Investor pessimism about a Continental recession seems overdone and European shares are starting to look good value, argues Pendal’s Paul Wild

• EU shares hit by war and energy crisis
• Value emerging
• Banks to benefit from rising rates

EUROPEAN shares are starting to look good value for investors willing to look through the Ukraine war and winter’s likely energy crisis, argues Pendal Group’s Paul Wild.

Companies in Europe are trading at an average of about 11 times next year’s earnings, which is around 20 per cent lower than the average price earnings ratio of the last few decades.

There is reason for the pessimism. The drawn-out Russia and Ukraine war shows no sign of resolution, and a looming energy crisis and potential power rationing is raising the risk of recession.

“The starting point is that investors are basically at maximum underweight for European equities,” says Wild, who manages a European equities fund at Pendal’s UK-based subsidiary J O Hambro.

“We’ve had about 30-plus weeks of outflows this year. Since 2016, investors have redeemed about 30 per cent of their holdings in European shares.”

For most investors, reducing euro holdings has been the right move.

European shares have underperformed US shares over the last 10 years, largely because the US economy has been growing faster and US market features more technology and other high-growth companies.

“But if you look at the decade before that, in local currency terms Europe and US performance was pretty similar,” says Wild.

Growth stocks outperforming

“So the question is, can the growth stocks keep outperforming?”

That depend on the path of interest rates, says Wild.

“The growth boom benefited from the extrapolation of very low risk-free rates and negative real rates which had a massive effect on valuations.

“Coming into the Covid period, it almost felt as if valuation didn’t matter anymore.

“Now with interest rates going back up, valuation has become a hot topic again.

“That’s quite exciting and puts Europe in a good place. Why? Because on a global basis, Europe shares are slightly underweight growth and overweight value.”

One of the main reasons European markets overweight value is because of a heavy weighting to financials, with some of the world’s largest banks listed on the European exchanges.

“European banks have around €6 trillion of demand deposits which until recently yielded zero or lower. If the European Central Bank moves rates move north of 2 per cent, sector profitability will be transformed,” says Wild.

“The bottom line that you are starting to see already is very large earnings upgrades for European banks, simply on the back of net interest margin expansion.”

Wild says the trajectory of global interest rates favour Europe over the US, with the likely peak in cash rates in Europe likely to be nearly half the level of where the US peaks.

“Interest rates in Europe are rising but they are still going to be far lower than in other parts of the world.”

European recession fears ‘overdone’

Wild also says investor pessimism about recession is likely overdone, with the eurozone likely to skirt recession over the winter.

“Fiscal policy in Europe, particularly in Germany, is having a significant turn. Germany has come out with three aid packages since the Ukraine invasion which in total equate to about 2.7 per cent of GDP.

“Unemployment in Europe is still at all time low levels and we’re seeing reasonable consumer resilience.”

And importantly, the EU has also been aggressively building gas reserves to head off shortages over winter.

“It feels like European governments have taken away the Armageddon scenario,” says Wild.

The environment is ripe for a shift in investor approach back to GARP — buying ‘growth at a reasonable price’ — which suits Europe’s weighting towards industries like pharmaceuticals, automotive, insurance and banks.

“Who doesn’t like to buy growth? But it absolutely has to be at the right price.

“There are banks in Europe trading at five- or six-times earnings, yielding 7 or 8 per cent — with share buybacks.”

---

About Paul Wild and Pendal global equities strategies

Paul Wild is senior fund manager with J O Hambro Capital Management, a London-based active investment manager which is part of Pendal Group.

Paul manages J O Hambro’s Continental European fund.

Pendal offers a range of global equities strategies to Australian investors including:

• Pendal Global Select Fund
• Pendal Concentrated Global Share Fund
• Regnan Global Equity Impact Solutions Fund
• Pendal Global Emerging Markets Opportunities Fund

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

Europe’s biggest economy is in the news for the wrong reasons. But Germany’s underlying economic picture still looks robust, says Pendal fund manager Paul Wild

SHOULD global equities investors be worried about the headlines coming out of Germany?

For a country dubbed the economic engine of Europe, Germany is in the news for all the wrong reasons at the moment, hit by rising energy prices, threats to gas pipelines, slowing production and a trade deficit after decades of surplus.

But the underlying economic picture for Europe’s largest economy still looks robust, says Paul Wild, who manages a European equities fund for Pendal’s UK-based J O Hambro asset manager.

Investors should look beyond disruptions caused by Russia’s invasion of Ukraine and cuts to gas supplies — and instead focus on longer-term fundamentals, says Wild.

“Put it in context. Germany has a fairly unparalleled track record of growth.

“Unemployment is much below European levels, the Bundesbank has always been very conservative, debt-to-GDP ratios are very low.”

Even the May trade deficit — the first for Germany since the 1990s recession — is not something investors should fear.

“The US has run a trade deficit for a very long time and done very, very well — so I don’t think a short-term deficit is going to be the death of Germany.

“And don’t forget that all these issues have helped weaken the euro. You could argue that Germany is the single biggest beneficiary of a weaker currency.”

Energy crisis impact

Still, Europe’s energy crisis is spooking investors in German companies.

The May trade deficit came almost entirely on the back of the rising cost of energy imports.

Germany’s domestic energy capacity is carbon heavy, with large deposits of dirty, lignite coal and it has no LNG terminals or regasification capacity. Instead, it imports some 40 per cent of its gas from Russia, principally through the Nord Stream 1 pipeline.

