The Pendal Multi-Asset team have completed their annual Strategic Asset Allocation review. As an outcome of the review, effective from 20 December 2023, a portion of the Fund’s international share exposure will be hedged to the Australian dollar. Currently the Fund’s international share exposure is generally not hedged to the Australian dollar.

ASX investors have seen a flurry of corporate transactions and associated equity raisings in recent months. Here Pendal equities analyst ANTHONY MORAN explains the opportunities

• Negative reaction to M&A can uncover opportunities
• Orora and Treasury Wine recent examples.
• Find out about Pendal Focus Australian Share fund

NEWSPAPER headlines have been full of merger and acquisition activity and associated capital raisings in recent months.

Chemist Warehouse-Sigma Healthcare. Brookfield-Origin. Newcrest-Newmont. Allkem-Livent. Woodside-Santos.

The activity is likely to continue in 2024, especially in the resources space.

Investors haven’t always been impressed with recent deals – but that doesn’t mean there isn’t opportunity, says Anthony Moran, an analyst with Pendal’s Aussie equities team.

Negative reactions and sell-offs following M&A deals can provide opportunities for investors, says Moran.

“Any deal that is large enough to be raising equity tend to be shareholder destructive in the short term,” he says.

“The market tends to over-react to the downside and that’s understandable because the market doesn’t like diluting the positive investment case for a company.

“M&A introduces a whole new element of uncertainty. There are going to be risks around the businesses being bought, and investors have to learn about them,” he says.

“Also, Australia’s track record of large M&A is extremely weak. It’s just a safer bet that a deal won’t go too well, almost regardless of the details.”

Opportunities from negative reactions

The negative reaction to M&A can provide potential investment opportunities, Anthony explains.

“Market over-reactions around M&A are exacerbated at the moment with fears that the economic cycle is rolling over.”

Investors are concerned that companies are buying businesses that may have puffed up earnings or been trading on a cyclical peak, he says.

“They are worried that the acquiring company has not done enough due diligence and that gives them a reason to sell off the acquiring stock.

“But if you can do the work on the acquired businesses and start to get an understanding and more informed perspective on the probability of the success of a deal, then the sell-off could be quite an attractive investment opportunity.”

Take a long-term view of M&A

Amcor’s purchase of US-based flexible packaging company Bemis in 2019 worked well with significant cost synergies extracted and an improved top line.

But initially, after the deal was announced, Amcor was sold off.

A similar example was Boral’s 2016 purchase of US-based fly ash producer Headwaters.

Following the announcement of the deal Boral was initially sold-off – then bid up as investors got excited by the potential growth prospects of the Headwaters business.

Ultimately there were few natural synergies between the businesses and as the underlying low quality of the Headwaters business became apparent, Boral underperformed over several years.

It recent months, two ASX-listed companies — both held in Pendal equities funds — have acquired businesses and are now trading on historically low multiples.

“Packaging group Orora (ASX: ORA) bought a France-based specialty premium glass manufacturer that supplies high-end glass bottles for luxury spirits and is a global leader,” Anthony says.

“But investors are worried that post COVID, the growth in luxury spirits, in particular, is rolling over.  

There are concerns Orora paid too much, the industry is going to become more competitive and the ESG burden of decarbonising returns will hurt returns,” he says.

Treasury Wine Estate (ASX: TWE) bought a US luxury wine company that has grown quickly in recent years.

Investors are concerned that the growth in earnings will not be sustainable, and that US consumer demand will wane.”

Anthony says that while it is much too early to tell whether the Orora and Treasury purchases are good deals, the kneejerk reaction from markets, selling off the companies, provides an opportunity for investors.

“Take the time to do the work on the underlying assets purchased. Talk to other industry participants and find out how these businesses are positioned, what’s sustaining their returns and what the outlook is.

“And bear in mind that doing the deals haven’t changed the underlying assets in the rest of the businesses.

“The de-rating has hit both the acquisition business and the legacy businesses. That means the legacy businesses have gotten cheaper.”

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About Anthony Moran

Anthony Moran is an analyst with more than 15 years of experience covering a range of Australian and international sectors. His sector coverage has included Australian Industrials and Energy, Building Materials, Capital Goods, Engineering & Construction, Transport, Telcos, REITs, Utilities and Infrastructure.

