As Portfolio Manager, Lewis co-manages our Australian smaller companies and micro-cap funds and conducts fundamental analysis on a range of smaller companies. Lewis joined the Pendal Smaller Companies team in 2013 as a small cap analyst, before being promoted to the role of Portfolio Manager in 2018. Lewis brings 20 years of industry experience with previous roles spanning equities research at boutique stockbroking firm, Taylor Collison, as well as commercial and investment banking roles at Westpac Bank and Commonwealth Bank. Lewis holds a Bachelor of Commerce (Corporate Finance) from the University of Adelaide.
As Portfolio Manager, Patrick co-manages our Australian smaller companies and micro-cap funds and conducts fundamental analysis on a range of smaller companies. Patrick has been part of the Smaller Companies team for a collective period of eleven years. Patrick initially joined the company in 2005 and developed his career as a highly regarded small cap analyst. Patrick worked at a small cap boutique as a portfolio manager for 3 years before re-joining Pendal’s Smaller Companies team in January 2018. Patrick holds a Bachelor of Commerce (1st class Honours) from the University of Queensland and is a CFA Charterholder.
Here are the main factors driving Australian equities this week according to our head of equities Crispin Murray. Reported by quantitative analyst Lee Ma
GLOBAL markets rebound marginally last week. The S&P500 gained 0.5% while the S&P/ASX 300 index finished in the red (-0.8%).
The market is clearly weighing up negatives around central banks removing stimulus earlier than expected versus the positives of a strengthening global economy.
Our view is that the taper is now largely priced in by the market. The incremental news is that the global economy is re-accelerating after the Delta-driven slowdown and an easing of some supply chain bottlenecks.
This should lead to an equity market rally into the year’s end.
The main news last week was the ongoing Evergrande story amid Chinese property concerns; and the Fed’s slightly more hawkish messaging, with the pace of tapering now slightly faster than the market expected.
Covid and vaccinations
Global trends have continued to improve, notably in the US. After school re-openings led to a rise in cases, US infection rates are now falling along with hospitalisations in some states.
Emerging markets are also improving as they ramp up vaccination. This is important since supply bottlenecks stemmed from factory closures in a number of EM countries such as Vietnam.
US data continues to show most hospitalisations and deaths are among the unvaccinated. This shaped the US Food and Drug Administration’s view on booster doses — which are approved only for over-65s.
The view is that the role of the vaccine is to stop people getting too sick, rather than completely stop the virus. The FDA did not see a need to approve an extra dose for the broader population given a lack of data on long-term effects.
This will give time for a variant-specific booster to be trialled (which is now underway).
At home, NSW is going better than expected and Victoria is in line with forecasts.
First-dose vaccination rates in NSW are averaging 42k per day v 46k last week. This has taken NSW to 88% first dose and potentially 90% this coming week. Second-dose vaccinations are more in line with expectations at 70k per day v 61k last week. The run rate is expected to pick up to 72k this week.
NSW is on track to reach 70% on October 5 and 80% by October 15.
Hospitalisations in NSW appear to have peaked at 1268 and are now down to 1146. ICU cases peaked at 234 and are now 222. Both figures are well below forecasts from the start of September.
We remain of the view that we will see a sharp recovery in activity on the east coast coming into November.
We are positive on domestic stocks leveraged to this.
Economics and policy
Updates from the US Federal Reserve last week were broadly in line with market expectations — with a slightly more bearish tilt.
The taper is due to start in November and finish by mid-year — two-to-three months earlier than consensus.
This implies a reduction of $15 billion per quarter rather than per meeting as the market previously thought (or $18 billion per meeting v $15 billion expected).
The dot plots were in line with an even split for the first hike in 2022 versus 2023. The logic for the faster taper is to give the central bank some flexibility if inflation stays higher next year.
The market has 25bp priced in by the end of 2022.
On the data front, median expectation for inflation has risen 20bp to 2.3%, implying the 30bp average increase in rate levels by the end 2022 in the dots.
The 2022 median GDP growth rate forecast has also risen by 50bps to 3.8%. Unemployment is now expected to fall to 3.8% by the end of 2022.
Fed chair Jerome Powell’s language has become more cautious on inflation, with the “transitory” period now lasting into 2023 and even 2024.
Overall, the underlying message was that inflationary pressures have been more resilient, particularly given supply chain bottlenecks.
This extended period of higher average inflation means the Fed will need more flexibility to respond, potentially before the end of 2022.
China
China remained in the limelight last week. Property giant Evergrande appears to have missed interest payments due on bank loans and offshore bond issues due last week. A grace period is likely to involve negotiating some form of restructure.
Cash flow appears to be directed into funding projects, which is politically sensible. We may see unfinished units sold at a discount to other developers, potentially those backed by the state.