In June, Russia cut volumes in Nord Stream 1 by 60 per cent in retaliation for Western Europe’s support for Ukraine in the war. It followed that with a further cut in July.

“Now Nord Stream 1 volumes are about 20 per cent of what they were pre-war,” says Wild.

“So, there is a small short-term possibility that there might have to be some kind of industrial rationing of gas over the winter period.”

Should global equities investors be worried?

Wild says it is important to look to the past for clues as to how things might play out.

“Germany has always been dependent upon Russian imports of oil and gas including through the Cold War — and through all of it, the gas has flowed.

“The question mark here is how long is the Ukrainian war going to last? If the war ends, we will likely see a normalisation of gas volumes.

“And in the shorter term, Germany will be dragging in gas through the interconnected pipelines with the rest of Europe and starting to build its own LNG terminals.

“It also has three remaining nuclear plants which are due to be shut down but could be prolonged. And they can generate more energy from coal.”

From an investment perspective, Wild says Germany offers much to like.

A strong industrial focus, open economy and expertise in autos, chemicals and machinery means it is fundamentally a play on global GDP growth.

“Frankly, none of that has actually changed,” says Wild.

“Remember if you buy shares in Siemens, it might be quoted in Germany but it gets most of its revenue and profits from overseas.”

---

About Paul Wild and Pendal global equities strategies

Paul Wild is senior fund manager with J O Hambro Capital Management, a London-based active investment manager which is part of Pendal Group.

Paul manages J O Hambro’s Continental European fund.

Pendal offers a range of global equities strategies to Australian investors including:

• Pendal Global Select Fund
• Pendal Concentrated Global Share Fund
• Regnan Global Equity Impact Solutions Fund
• Pendal Global Emerging Markets Opportunities Fund

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

When looking for good companies to invest in, remember that the medium term is an aggregation of many short terms, says Pendal’s PAUL WILD. Here are some tips for finding good companies right now

• Think medium term, buy sustainable themes
• Look for opportunities in healthcare, finance, tech
• Drip feed or average into the market

THE first tip for equity investors right now is “buy good companies”.

Sound obvious?

“It’s an obvious thing to say until you try and work out what a good company is,” says Pendal senior fund manager Paul Wild.

So what’s a good company?

“A good company needs a moat around it – a moat that provides it with a defensible market share and pricing power,” says Wild, who runs European equities at Pendal’s UK asset manager J O Hambro.

“That’s most clearly illustrated in financial metrics by the return a company makes on equity, or on capital employed over a reasonable period of time.

“When you’re investing for the medium term, remember that the medium term is an aggregation of many short terms. And in the short term, prices can be distorted from fundamentals, affected by the positioning of funds.

“So, it’s a good idea to drip feed or average into the market, knowing that you’re very unlikely to ever pick the absolute low.”

Look for sustainable themes and trends “which are irrefutable”, says Wild.

“The whole area of energy efficiency is one and there’s a myriad of ways to play this.

“It might be via renewables and investing in semi-conductor capital expenditure plays, or it might be within the industrials sector.

“Digitalisation is another irrefutable trend,” Wild says.

Time for equities?

With that in mind, is it time to start putting money into equities?

“The more markets fall, the more optimistic we should be getting,” Wild says, with just a hint of irony.

“But managers do need to fight the behavioural instinct to get more bearish as the market falls.”

“It’s important to be cognisant of the impact of the current sea change.

“We have the dawn of serious inflation for the first time since the 1980s and rates in Europe and elsewhere are going to be rising significantly over the next year. The market needs to price this in and the effect on growth and earnings.”

How inflation and interest rate increases impact consumption, investment and credit risk, are key considerations for investors, Wild says.

Sectors that look promising

 “Which companies have pricing power and can maintain profit margins? Which companies can maintain their return on equity?” Wild asks.

Healthcare and pharmaceutical stocks have been a “port in the storm”.

Financials have been a little more mixed, and their outlook remains that way.

While rising interest rates help many lenders improve their net interest margins, fears of a surge in non-performing loans as rates rise have partially overwhelmed the good news.

“Our view on banks is that the need to provision for bad loans will increase, but it’s coming off very low levels and thus we will see some normalisation,” Wild says.

Insurance companies look relatively attractive.

“Most large European insurance companies are undertaking share buy-backs and dividend yields tend to be north of 6 per cent.

“While they do have a lot of credit exposure in their portfolios, it tends to be high grade. It’s also a sector which has pretty good pricing power and solvency,” Wild says.

Some technology stocks present an opportunity, though they need to have strong balance sheets and be profitable.

Companies that facilitate the digitalisation process for corporates are examples of strong tech opportunities.

And there’s also opportunities in the semi-conductor sector — though Wild prefers companies that benefit from the lithography capital investment by semi-conductor companies, rather than the companies themselves.

“Clearly it is time to avoid companies that are excessively speculative, or have weak balance sheets, or will have difficulties accessing finance at reasonable rates,” Wild says.

“Investors need to look through the crisis or dislocation as best they can and know that there is always the other side, patience tends to be rewarded.”

---

About Paul Wild and Pendal global equities strategies

Paul Wild is senior fund manager with J O Hambro Capital Management, a London-based active investment manager which is part of Pendal Group.

Paul manages J O Hambro’s Continental European fund.