He has previously worked as an equity analyst for AllianceBernstein and Macquarie Group, spending a further two years as a management consultant at Port Jackson Partners and two years as an institutional research sales executive with Deutsche Bank.

Anthony is a CFA Charterholder and holds bachelor’s degrees in Commerce and Law from the University of Sydney.

Find out more about Pendal Focus Australian Share Fund  

Contact a Pendal key account manager

What lessons can fixed-income investors take from 2023 into 2024? Pendal’s head of income strategies AMY XIE PATRICK summarises the outlook with fellow PMs TIM HEXT, GEORGE BISHAY and STEVE CAMPBELL

• Pendal’s 2024 outlook for bonds, credit and cash
• Why bonds, why now? Pendal’s income and fixed interest experts explain
• Find out about Pendal fixed interest capabilities

I LOVE this time of year. Not only is there plenty of holiday cheer, there is also time to survey the landscape as we head into a new year.

Five key observations that stand out to me from 2023:

• Recession never arrived, though it was widely expected at the start of the year
• Inflation came off without a significant rise in unemployment
• Riskier assets saw healthy returns while bonds had another challenging year
• US 10-year real yields pushed past 2%
• Small and regional US banks have not solved their fundamental problems.

Interestingly in October, when the real yield on 10-year US treasuries tested 2.5%, the bond sell-off halted.

Perhaps the market was saying: “sure, growth is strong now, but the party won’t last forever”.

How we fared in 2023

Pendal’s fixed income team reassessed the situation when we saw the economic data wasn’t weakening.

We identified that, in Australia, the fixed-rate mortgage cliff was a red herring.

George Bishay, our head of credit and sustainable strategies, moved away from a more conservative stance and started to re-risk his credit portfolios.

From banks to utilities, industrials to infrastructure, George has been cherry-picking his way through the primary market since things calmed after the US banking crisis.

“As long as inflation can continue to come down, bond market volatility can be contained,” says George.

“As long as bonds are no longer aggressively selling off, I’m happy to be tactically raising my credit exposures.”

Tim Hext, Pendal’s head of government bond strategies, recognised that just because inflation had peaked, it didn’t mean the fight was over.

While keeping duration positions small during the year, volatility threw up many opportunities in the physical bond space that he was able to take advantage of.

“You can’t ignore the fact that they’ve continued to pump out fiscal stimulus in the US,” says Tim.

“Australian bond markets have been passengers in the US-led sell-off.

“However patient the RBA wants to be, CGLs (Commonwealth Government Loans) couldn’t fight the strong tide of US Treasuries.”

Steve Campbell, our head of cash strategies, has had similar views, but was able to position a little differently in his portfolios.

“The cash funds were predominantly longer than the benchmark over 2023, despite the Reserve Bank continuing to tighten monetary policy,” Steve says.

“The additional yield and the steepness of the curve helped protect the cash funds’ performance from the move higher in yields over the period.”

As Pendal’s head of income strategies, I have the privilege of all this expertise around me.

The income funds benefited from the wisdom of my peers, positioning at first defensively and then risking up on credit.

Positioning long enough in duration earlier in the year in time for the Silicon Valley Bank crisis, then pulling back in to weather the bond storm.

In more defensive moments, Steve made sure extra cash in the income funds kept up with or beat offerings on term deposits – with the added advantage of liquidity.

I’ve enjoyed having that liquidity at my disposal this year. The income funds can take on exposures in Australian equities and emerging markets.

Although both those asset classes generated positive returns this year, there was plenty of volatility along the way.

Thanks to liquidity provided by Steve, the high yield he has offered on cash and our active asset allocation process, the income funds have been able to take advantage of this environment.

Where to from here?

Here’s a quick 2024 outlook on bonds, credit and cash from our income and fixed interest portfolio managers.

Bonds

Bonds have had three challenging years in a row – will there be a fourth? I ask Tim Hext.

That’s very unlikely, he argues.

“My framework for 2024 is for falling inflation and yields. Though as always, I’ll be flexible within the framework, since it likely won’t be a straight line down.”

That’s a good point to remember, I believe. It’s been a while since we’ve had straight-forward, unequivocal bond rallies.

“If the US Fed cuts rates as expected, markets will price in cuts here,” says Tim. “Though the RBA will likely be slow to react, since they rely on the lagging indicator of inflation to set policy.

“I’m watching the new RBA monetary policy board and how that works.

