In addition to Fed hawk Christopher Waller’s recent “case for cautious optimism”, prominent economist Larry Summers has said economic figures are looking better than he expected three months ago.

Summers had previously been bearish on the Fed’s ability to avoid a hard landing.

International Monetary Fund managing director Kristalina Georgieva also noted the global economic situation was “less bad than we feared a couple of months ago”.

Elsewhere, there was a slew of data released last week, none of which was individually significant or market moving.

December’s Core Personal Consumption Expenditures (PCE) index (a measure of inflation that excludes more volatile categories such as food and energy) increased by4.4% annually.

This is down from November’s annual rate of 4.7%.

On a monthly basis it was up 0.3%, in line with consensus. It is now at its lowest level since October 2021.

The deflator rose at 3.1% (annualised) in Q4, slowing from 4.5% in Q3 and 5.4% in Q2. Most of the downshift is in the goods component, with rents expected to begin slowing.

Data shows consumers pulled back in December, with spending falling by 0.2% from the month before. Personal income rose 0.2% last month, the smallest increase since April.

Personal saving rate as a percentage of disposable income increased to 3.4% from 2.9% in November.

The savings rate is now up one percentage point from its September low. This is all possible evidence of belts tightening.

Headline US GDP growth of 2.9% looks positive, but strength was driven by inventories.

Domestic demand was relatively modest and likely further weakens in the March quarter.

December new home sales rose 2.3% to 616K, marginally below the consensus of 617K. It’s likely a lack of existing homes for sale is pushing people to buy new homes.

Initial jobless claims are extremely low at 186k, well below the four-week average of 198k.

Employment agencies continue to indicate that wage pressures are subsiding.

Australia

Australia bucked the trend of moderating inflation, with the December quarter’s CPI print coming in hotter than expected.

Inflation rose 7.8% year-on-year, its highest rate since 1990 and ahead of 7.6% expected. It was up 1.9% over the quarter versus 1.8% expected.

The RBA’s preferred measure – the trimmed mean CPI – lifted 1.7% in the quarter to 6.9% year-on-year, versus consensus expectations of +1.5% and +6.5% respectively.

This is well above the central bank’s 2-3% target and ahead of its 6.5% end-of-2022 forecast.

A 25bp hike in February is now baked in.

Consensus still expects rates to peak at about 3.75% somewhere in the middle of the year.

Digging into the numbers, 87% of categories in the inflation basket are now exceeding 2.5% annualised growth.

Services inflation is now at the highest level since 2008, at 5.5% annualised. This was driven by travel-related categories including domestic airfares and accommodation (+19.8%).

Rents continued to rise in the quarter with the annual pace of increase now at 4%.

Given the current rental crisis across Australia it is hard to see any abatement in this area soon. Food and grocery inflation remains high and broad-based.

One bright spot is that the rate of growth in business input costs, including labour, have been falling across all industries since the mid 2022 peaks

Europe

The outlook for economic activity in the European Union continues to look less dire.

The Euro area composite flash PMI – a measure of economic activity – increased 0.9pts to 50.2.

The gain was broad-based across sectors as the services sector surpassed 50 for the first time since July 22. New orders, employment and backlogs all showed improvement.

US Reporting Season

About 30% of S&P 500 companies have so far reported actual results for the December quarter.

Of these, 69% have reported actual EPS above estimates. This is an improvement on 67% at the end of last week. But the five-year and ten-year averages are 77% and 73% respectively.

At an index level, aggregate Q4 earnings are 5% lower than the previous quarter. If this figure holds, it will be the first time the S&P 500 has seen a decline in annual earnings since Q3 2020, when earnings fell 5.7%. 

Four of the GICS 11 sectors are reporting year-over-year earnings growth, led by the energy and industrials sectors.

On the other hand, seven sectors are reporting a year-over-year decline in earnings, led by materials, consumer discretionary, communication services and financials.

Financials have been the biggest contributor to the decline in earnings estimates since December 31.

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About Jim Taylor and Pendal Focus Australian Share Fund

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

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

Pendal is an independent, global investment management business focused on delivering superior investment returns for our clients through active management. 

Contact a Pendal key account manager here

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

• Find out about Pendal Focus Australian Share fund

THE market seems increasingly convinced that inflation is last year’s problem and is falling faster than expected.

The focus has now shifted to the size of the economic downturn and the impact on earnings.

In that context, bad economic news now becomes bad for the market as it indicates a worse downturn. Good news, conversely, indicates less earnings risk. 

Last week manufacturing sentiment indicators and retail sales flagged a weaker US economy, driving the market lower. However supportive comments from Fed officials boosted markets late in the week.

The S&P/ASX 300 ended up 1.7% for the week. The S&P 500 fell 0.7%, while US 10-year government bond yields dropped 19bps.

The market looks bound in a tight technical range for now.

Investor positioning has shifted away from a more defensive stance and is now more of a headwind. However the market’s breadth and resilience provide confidence that support levels will hold.

US quarterly earnings season have just kicked off. So far we do not have a strong signal either way.

Until we get more clarity on the economy, the S&P 500 is likely to stay range-bound between 3800 to 4000 with the flip-flop of sentiment set to continue.

In this environment stock specifics are set to become a greater focus locally and offshore.

US economics and policy

Indicators such as the EVRISI employment costs and pricing power surveys continue to highlight that inflation is decelerating rapidly.