Pendal offers a range of global equities strategies to Australian investors including:

• Pendal Global Select Fund
• Pendal Concentrated Global Share Fund
• Regnan Global Equity Impact Solutions Fund
• Pendal Global Emerging Markets Opportunities Fund

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

Investors everywhere can learn a lot from the dramatic changes in European stockmarkets over the past six weeks. Pendal European equities fund manager PAUL WILD explains

• Investors must be prepared to shift as the opportunity set changes
• Pricing power and relative resilience critical to stock success
• Sell-offs can allow investors to create better portfolios

DRAMATIC changes in European equity markets over the past six weeks — and particularly energy prices over a longer time frame — provide poignant lessons for investors everywhere.

“It shows that investors, no matter where they are, always need to think about pricing power and relative resiliency,” says Pendal senior fund manager Paul Wild, who runs the group’s European equities fund.

“The opportunity set for investors can change very quickly. In Europe it has shifted hugely since the beginning of the year and investors need to alter their stance accordingly,” he says.

“For example, we were confident for the prospects of our overweight positions in automobiles and financials, but we have had to alter our stance.

“Equity sell-offs are never disciplined affairs. Investors should now be focused on buying companies with strong franchises and strong relative pricing power against an inflationary backdrop,” Wild says.

The inflationary impact of higher energy prices affects consumers, Wild says. They’re re also hit by other issues such as higher raw materials prices and supply chain challenges. Corporates are facing similar challenges.

“Investors need to think through how shocks to the system, such as higher energy prices, flow through to the real economy. Almost no sector or company is unaffected by what’s going on in Ukraine,” Wild says.

“People in different parts of the earnings spectrum will react differently. Household fuel bills will clearly be more impactful on low-income households, than they will on higher income households.”

Sectors to watch

Wild expects luxury demand to hold up better than many other retail categories. “Many of the brands have very strong pricing power. We’ve already seen prices rising for jewellery and watches at the very high end.”

Healthcare is a sector that will be less affected, and that’s been demonstrated in the share price of large pharmaceutical companies.

“Utilities as well because of the expansion of renewable assets, notwithstanding some are more exposed to Russian gas exports.”

It’s important to look beyond the current crisis, no matter where an investor is placing funds, Wild says.

“While growth is Europe will be lower than January forecasts, the region’s baseline is extremely low interest rates.

“Investors need to keep in mind that Europe had some very significant post COVID tailwinds including a huge fiscal stimulus during the recovery plan. Unemployment is at all-time lows.

“The best opportunities are in companies with pricing power and reliability. If investors can find these and trade their way into them, they might just find themselves with a higher quality portfolio than where they started.”

---

About Paul Wild and Pendal global equities strategies

Paul Wild is senior fund manager with J O Hambro Capital Management, a London-based active investment manager which is part of Pendal Group.

Paul manages J O Hambro’s Continental European fund.

Pendal offers a range of global equities strategies to Australian investors including:

• Pendal Global Select Fund
• Pendal Concentrated Global Share Fund
• Regnan Global Equity Impact Solutions Fund
• Pendal Global Emerging Markets Opportunities Fund

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

What can investors learn from 2021 as we look ahead into next year? Here are five lessons from a European perspective courtesy of UK-based senior fund manager PAUL WILD

THE past two years have been more tumultuous than most others in recent decades.

But with a greater ability of businesses and citizens to live and work with Covid, what are the lessons from 2021 to take into 2022?

Paul Wild, senior fund manager with Pendal Group’s UK-based asset manager JO Hambro Capital Management, provides five lessons from a European perspective:

1. The importance of earnings momentum

If you look at Europe, there’s been earnings upgrades of 27 per cent year to date, and clearly there’s a very high correlation between earnings upgrades and performance.

At the sector level this year, the best performers have been technology and banks, and there’s no surprise that’s where much of the earnings momentum has been.

Looking at 2022, you need to focus on areas of the market which still have earnings upside. In Europe I’d pinpoint banks again this year and automobile stocks.

2. Monetary policy matters

Monetary policymatters for market direction, sector performance and degrees of volatility. With bond buying to be wound down and US interest rate rises expected by the middle of next year, the decade-long bull market in growth stocks is set to be challenged. Equity valuations will start to really matter again.

3. The green agenda matters

Europe, in particular, is serious about the green agenda. At the UN’s COP26 Climate Change Summit in Glasgow in November, Europe showed leadership and there’s now a huge regional focus on levels of decarbonisation. Investors need to consider the green agenda.

4. The importance of digitalisation

We know the pandemic had a phenomenal impact on expediting business model change, driven by the shift to the cloud and computerisation generally. The flexibility afforded from cloud computing is enormous and companies that embrace technology will continue to reap benefits in coming years.

5. Supply chains and logistics have changed forever

One of the big themes running through 2021 revolved around transportation and supply chain shortages. In 2022 companies will react to that thematic and there will be de-globalisation. This is likely to be a permanent impact of the pandemic, particularly in manufacturing.

Companies will shift away from just-in-time manufacturing to just-in-case inventories. Management will bring supply chains closer to themselves. That will impact earnings and performance.

---

About Paul Wild and Pendal global equities strategies

Paul Wild is senior fund manager with J O Hambro Capital Management, a London-based active investment manager which is part of Pendal Group.

Paul manages J O Hambro’s Continental European fund.