“Also, don’t forget stage-three tax cuts come in July.”

And the line I like the most from Tim: “Even if policy is on hold here for most of 2024, markets will not be standing still.”

This paints a backdrop against which our active investment process can shine.

Credit

Would rate cuts mean bad news for riskier assets like credit?

“Not necessarily,” says George Bishay.

“Like the past year, if the market can feel that inflation can be contained and the growth picture holds up, that’s basically a Goldilocks scenario and equities should do fine.”

Where Australian credit goes is largely led by where US equities have gone before, George often reminds our team.

If the Goldilocks picture can continue, George will be happy to hold on to the risk he now has. But he’s also ready to act if that isn’t the case.

“That’s why I’ve been very discerning in the type of risk I’ve been adding over the year,” George says.

“You can’t ignore the tail risks out there. As the US banking crisis showed us earlier in the year, sentiment can sour very quickly.

“I’ve kept to top-quality issuers, stayed in senior positions in capital structures and always had an eye on liquidity when I’ve been adding risk this year.”

Thanks to George’s nimble approach, I’m not worried about the income funds’ ability to pull credit risk in at the right time.

Cash

Will cash still be in vogue if a new cutting cycle starts in 2024? I ask Steve Campbell.

“Let’s not confuse the RBA with the Fed,” Steve reminds me.

“I expect fourth-quarter inflation to be lower than the RBA’s forecast. That should mean the Reserve Bank is done hiking.

“But any talk of a new RBA rate-cutting cycle is premature. Inflation is still too high and the labour market is still too tight.

“I expect the cash rate to remain unchanged over 2024, though with bouts of volatility.

“Significant global monetary policy tightening since early 2022 and related spill-overs will become more obvious in the coming year as economic growth slows further.”

Because of the uncertain environment ahead, Steve argues that “highly liquid cash strategies rather than term deposits are a better way for investors to capitalise on any bouts of volatility.”

If things go south and bonds still can’t protect you, it’s critical to have a deeply experienced cash manager by your side.

If Steve is right about bouts of volatility, our active and tactical return booster levers – which buy equities or emerging markets – should continue to get a work-out in 2024.

But if he is also right about a further slowing of economic growth, I expect tactical forays into riskier exposures in the income funds will become less frequent.

Recession odds for 2024

The consensus on US recession stands in stark contrast to this time last year.

Economies have been far more resilient than markets anticipated – and markets in turn have adjusted their expectations.

Soft-landing is now the narrative.

Worryingly, fundamentals have deteriorated as the lagged effects of monetary policy tightening play through.

There doesn’t need to be another Silicon Valley Bank-like shock to send the US economy into recession in the second half of next year.

In fact, I’d put the odds at about two-thirds.

It just takes the continuation of the same economic trends we’ve witnessed in recent months.

Slack is coming back into labour markets. Fewer people are quitting, fewer employers are saying it’s hard to find workers.

Lending standards have tightened, meaning credit growth will keep contracting and default rates will keep climbing.

Delinquency rates in consumer loans have risen for seven quarters straight (not months).

The concentrated exposure of smaller US banks to the commercial real estate sector is an unresolved tail risk.

Nothing in that list is dramatic, but the collective force is more likely than not to bring on a recession in 2024.

For much of 2023, the narrative was about too much supply and not enough demand for US government bonds.

If a recession hits next year, demand for safe-haven assets will overwhelm supply, even if the fiscal taps remain on.

Equity markets tend to peak about six months ahead of a recession.

The next few months is a chance to get your house in order.

Consider rotating back into fixed income and cash – and look for good active management.

Here are the main factors driving the ASX this week according to portfolio manager JIM TAYLOR. Reported by portfolio specialist Chris Adams

• Find out about Pendal Focus Australian Share Fund

THE constructive narrative was unchanged by last week’s US data.

November’s non-farm payrolls and average hourly earnings data — along with surveys of inflation expectations and Job Openings and Labor Turnover (JOLTS) — all told a story of modest slowdown. There was no significant evidence that consumers or businesses were walking off a cliff.

The short end of the US Treasury curve sold off – perhaps reflecting a realisation that the market was a touch over-optimistic on the potential pace of monetary easing.

Ten-year US yields were relatively flat for the week, while yields rose at both the long and short end of the Australian curve.