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Our view remains that this will not be a systemic issue. There will be some attempt to put a floor under the economy given the importance of the property market.
Market moves suggest this is the case — the Chinese currency, credit spreads and equity market did not move much despite the headlines.
Against this backdrop we think the case for a policy shift in China is high, which will support cyclicals.
There is a lot of sensitivity about an overly sharp slowdown next year as president Xi Jinping locks in his third term. The need for economic growth remains important.
Meanwhile the UK is experiencing some chaos from rising electricity prices, gas shortages and labour shortages (notably truck drivers).
This is leading to some food and fuel shortages. The issue reinforces the need for more inventories of strategic commodities, higher wages and more investment. This probably contributed to a more hawkish Bank of England meeting last week. A rate hike is now becoming likely by May.
A positive outlook
Overall we are becoming more positive as falling global Covid cases allow economies to re-open.
We can see the Fed GDP numbers start to tick better, having weakened sharply over the last two months.
The bond market also continues to signal that the economy is faring better. US bond yields are following their European counterparts in breaking out of their recent trading range.
The economic surprise index also looks to be bottoming. And a significant inventory re-build is required in a number of industries as soon as supply chain blockages are resolved.
All in all, this should be supportive of cyclicals and financials v defensives. Cyclical growth will continue to do well, but more defensive growth, such as healthcare may underperform.
Markets
Bond yields went up last week in the US and Australia. Commodities generally recorded gains.
Iron ore had a wash-out last week, bottoming in the US$90s, before sharply bouncing off these lows. In the $90s, the cost curve will start to move.
We have already seen a lot of marginal suppliers for iron ore — such as Ukraine and India — redirect stocks back into their own markets as prices fall. This will make China more reliant on Australian ore.
While we don’t expect a big bounce in iron ore, we do believe the falling prices have come to an end for this year.
About Crispin Murray and Pendal Focus Australian Share Fund
Crispin Murray is Pendal’s Head of Equities. He has more than 27 years of investment experience and leads one of the largest equities teams in Australia. Crispin’s Pendal Focus Australian Share Fund has beaten the benchmark in 12 years of its 16-year history (after fees), across a range of market conditions.
Pendal is an independent, global investment management business focused on delivering superior investment returns for our clients through active management.
Find out more about Pendal Focus Australian Share Fund here.
Oliver co-manages the Pendal income strategies with Amy Xie Patrick. He has extensive experience in macro, quant and credit research. Primarily, his role is to enhance the Income & Fixed Interest team’s quant process including development of machine learning models and big data capabilities. Prior to joining the team, Oliver spent two years in the Pendal Investment Products team, where he worked closely with both the portfolio management and distribution teams, providing quantitative support, portfolio positioning and commentary to the business and clients. Oliver received his Bachelor of Commerce (Finance) from the University of Sydney and is also a CFA Charterholder.
As Melbourne construction workers protest mandatory vaccinations, investors may want to consider how a ban on unvaccinated workers could impact the economy, says Pendal’s Tim Hext
THIS WEEK has been relatively quiet for bond markets, despite an attempt at excitement around China.
I learnt long ago that little happens by accident in China.
The government has the ability and the smarts to control what is going on. Letting Evergrande wobble is more about sending a message than a misguided step that will send the economy into freefall.
Of course the usual chorus line of doomsdayers have lined up to predict just that.
I am not one of them.
Maybe eventually they do stumble, but you’ll go broke betting on it long before then.
The impact of banning unvaccinated workers
Our attention is more focused on what is happening domestically — in particular the how and when of re-opening in NSW and Victoria.
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The area of concern for us is how unvaccinated workers are treated.
The concern is less ethical — I will leave readers to their own views — but what it means for the workforce.
If one in ten workers end up unvaccinated, whether for health or personal reasons, their potential exclusion will have a significant impact on the supply side of the economy.
Most employers are currently awaiting government guidance, but until rapid testing is widely available it seems many will be banned from working.
The demand side of the economy is likely to return quicker than the supply side.
We are increasingly confident that 2022 will see higher — not lower — inflation and the RBA will be tested on its benign view.
Wages should also pick up faster.
Future inflation as measured by markets remains stuck around 2%, which to us provides an opportunity.
About Tim Hext and Pendal’s Income & Fixed Interest boutique
Tim Hext is a Pendal portfolio manager and head of government bond strategies in our Income and Fixed Interest team.
Tim has extensive experience in banking, financial markets and funding including senior positions with NSW Treasury Corporation (TCorp), Westpac Treasury, Commonwealth Bank of Australia, Deutsche Bank, Bain & Co and Swiss Bank Corporation.
Pendal’s Income and Fixed Interest boutique is one of the most experienced and well-regarded fixed income teams in Australia.