Pendal offers a range of global equities strategies to Australian investors including:

• Pendal Global Select Fund
• Pendal Concentrated Global Share Fund
• Regnan Global Equity Impact Solutions Fund
• Pendal Global Emerging Markets Opportunities Fund

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

Europe’s re-opening is about two months ahead of Australia. Pendal’s PAUL WILD explains what we can learn from its recent earnings season

• European re-opening two months ahead of Australia
• Earnings season provides pointer to local sectors
• Banks and financials the big winners

European and north American economies are a couple of months in front of Australia in terms of COVID re-openings.

The current European earnings season has highlighted the stocks and industries, that have benefited from re-openings, and provides a pointer as the Australian economy opens up.

“The European earnings season is going much better than expected,” says Paul Wild, senior fund manager at Pendal’s UK-based asset manager J O Hambro Capital Management.

“The big winner is again financials — especially banks, where there’s strong fee momentum, very strong capital momentum and a further commitment to give capital back to shareholders.

“The bank sector is yielding nearly 6 per cent and that looks favourable given the monetary policy outlook,” he says.

“Elsewhere while energy in Europe is now a small sector, the oil companies have had a strong season because of oil prices. Industrials and technology stocks have been pretty good.”

Heading into the European September quarter earnings season, expectations weren’t high given the loss of economic growth momentum, high commodity costs and supply chain issues wracking the continent.

But with more than two-thirds of the market having reported, there have been plenty of positive earnings surprises, demonstrating the benefits of re-opening.

“Only two sectors have disappointed. One is utilities and the other is consumer discretionary. In the case of the latter, it is partly because of autos and the semiconductor chip shortage and partly due to the slowdown in China.”

The semi-conductor chip shortage has hit many companies around the globe, but Wild says the tone of conversations among vehicle manufacturers suggests the situation will soon start improving.

Wall Street, and particularly the big technology companies, have dominated markets over the past five years.

“But as economies re-open, and investors look beyond growth companies, such as the tech stocks, and Wall Street, there are plenty of opportunities emerging.”

Financials, auto manufacturers and green stocks are attractive opportunities in Europe, Wild says.

“I would say banks where there’s strong momentum at the moment,” he says. “I would say autos because they will recover from the semi-conductor chip shortage.

“And I would say green stocks that have been left in the cold this year somewhat. That includes green energy, building efficiency plays and areas geared into electric vehicles.”

Europe has been a relatively unrewarding market to invest in since the Global Financial Crisis.

“Earnings are still 15 per cent below 2008 and much of that is to do with the loss of earnings within the banking sector. So, it’s very important for Europe that the bank sector gets on the front foot.”

Apart from the banking sector, Europe has underperformed because of lower economic growth and lower earnings growth.

“But earnings for Europe are forecast to grow faster than pretty much any other major area over the next year,” Wild says.

“Europe has underperformed the US so far this year, but from a GDP and earnings view, on a relative basis, Europe is starting to look like the place to be. The question for the US is how long can the technology sector outperform.”

Wild says while European equities look attractive relative to Wall Street, valuations are unequivocally high.

“So, then you look at bond markets. In the US you have seen a recent slight flattening in the yield curve but this may be premature.

“Markets have priced in more increases in short-term rates and long-term rates have come down just a little.

“Inflation is high at the moment, and it does look like it will stay higher. Fortunately for Europe the ECB will be slower than most at raising rates.”

Wild says because of the yield curve, and the fact that the European earnings season has beaten expectations, he is less bearish on Euro equities than he might otherwise be, given valuations.

“The demand side of the equation is still strong. Some of the areas suffering at the moment because of semi-conductor chip shortages will improve. For example, the size of the backlog for auto companies is huge.

“People have savings, employment prospects in general are pretty good and corporates are under-levered.

“In the short term, while it’s hard to see big upside in markets from here, there will relative outperformance and that will come down to style, sector and thematic.”

---

About Paul Wild and Pendal global equities strategies

Paul Wild is senior fund manager with J O Hambro Capital Management, a London-based active investment manager which is part of Pendal Group.

Pendal offers a range of global equities strategies to Australian investors including:

• Pendal Global Select Fund
• Pendal Concentrated Global Share Fund
• Regnan Global Equity Impact Solutions Fund
• Pendal Global Emerging Markets Opportunities Fund

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

Supply chain issues and inflation concerns are affecting European equities ahead of the Q3 earnings season. Paul Wild explains the opportunities and risks

• Companies with pricing power will endure inflation best
• Products and parts shortages causing price pressures
• Earnings risk for many European companies

INFLATION and the pricing power of companies are emerging as key determinants of the earnings outlook for European corporates, as the third quarter ends and central banks take steps to address rising inflation.

The September quarter earnings season in Europe is still two weeks away, but already the theme of product and parts shortages has emerged among big corporates. And that’s led to investor concern about inflationary impacts on profit margins.

Inflation — be it transitory or structural — is being felt across the region and the recent shift by global central banks away from ultra-loose monetary policy is adding to fears that rising prices are more than just temporary.

“It’s clearly a good time to look for stocks that have strong pricing power, and the German car makers are an example of that,” says Paul Wild, senior fund manager at Pendal Group’s UK-based asset manager J O Hambro Capital Management. “Or simply look for service companies that are relatively immune, not least the banks.”

The type of inflation he is talking about is related to delays and supply chain challenges, which have affected many industries across Europe.

“Heading into the third quarter, there’s definitely a little bit more earnings risks for markets,” Wild says.

European markets have performed well in 2021, with the STOXX Europe 600 – a measure of the largest companies in the region – up 14 per cent so far this year. But the index is down 4 per cent over the past month. It’s underperformed the S&P500 over both time periods, notwithstanding the outlook for recovery in Europe is strong.