Oil remained under the pump, with Brent crude down 3.9% for the week and 20.4% lower over the quarter to date. This is starting to translate into some relief at the fuel pumps for consumers. 

Gold pulled back from its highs (down 3.8%) while iron ore rose 3%, and its resilience is likely to persist into Q1 2024.

US equity markets delivered their sixth straight week of positive returns – the best run since November 2019 – though returns were relatively modest in the context of what we have seen over the last couple of months.

The S&P 500 gained 0.24% while the S&P/ASX 300 was up 1.69%.

This week, we have the Fed Open Monetary Committee meeting (December 12-13) as well as the November US CPI report.

On the latter, consensus is looking for a 0.05% month-on-month rise in headline inflation but a steep step-up to 0.3% month-on-month in core inflation.

US macro and policy

October JOLTS came in at 8.73 million versus September’s 9.35 million and consensus expectations of 9.3 million. 

It paints a picture of broad-based slowing in the labour market, but not the plunge some feared given the scale of rate increases. For every employed person, there are now an estimated 1.3 jobs available (down from 1.5).

The largest declines in job openings come from private sectors such as education (down 238,000) and financial services (down 217,000).

The Quits rate remained at 2.3%. (The three-month moving average in the private sector is running at 2.6% and falling).

This has historically provided a strong six-month lead on the direction of private-sector wages and salaries in the US Employment and Cost Index. It suggests growth in the latter should continue to soften.  

November payrolls rose 199,000, which was a touch above consensus of 185,000. This helped by an end to the auto worker strike.

The unemployment rate fell 0.2% to 3.7% versus consensus of 3.9%. This rise was driven more by an increasing workforce rather than more unemployed people.

Average hourly earnings rose 0.4% versus consensus at 0.3%. The three-month annualised rate of 3.4% versus 4% previously seems to be heading in the right direction. 

With commodities, goods and rent inflation all seemingly under control, wages remain one of last areas to address.

The US Federal Reserve is focusing on wages growth, which is the main driver of core non-rent PCE services inflation. Because of low productivity growth in many services, wage growth can quickly change price inflation.

Wage growth between 3% and 3.5% should be enough to see core non-rent PCE services inflation at 2.5% and overall medium-term core PCE inflation at 2%.

Lower petrol prices and higher stock markets played an important role in the December Michigan consumer sentiment index hitting 69.4 – up from 61.3 in November and ahead of consensus of 62.

In the same survey, one-year inflation expectations fell 1.4% percentage points to 3.1%, which is the largest single drop in a month since Covid.

Meanwhile, expectations over the five to ten-year timeframe also fell from 3.2% to 2.8%. 

This is all good news for the Fed, which closely watches consumer inflation expectations.

RBA leaves rates on hold

As expected, there was no Christmas Grinch from the RBA – with rates unchanged at 4.35%, as expected. 

However, the forward-guidance of data-dependency and the evolving assessment of risks was maintained.

On the labour market, the statement noted that “wages growth is not expected to increase much further and remains consistent with the inflation target, provided productivity growth picks up. Conditions in the labour market also continued to ease gradually, although they remain tight”.

We see some risk to this view. Recent data suggests there may be further persistence in wage growth in contrast to other economies.

The Board will next meet in February, after monthly and quarterly CPI data (due on January 10 and 31 respectively) and labour market updates.

Comments from the RBA’s head of financial stability Andrea Brischetto last week were consistent with the feedback we’ve received from banks: the cohort of borrowers that are under severe financial stress is unexpectedly very small given the magnitude of the rate rises we have seen.

Brischetto’s observations included:

• around 95% of variable-rate owner-occupier borrowers still have spare income after meeting their mortgage payments and essential expenses
• around 5% find their income insufficient to cover their mortgage payments and essential expenses, however, many of these mortgagees do have savings in their mortgage offset and redraw accounts
• this leaves less than 2% of all variable-rate owner-occupier borrowers who have both an income shortfall and low savings buffers, and so could fall into severe financial stress within six months assuming interest rates remain around current levels.

This suggests an aggregate level of the economy is getting through the great variable-rate reset without falling off “the mortgage cliff.”

The RBA and government’s conduct of monetary policy statement included a key change towards a shift to greater emphasis on the midpoint of the 2-3% inflation target, less emphasis on financial stability, and a requirement of the RBA to provide a more detailed assessment of full employment.