The question is whether inflation plateaus in the high 3% range and holds or continues to fall into the 2% range.

Friday’s market bounce came in response to a speech from US Federal Open Market Committee member Christopher Waller.

While considered a hawk on monetary policy, Waller said recent data was breaking more positively and the Fed might be less rigid regarding rate increases than the market feared.

This echoed comments from the more dovish Fed vice chair Lael Brainard.

Neither Waller nor Brainard tried to adjust market expectations for rates to stay below 5%.

This potentially means two more 25bp hikes, with rates peaking in March at 4.75 to 5%.

Waller said the Fed might stay higher for longer than market would like – to manage risk and avoid inflation picking up later in the year.

On the economic front a survey of economists reported an average 65% expectation of recession in the US in the next 12 months.

Manufacturing surveys, weak housing, softer retail sales, low savings rates and inverted yield curves all support the recession call.

The holdouts expecting no recession or a shallow downturn are quoting some combination of these reasons:

1. Job momentum remains supportive. This is evident in lagging indicators such as solid payrolls and coincident indicators such as jobless claims which have not deteriorated. Forward-looking measures such as layoffs are not yet back to pre-pandemic levels, let alone those consistent with a recession. It is likely companies are more cautious on firing in certain sectors, given recent shortages of labour.
2. Consumer real incomes are set to rise – potentially up to 3.5% – as inflation falls and wages catch up. This can support consumption.
3. There are no major structural imbalances in terms of excess credit growth, overcapacity in industries or too much leverage in households. All these exacerbated the downturn in the GFC.
4. Financial conditions have been stable for six months, so the effect of tighter monetary policy is fading.
5. Lower bond yields are supportive for housing, possibly alleviating the risk of larger downturn.
6. Economic momentum is still quite good. Q4 GDP is likely to come in at 2%. While moving below trend, we have not yet seen a tipping point in the economy.

The bull-case scenario from here is that earnings-per-share (eps) for the S&P 500 holds at about US$220 and the market valuation multiple rises to 20x P/E as bond yields fall. This would equate to the S&P 500 index around 4400, or up roughly 10% from here.

The bear-case scenario is a drop in earnings of about 11% to around US$200 eps and a de-rating on uncertainty to 16x P/E. This could see the S&P 500 fall some 20% to 3200.

The US market multiple remains above its long-term average, in the 75^th percentile. A weaker US dollar, a better outlook for Europe and Chinese re-opening should all be supportive for earnings.

We remain of the view that the market’s upside remains capped by earnings risk and Fed actions to contain financial easing.

However, the downside scenarios are looking more benign for now.

US debt limit

The US Treasury has technically hit a debt ceiling approved by Congress. But Treasury officials say they won’t run out of money until June at the earliest. There are lots of moving parts to this equation.

There will be no impact on bond issuance through to the end of February. From March, Treasury will start running down cash holdings, reducing bond issuance and the Fed’s liquidity.

This will reverse in April as tax receipts come in, then resume until all the cash is spent. The market is seeing late July/early August as the crunch time.

Some sort of last-minute compromise in Congress is the best-case scenario.

Some scheduled payments could be missed. This is likely to be social security obligations rather than bond coupons. 

The risk here is that the market assumes a last-minute deal will be done – and doesn’t send a strong signal to Washington to solve the problem.

This could see a 2012-13-style scenario come July. However, it is not a major near-term market driver.

US earnings

Some 10 per cent of the US market reported last week, with a skew to financials. Earnings continue to be revised down, with S&P 500 eps growth for the year now at -1% versus flat two weeks ago.

 

US banks had a good 2022, with return on tangible equity (ROTE) at 15% versus 11.5% the previous year.

This is the highest since the GFC and was driven by a roughly 20% increase in net income as margins rose and loans grew 10%.

So far credit losses are still only half 2019 levels.

The picture gets tougher as deposits fall and competition increases. This is reflected in the sector’s 16% fall last year.

Australian equities

The S&P/ASX 300 has returned almost 6% year-to-date, with good returns across most sectors.

Commodity prices remain supportive on the back of improved sentiment around China. Lower bond yields are helping REITS and growth sectors – notably healthcare. 

A number of positive corporate updates last week reflect resilient earnings.

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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

IN LINE with our previous communications, today marks the official union of two of Australia’s leading asset managers, Pendal and Perpetual.

Last August we announced plans to create Australia’s pre-eminent global asset manager — with approximately $200 billion of FUM and clients benefitting from greater scale in customer service, distribution, technology, infrastructure and ESG leadership.

The process over the past few months was to seek approval from shareholders and regulators around the world. This has now been achieved.

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• Crispin Murray: Why bringing together Pendal and Perpetual makes sense

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Pendal and Perpetual have been built on the concept of investment autonomy, so clearly there are no changes to the way our investment teams look after your assets.

However, we now gain access to deeper, more diverse coverage from a global network of investment and ESG experts across the United States, UK, Europe, Singapore and Australia.

There will be no change to your relationship with Pendal and we will continue to manage your investments to the best of our ability, as we have always done.

I warmly thank you for your support and trust. Please do not hesitate to call or contact your Pendal account manager

In the meantime, I encourage you to watch the video below from Perpetual CEO & Managing Director Rob Adams.

Yours sincerely,

Richard Brandweiner
Pendal

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A message from Perpetual CEO & Managing Director Rob Adams