Much of that comes down to the supply chain issues.

“The loss of capacity of semi-conductor chip production in Malaysia is hitting the automobile companies, for example,” Wild says.

“But so too is a slowdown in manufacturing in Vietnam, where 40 per cent of Adidas shoes are made.” The unifying factors are continuing lockdowns amid low vaccination rates in these countries.

Global shipping delays and costs are adding to price pressures.

“The supply chain issues are exacerbated by port delays, particularly in China and the west coast of the United States.

“And then you have internal trucking costs which have become more scarce and increasingly expensive. The question is how long will all these things last?”

Look for European strong pricing power

Wild says investors should look towards companies that have strong pricing power and sell products that people will wait to buy.

Again, he points to German auto makers which are rapidly increasing their range of sought-after electric vehicles.

“New car prices in some examples are going up by over 10 per cent — driven by the rising steel cost burden — and that’s having an impact on second-hand car prices. Global production levels are running at about 10 per cent below 2019 levels.”

Wild says investors should consider whether delays in the supply of some products will defer demand or destroy it.

Otherwise look for companies that are relatively unaffected by supply chain and manufacturing disruptions on the other side of the world.

“That’s the service sector. Banks look perfectly placed in the current environments, inflation beneficiaries with relative insulation within their own cost base.”

---

About Paul Wild and Pendal global equities strategies

Paul Wild is senior fund manager with J O Hambro Capital Management, a London-based active investment manager which is part of Pendal Group.

Pendal offers a range of global equities strategies to Australian investors including:

• Pendal Concentrated Global Share Fund
• Regnan Global Equity Impact Solutions Fund
• Pendal Global Emerging Markets Opportunities Fund

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 Australian equities this week, according to portfolio manager BRENTON SAUNDERS. Reported by head investment specialist Chris Adams

• Find out about Pendal MidCap Fund

EQUITY markets continue to make gains, even with the US large cap indices held back by a negative reaction to Nvidia leading up to and post its result last Thursday morning AEST.

Nevertheless, the S&P 500 gained 0.9% last week, while the small cap Russell 2000 was stronger at 2.8% and the Euro STOXX 50 was up 3.5%.

Energy markets were weaker as the latest round of negotiations between the US and Iran gave some hope for a resolution, with Brent crude down 5.2% for the week.

Further comments from US President Donald Trump over the weekend that “an agreement has been largely negotiated” which involved opening the Strait of Hormuz leant some substance to this, though as of Monday morning this is still yet to be confirmed.

Long-term bond yields in OECD countries continue to rise. This is getting more attention and raising concerns around the possible structural nature of yield increases relating to generic risk premia and the potential for structurally higher inflation.

Domestically, a weaker employment release saw Australian bond yields and implied interest rate trajectories fall.

In contrast, US implied interest rates continue to rise, with 1.5 hikes now priced in by April 2027, reflecting ongoing concerns around rising inflation.

A fair amount of political and market backlash to the Australian budget spilled over into the week, with particular focus on the new macro prudential implications for real estate.

Gulf conflict

There were headlines over the weekend relating to some potential progress with regard to Iran’s contemplation of the latest US 14-point proposal. The details are as yet unknown.

The major ideological points around Iran’s nuclear capabilities and control over the Strait of Hormuz continue to seem intractable.

Both sides are however under pressure to find a solution, but the offramps remain unclear.

There have been some shipments through the Strait in the last week, but volumes remained close to zero.

Both China and Russia suggested that a comprehensive ceasefire in Iran was imperative, in the wake of Russian President Vladimir Putin’s visit to Beijing.

One of the stories of the week has been the precipitous decline in oil and product inventories in the US and other countries.

It still feels like the world could be sleepwalking into a real supply shortage issue without imminent resumption of Middle Eastern exports.

The US Energy Information Administration (EIA) data showed US crude inventories reduced by 7.9 million barrels last week. Including the strategic petroleum reserve (SPR) drawdown, it’s the largest drop in US crude stocks on record. Gasoline stockpiles also fell 1.55 million barrels.

US policy and macro

US data was mostly more of the same; inflation fears are making policy makers more hawkish at the margin and there was little change to the trajectory of real estate (soft) and labour markets (stable).

Housing

US housing data was mixed (and largely unchanged) but continues to reflect a market that is battling with high mortgage rates.

• Residential starts are looking like being down for the fourth year in succession and declined in April as construction of single-family homes dropped by the most in nearly a year, suggesting builders are growing cautious amid higher mortgage rates.
• The main geographical weakness remains in the South.
• Building permits were stronger but driven by multi-family dwellings, while single-family permits declined.
• MBA mortgage applications fell 2.3% for the week and applications for home purchases were down 4.1%, with prospective buyers pulling back as the US 30-year mortgage rate rose 10 basis points (bps) to 6.56%. This mortgage rate has since moved higher to ~6.7% given the move in the US 30-year bond yield.

The Fed

US interest rate expectations continued to increase, with 1.5 rate rises priced by April 2027 in light of high energy prices and its impact on inflation.

During the week Richmond Fed President, Tom Barkin, said the ability of businesses and consumers to tolerate supply shocks would determine whether the Fed can look through higher inflation without raising rates.

Meanwhile, Chicago Fed President Austan Goolsbee said he’s most focused on a resurgence of inflation against a backdrop of mostly stable employment indicators.