It also outlined changes to improve communications and accountability, such as publishing unattributed votes after each meeting and requiring external Board members to give public speeches.

Australian macro

Third-quarter GDP growth was softer than expected at 0.2% and 2.1% over 12 months.

Due to the increasing cost of living, consumption is growing at its slowest yearly rate since Q1 2021 while the savings ratio dropped to its lowest point since Q4 2007.

There were positive drivers from government expenditure (up 0.2%), investment (up 0.2%) and inventory growth (up 0.4%), which helped offset a drag from net exports (down 0.6%).

Productivity improved, rising 0.9% after a 1.6% fall in Q2. This was in a response to hours worked falling 0.7% (a level that is down 2.1% year-on-year).

Unit labour cost growth slowed to 1.2% for the quarter and is up 6.4% year-on-year, down from 7.4% in Q2.

While high, it is heading in the right direction.

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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

Rates to stay on hold | The case for corporate bonds | An asset class you probably haven’t thought of | Aussie mid-caps with India exposure

Here are the main factors driving the ASX this week, according to CRISPIN MURRAY. Reported by portfolio specialist Chris Adams

• Find out about Pendal Focus Australian Share fund

MARKETS have been emboldened by several factors: continued signs of slowing inflation with a soft landing, signals from policymakers that possible rate cuts are on the horizon, and a failed meeting between OPEC+ constituents which drove oil prices back to recent lows.

This growing confidence in slowing inflation, combined with the unwinding of bearish positioning in the markets, has driven the S&P500 to calendar-year highs.

Since the end of October, the US Dollar has fallen about 3%, while US 10-yr Treasury yields are some 70 basis points (bps) lower, and oil is down about 8%.

This has all contributed to the S&P 500 rallying 8.9% in November.

This risk-on rally has led to the Goldman Sachs US Financial Condition Index easing the most in any single month for over forty years. And the VIX – a measure of volatility – has fallen from 19 to 13, which is a post-pandemic low and also signifies market confidence.

Interestingly, US Federal Reserve (the Fed) board member Christopher Waller’s comments last week fuelled rate cut expectations – sentiments Chairman Powell chose not to reverse in his speech on Friday.

The S&P/ASX has lagged the US, but still posted a 5% return for November.

It still sits about 7% below 2023 highs, reflecting a worse inflation/growth trade-off than in the US, which leaves policy risks higher here.

The S&P/ASX 300 returned 0.53% for the week, while the S&P 500 was up 0.83%.

Economics and policy

Inflation data continues to trend in the right direction.

The US Personal Consumption Expenditures index (PCE) was in line with expectations, with the headline measure flat month-on-month and up 3% year-on-year.

Core PCE was up 0.2% month-on-month and 3.5% year-on-year, while the core services ex-housing PCE (the Fed’s preferred measure) rose 0.1% month-on-month versus 0.4% in the previous month.

This shows we are back to a clear, slowing trend.

The weakness in oil has also helped reinforce these positive signals, while US macro data has also been softer – though not to a point that could fan recession concerns:

• There were some softer signals in the labour market, with continuing claims ticking higher. US payroll data is due later this week.
• US Real Consumption growth has slowed, rising 0.2% month-on-month and 2% year-on-year, even with demand bolstered by a fall in gasoline prices.
• Real disposable income growth picked up 0.3% month-on-month, the fastest rate in five months. This highlights one of the potential supports for the US economy into 2024, as wages catch up and inflation falls.
• The rundown of excess savings has supported consumption. Though this month savings rates improved slightly to 3.8%, this is still down from 5.2% six months ago.
• The Fed’s “Beige Book”, which includes anecdotes at a regional level, is also highlighting slowing activity and softer labour markets.
• The US ISM Manufacturing PMI data was slightly weaker than expected, staying flat month-on-month at 46.7 versus consensus at 47.6. The production and employment components both fell month-on-month, while orders improved.

All these signs of slowing are validated by the Atlanta Fed GDPNow tracker which – in previous quarters – has been a good predictor of economic growth proving more resilient than consensus expectations.

Now, it is slowing sharply.

Elsewhere, eurozone inflation was weaker than expected too.

Core CPI fell 0.15% month-on-month. The three-month annualised rate is 0.65% and is running at 4.9% year-on-year. Services inflation is rolling over, albeit with some one-off drivers, such as packaged tour prices.

The Fed

These signals are fuelling a bond market rally, which has been reinforced by Fed speakers.