Find out more about Pendal’s fixed interest strategies here
About Pendal
Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management.
In 2023, Pendal became part of Perpetual Limited (ASX:PPT), bringing together two of Australia’s most respected active asset management brands to create a global leader in multi-boutique asset management with autonomous, world-class investment capabilities and a growing leadership position in ESG.
With over 14 years’ industry experience, Oliver is an analyst focused on the Health Care and Utilities sectors. Starting his career with the business in 2004, Oliver has also worked with the Quantitative Services, Product and Performance and Attribution teams. He holds a Bachelor of Commerce (Finance and Financial Economics) from the University of New South Wales, where he was awarded the Australian Institute of Banking and Finance Award in his penultimate year, and is a CFA Charterholder.
Higher interest rates will eventually work, but they’re not working just now, argues Pendal’s OLIVER GE. That could mean bonds become even better value next year
- Inelastic demand and supply mean rates work differently
- In likely scenario, bonds a good place to invest
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WHAT if higher interest rates worked against cutting inflation?
Or at least had little effect on demand — making rate hikes ineffective in the fight against inflation?
“I want to talk about the idea that in an environment where demand is still reasonably strong, interest rate hikes effectively do nothing,” says Oliver Ge, an assistant portfolio manager with Pendal’s income and fixed interest team.
“Rather than cooling things down, they might be pushing them back up,” Oliver says.
The idea comes down to the notion of elasticity of demand – a measure of the change in the demand for a product in relation to the change in its price.
Elastic demand means there’s a big change in quantity demanded when there’s a change in price.
Inelastic demand is the opposite – little change in demand no matter what the change in price.
“When households are in decent shape, as they are today – when you have wages growth at decade highs and unemployment at near record lows, and savings are still plentiful – you end up with an environment where people are much less sensitive to price changes,” Ge says.
Covid lowered our price sensitivity
“During lockdowns, people were happy to pay for a whole range of goods like laptops, gardening tools, toilet paper,” notes Ge. “Consumer demand collectively channelled its momentum into household items.
“Suppliers jacked up prices but there was still plenty of demand.
“While we have moved on from Covid, we haven’t moved on from this sort of low-price sensitivity environment.
“The money has only moved on from chasing goods to instead chasing services.
“The bottom line is that the elasticity of demand is very, very low. It’s basically inelastic.”
Services are labour intensive – hospitals, hotels, cafes, restaurants, airlines employ hundreds of thousands of people, Ge says.
“Even though we’ve added a million people to the workforce since 2020, businesses are still experiencing labour shortages.
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“It’s a Covid hangover. People want to go out. They don’t want to be the people serving everyone else.”
“As a central banker you see inflation rising and your natural instinct is to raise rates. But the usual transmission mechanism is broken,” he says.
Transmission breakdown
Previously lifting interest rates would trigger tighter lending and refinancing, and companies would cut back on costs, including staff, says Ge. That would lead to higher unemployment and that would dampen inflation.
“But today, businesses aren’t really cutting back on staff. They’ve struggled to find and retain the right people, and thus don’t’ now want to lose them,” Oliver explains.
“Instead what they’ve chosen to do is compromise in other areas – say reduce the quality of ingredients if they are a restaurant.
“Or they are just passing the cost through to the consumer. And people are happy, at present, to pay the higher prices. Until they’re not.”
This process demonstrates an inelasticity of supply, as well as demand.
“So you have this relationship where higher rates are hurting businesses and to cope, they’re lifting prices, which consumers are paying.
“There’s a breakdown in the transmission of monetary policy to the employment market. In a very counterintuitive way, hikes are making things worse, not better.”
What it means for fixed interest investors
Higher interest rates will eventually work, but they’re not working just now, argues Ge.
“It will be the straw that breaks the camel’s back. It’s hard to see the stresses today but when it comes, it will come suddenly.
“I think there will be a fairly aggressive breaking point around the middle of next year. The Reserve Bank could realise too late, and then desperately try to reverse the rate rises.
“At which point bonds could become very good value. They are already good value, but that’s when the have the potential to become even better value.”
About Oliver Ge and Pendal’s Income and Fixed Interest boutique
Oliver Ge is an assistant portfolio manager with Pendal’s Income and Fixed Interest (IFI) team.
Oliver works on developing and running key quantitative investment models, and acting as trading support for the team. Oliver received his Bachelor of Commerce (Finance) from the University of Sydney and is also a CFA Charterholder.
Pendal’s IFI boutique is one of the most experienced and well-regarded fixed income teams in Australia. In 2020 the team won the Australian Fixed Interest category in the Zenith awards.
The invests across income, composite, pure alpha, global and Australian government strategies.
Find out more about Pendal’s fixed interest strategies here
About Pendal Group
Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management.