Fed Governor Christopher Waller was notably hawkish, suggesting supporting the removal of the easing bias and tabling the possibility of hikes in the absence of inflation abating.

FOMC meeting minutes from late April were released last week. The commentary was incrementally hawkish – and moderately more hawkish than expected – but given there were four dissenters in the meeting, the content is understandable.

The committee pointed to persistently high inflation and the vast majority saw increased risk that inflation takes longer to get back in target.

New Fed Chair Kevin Warsh was sworn in. He is seen as somewhat of a centrist on rates, but definitely not as dovish as Trump.

Not many have much to say on how Warsh’s likely tack on interest rate policy will differ from recent history. Most think he’s a sensible replacement with, if anything, a slightly hawkish bias.

Employment

Despite job cut announcements at Meta and Intuit, employment data remained fairly unchanged/stable and reasonably strong.

Meta began the first round of its planned 10% workforce reduction, cutting ~8,000 roles as it ramps up spending on AI infrastructure and automation. Management noted that workforce efficiency is needed to fund that capital outlay without eroding core operating margins.

Intuit announced ~3,000 roles (~17% of workforce) would be cut as well, citing similar reasoning to Meta regarding a focus on AI spend. US jobless claims were little changed for the week, signalling aggregate layoffs remain muted despite the recently announced job cuts.

Global rates

Concerns around the outlook for inflation are building at central banks globally.

This was clear in the FOMC’s last 8-4 split decision, more hawkish rhetoric from the European Central Bank (ECB) and Bank of England (BoE) and Norway’s Norges bank delivering a surprise rate hike earlier in May, when the market was only ~50% priced.

Every major central bank has seen pricing for their policy rate lift since the Iran war began.

Pricing by the end of 2026 has shifted ~60bps higher for the Fed, ~87bps higher for the ECB, ~54bps higher for the Bank of Canada and 114bps higher for the BoE – for an average increase of 78bps across these major central banks.

The shift in short rates is also reflected in longer dated yields. Across these major economies 10-year yields have risen by an average of 65bps since the Iran war began.

The shift in the curve appears to largely reflect greater inflation uncertainty and the expectation that rates will remain higher for longer.

Australia macro and policy

Employment

Last week’s weak unemployment print surprised the market.

Unemployment increased to 4.5%, versus 4.3% previously and expected by consensus, with some evidence the labour market is feeling the pressure of higher rates and the Middle East shock.

Youth unemployment rose 0.9% to 11.1%.

Both full-time and part-time employment fell, and the decline was concentrated in female employment. Westpac flagged Easter timing as adding noise, but the underlying signal appears genuinely weaker.

The unemployment rate is at a five-year high, although there was some noise in the data and it was not all bad.

Hours worked jumped 0.8% month/month to be 3.5% higher year/year, the highest rate of growth since July 2023.

Nevertheless, this likely rules out the possibility of a June RBA rate hike.

Implied interest rates still show another hike in 2026, but the amount and probability of further hikes have decreased materially in the past month – from 2.5 hikes to one.

RBA minutes

Minutes from the RBA meeting in early May where the board hiked 25bps to 4.35% in an 8-1 vote were mixed.

The board made clear it will tolerate weaker growth and rising unemployment (baseline UR 4.7% by mid-2028) rather than risk inflation expectations de-anchoring after a prolonged period above target. The RBA also acknowledged that it has space to pause and observe.

Given underlying inflation is forecast to stay above 3% until late 2027, and total financial conditions have tightened more in Australia than global peers given rate hikes and currency appreciation, the full transmission lag from hikes in February and March is still potentially to come.

This means the economy could weaken further from here even if rates stay on hold.

The board did explicitly leave the door open to future hikes if the data warrants. The market interpreted this as a potential hold coming for the upcoming meeting.

Federal budget

The 2026–27 federal budget continued to attract criticism.

Given it landed in a high-pressure environment, with inflation at 4.6% and the cash rate at 4.35% after three consecutive hikes, there is a view it is excessive and poorly thought through.

Polling showed as much with a continued rise in One Nation’s numbers, primarily at the expense of the ALP in the last month.

The main points of conjecture have been the impacts on residential real estate – and particularly first-time home buyers – and the impact to trusts.

Auction clearance rates continue to fall against a backdrop of high rates and the partial removal of incentives for residential real estate buyers and investors.

Other data

Westpac consumer confidence rose 3.5% to 83.0 (prior: 80.1, consensus: -1.1%).

• This was a modest bounce from April’s 12.5% plunge, driven by lower petrol prices after the government halved the fuel excise.
• Despite the uptick, the index remains deeply pessimistic and well below the long-run average of ~100, with 85% of respondents expecting further mortgage rate increases.

Consumer Inflation Expectations came in at 5.6% for May, versus the prior month at 5.9%, which is a mild positive for the RBA, but still well above comfort levels.

CBA confirmed it would be passing on the full 25bp RBA hike to variable home loan rates, effective 22 May 2026. Other major banks followed suit, adding to mortgage stress for households already strained by three consecutive hikes.

China macro and policy

Chinese economic data disappointed last week. Retail sales, industrial production and fixed asset investment all disappointed market expectations.

• A lack of consumer confidence and the effects of higher global fuel costs were evident in retail sales, up just 0.2% year/year relative to market expectations for a 2.0% gain.
• This came amid an ongoing decline in house prices – existing house prices fell 0.23% month/month, continuing a prolonged downturn in the housing market. Across China’s largest 70 cities, 49 saw price declines in the month.
• Industrial production of +4.1% year/year fell short of market expectations for 6% growth.
• Fixed asset investment fell 1.6% year-to-date relative to consensus looking for a 1.7% gain.

Broadly speaking, the Chinese domestic economy continues to disappoint expectations, with the export industry remaining the primary support for growth.

Markets

Nvidia result

The world’s biggest company reported Q1 2026 results last Wednesday. It was another “beat and raise” but failed to inspire markets – the stock traded lower before and after the result against the backdrop of a reasonably buoyant semi-conductor sector.

• Nvidia also announced an additional US$80 billion buyback and a dividend increase to US$0.25 per share from US$0.01.
• Management commentary continued to highlight strong AI infrastructure demand, alongside the company’s dominant market position, with Vera Rubin (its next-gen AI computing platform) on track for a H2 rollout.
• This came alongside solid execution in managing supply chain pressures, while maintaining a commitment to mid-70% range gross margins.
• The most notable developments were the newly announced reporting structures, increased attention around their CPU strategy (US$200 billion TAM), and higher capital returns (both buybacks and dividends), which were in focus ahead of the release.

The stock’s reaction is interpreted more as a response to heavy positioning in the stock and semiconductor sector generally. Nvidia’s stock price has had a similar response to the last seven quarterly results on a T+1 basis, despite ongoing beat and raise results.

Australian equities

Broad market moves on the ASX were moderately higher, tempered in the mid and small cap sectors which were hurt by a weaker gold sector (-6%).

Consumer staples (+2.7%), banks (+2.9%) and consumer discretionary (+1.2%) advanced while utilities (-3.7%), communication services (-2.3%) and industrials (-2.0%) lagged.

Here are the main factors driving Australian equities this week, according to portfolio manager BRENTON SAUNDERS. Reported by head investment specialist Chris Adams

• Find out about Pendal MidCap Fund

THE market is wrestling with the implications of the Iran conflict, which escalated over the course of last week.

Ahead of today’s market drop, the S&P/ASX 300 last week fell 3.3%, underperforming the S&P 500 (-2.0%) and NASDAQ (-1.2%) but holding up better than the Eurostoxx 50 (-6.8%), FTSE 100 (-5.7%) and Topix 500 (-5.7%).

Energy markets have unsurprisingly been the biggest movers so far, with West Texas Intermediate (WTI) and Brent crude oil up 36% and 28% respectively as at the week’s end.

The potential for significant knock-on impacts via energy-related prices and availability depends on the duration of the conflict.

Market expectations for interest rates and inflation also increased.

The US dollar continued to strengthen during the week as part of a “risk-off” trade. The US dollar trade weighted index (DXY) is now 2.9% up from its late January 2026 lows. The Australian dollar fell 1.2%.

Other commodities were mixed. Among base metals, copper was down 4.1% but aluminium was up 7.2%, given Middle East exposure to supply. Lithium fell 3.9%. Gold was down 1.6%, hurt by the prospect of higher rates and a stronger US dollar.

Software had some respite as the din around AI disruption softened. In the US, the software sector has outperformed the semiconductor sector by ~20% since 23rd February. 

It was a lighter week on the macro data side, but such that there was continues to point to a solid economic backdrop for both the US and Australia. 

Bond and rate markets have moved quickly to price the likelihood of higher inflation in the investment horizon and decrease the chance of short-term rate cuts (in the US) and increase the likelihood of short-term rate hikes (in Australia).

US labour markets are mixed – a surprise higher unemployment print on Friday did little to quell Fed Speak, which was incrementally hawkish largely because of the effects of the Iran conflict.

The main consideration for risk asset markets and economies is the duration of the conflict and associated disruptions/dislocations.

Iran

The conflict enters its second week causing major disruptions to all forms of air and sea traffic in the region and energy markets to inflect higher. Oil is now up 54-59% YTD.

There are some signs of fatigue from both sides. The Iranians appear to be running short of missile launch hardware and the Trump Administration appears to be starting to react to equity market weakness and oil price strength. Israel shows no signs of slowing.

The Strait of Hormuz is effectively shut for sea traffic, meaning of the ~20% of global crude that flows through it, around 90% is now choked off. Air traffic in the region is limited.

Oil and gas markets are showing significant first order consequences of the disruption and there is multiple second and third order effects starting to stack up.

For example:

• The price of aviation fuel has surged on the back of fear of shortages in Asia.
• “Crack spreads” – the margin made by refining crude into products such as petrol and diesel – have rocketed (potentially a tailwind for local refiners Viva Energy and Ampol).
• Coal prices have increased as a potential substitute.

Insurance for shipping in the region has dried up and is one of the major causes of the logjam of marine traffic in the region.

The US is planning a combination of marine escorts and insurance in an attempt to alleviate the situation, but this is likely to take more time.

Qatar, the world’s largest LNG exporter, has suspended production at its Ras Laffan Industrial City LNG complex, notwithstanding that most Iranian attacks have focused on US military instalments and civilian infrastructure as opposed to energy facilities in the region.

This has seen LNG prices – and gas prices generally – increase significantly.

The Dutch benchmark gas futures price is up 108% since its December 2025 lows to EUR53/megawatt hour (MwH), versus the 2022 (Ukraine Invasion) peak of EUR70/MwH, which caused major issues in the EU.

Some 9% of global aluminium production comes from the Middle East region – prompting the 7.2% gain.

Risk Asset Health

To date markets have been largely rational and fairly moderate in the interpretation of events.

There are, so far, few obvious signs of distress. This could change if the war drags on. 

Volatility

The VIX volatility index only shows signs of moderate stress and while it has spiked, it remains far lower than 2nd April 2025 (when Trump announced the tariffs) and Covid.

However, underneath this there is higher single stock volatility being masked at the headline level by high dispersion.

The point being is that this needs monitoring.

Credit spreads

At face value credit spreads are stable.

The bit that can’t be easily assessed is private credit stress, where defaults have been rising, with one of the big risks being software private credit on the back of AI disruption.

The market profile of this narrative is reaching high levels with private credit entering 2026 under clear strain, rising default rates, rising restructurings, dividend cuts at business development companies, and growing concern over opaque, floating rate middle market loans.

While losses have so far been contained, defaults and credit erosion have increased meaningfully, particularly among smaller borrowers and retail facing private credit vehicles.

The widespread adoption of the asset class poses a broader market risk if defaults continue to rise.

US Macro and policy

Activity data in the US was solid, with both the ISM manufacturing index and the Fed’s Beige Book indicating fairly broad-based strength.

Labour data was weaker and tax returns lower than expected, questioning the expectations around consumption strength in 1H 26.

The latest Beige Book (information collected on or before February 23) suggests that:

• Economic growth was broadly unchanged, with activity increasing at a slight to moderate pace in the majority of districts.
• AI-related spending was seen as an important driver of economic growth.
• Consumer spending continued to grow although at a slower pace and notably K-shaped. 
• Employment levels were generally stable, and wage growth was also roughly unchanged, continuing at a moderate pace.
• The US ISM continues to be solid and point toward a manufacturing upturn.
• The ISM manufacturing index dipped to 52.4 in February, from 52.6 in January, but came in ahead of the consensus of 51.5.
• One of the most notable parts was the 11.5 point increase in prices paid to 70.5. This is the highest since June 2022 and is a function of the year-to-date increase in oil prices and a delayed boost from tariffs.
• Until recently US employment data has mostly been solid with most interpreting this as the start of an upturn in employment. It is now showing signs of some softness.
• Last week’s data continues to support strong average hourly earnings growth but payrolls data on Friday was unexpectedly weak.
• February 2026 payrolls fell by 92,000, well below the consensus expectation of +55,000. The two-month net revision was -69,000.
• The unemployment rate rose to 4.4% in February, from 4.3% in January, above the consensus of 4.3%.
• Average hourly earnings rose by 0.4%, above the consensus of 0.3%.

Many commentators point to the volatility and large revisions the data frequently undergoes, but this is a weak print, nonetheless.

It should help offset some of the strength in inflation data, with respect to forward interest rates.

In that vein, it is worth noting that a $10 increase in oil prices roughly results in a 30-40-basis-point increase in headline personal consumption expenditures (PCE) inflation.

The gasoline price is up materially year-to-date but still in the range of the past four years (as of 5th March 2026).

Elsewhere:

• US Tax refunds are only up 10% year-to-date versus the +30% expectation. Given a fairly widespread expectation of accelerated tax return driven-consumption in 1H CY26, this needs to be watched.
• US Non – Farm Productivity remains strong and increased at an annualised rate of 2.8% in Q4, above the consensus of 1.9%.
• January retail sales were down -0.2%, albeit slightly above consensus and mostly unalarming as sales ex gasoline were up +0.3%.

Comments from various Fed members and officials became incrementally more hawkish in the wake of the Iran conflict and despite the weak jobs print on Friday.

Oil and its impact are clearly a major issue for the committee now. 

Both Michelle Bowman (Fed Vice Chair for Supervision) and Neel Kashkari (Minneapolis Fed President) noted that their expectations on inflation have changed in recent days.

New York Fed President John Williams struck a more dovish tone, noting that the market response at that time had been muted and still pointed to further rate reductions.

Macro and policy Australia

There was something for everyone in terms of interest rate expectations last week, with a weak household consumption number offset by a strong GDP print.

• Q4 real GDP jumped 0.8% quarter/quarter and revisions lifted year/year to 2.6%, the best since Q1 2023. The composition was messy, but a strong beat nonetheless.
• Corporate profits increased a strong 5.8% in Q4 2025.
• The Household Spending Indicator (HSI) increased 0.3% month/month in January 2026, slightly below the +0.4% expected after December 2025 retraced by -0.5% month/month.

Also, housing prices continue to be strong as a national average up 9.9% year/year and rents up 5.6%.

Bond yields and interest rate expectations both rose because of this and the rise in oil prices.

Most expect the RBA to raise rates in May if not March – which is now considered “live”.

Markets

While near-term uncertainty remains high, “captive liquidity” can help markets. Retail investors via ETFs and trend following investors continue to “buy the dip” as economic liquidity remains high. Market movements in the last while need to be seen against this backdrop i.e. markets are still fully functional. 

US software had a materially better week and has outperformed semi-conductors by 20% since 23 February 2026 – still way below 2025 relative levels, but a significant improvement.

It felt like AI disruption took a bit of a back seat as the market’s understanding of the threat to Software continued to evolve.

This helped the S&P/ASX 300 Information Technology sector gain 2.4%, beaten only by Energy (+8.7%). There was a part reversal of some of the outperforming sectors year to date, like Banks (-3.2%) and Resources (-5.2%)