Waller really fired things up, saying that if the data was to continue on the current trend for the next three-to-five months, then the Fed would have to consider rate cuts on the premise of keeping the real rate flat.

This was the first signal that the March meeting could be “live” for a cut.

Though he is not seen as central bank leadership, Waller has been hawkish through this inflationary cycle.

On Friday, Chairman Powell chose not to offset Waller’s comments – noting that policy is restrictive and putting downward pressure on growth and inflation, that the full effects of tightening have not been felt, and that the Fed remains “data-dependent”.

However, Powell also said it was premature to speculate on when policy may ease.

This has all been taken positively by a market that is keen to pull the trigger on a peak in the rate cycle. The first market-implied rate cut has been brought forward from June to April and the number of cuts for 2024 has increased from three to five.

There is a risk that the market is getting ahead of itself here, as it did in March and April of this year.

There is a self-regulating aspect to the US economy in that the rally in bonds and a weaker US Dollar already provide looser financial conditions, reducing the need for actual rates to be cut this quickly.

Markets

November’s equity market displayed some of the hallmarks of a liquidity-driven rally.

For example, the more speculative end of the technology sector outperformed the NASDAQ, suggesting some rotation away from larger tech names.

Within Australia, small-caps outperformed larger caps.

Commodities

Gold has been a key beneficiary of the shift in rate expectations, testing all-time highs.

Gold mining stocks, which lagged the gold price move in October, are now catching up and made gold the best-performing sector last week.

Copper also showed signs of life last week, despite the outlook for slowing growth.

This partly reflects supply disruptions, with the First Quantum Cobre Panama mine contract (which represents 1.5% of global supply) being ruled as unconstitutional and the President saying the mine would be closed.

First Quantum have taken the matter to the International Court of Arbitration.

Oil is testing its lows for the year, after the OPEC+ meeting failed to result in a new target for 2024 production cuts; instead, there is to be a deepening of existing voluntary cuts into Q1 2024.

Theoretically, this implies 700,000 barrels-per-day (bpd) of additional cuts.

Saudi will roll its existing voluntary cut through to March and Russia said it would raise its cut from 300,000 from 500,000 bpd. Elsewhere, the UAE, Iraq and Kuwait have all offered to cut by an additional 163,000, 223,000 and 153,000 bpd, respectively.

But the issue is that the market has no conviction in these cuts being met.

For instance, Russia is cutting exports – not production – and sanctions have not worked. The same is true for Iran. Meanwhile, Angola said it wouldn’t follow the deal and Brazil, which was added to OPEC+, said it would not be party to quotas.

The scale of the cuts, the limited impact on prices, and the prospect of a seasonally weak Q1 leave the market believing the additional cuts may prove to be less than 100,000 bpd and insufficient to offset weakness in oil.

We note that oil price weakness relates more to incremental supply in 2023 from US shale and Brazil – plus more supply from Russia and Iran reaching the market – than any demand weakness.

The concern is that any slowing in the economy could compound the imbalance.

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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 a 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 bonds still look better than TDs | What we learned from the OpenAI coup | Why our EM experts like India

India may have fallen short in the 2023 Cricket World Cup, but it’s been on a winning run since last hosting a world cup in 2011

• India now an attractive EM for investors
• Digital infrastructure has strengthened economy
• Find out about Pendal Global Emerging Markets Opportunities fund

INDIA hosted the ICC Cricket World Cup in 2023 for the first time in 12 years.

The result was not what local fans wanted to see, unlike 2011 when India last hosted — and won — the tournament.

But the country is certainly winning in other ways, points out Paul Wimborne, who co-manages Pendal Global Emerging Markets Opportunities fund.

In the intervening 12 years between the two tournaments, the country changed massively, becoming a more attractive location for emerging markets investors, says Wimborne.

“The most significant changes have been in internet connectivity and digital infrastructure.

“India now has the second-highest number of internet users in the world. An estimated 60 per cent of the population are connected so we are talking about hundreds of millions of people.

“They have high-speed internet access particularly in the urban areas and that’s a massive change since the 2011 World Cup,” he says.

How India became a digital giant

In 2015 the Narendra Modi government launched Digital India, a program designed to digitise government services and provide internet infrastructure across the country.

The successful project altered India and became a blueprint for developing nations, Wimborne says.

There are three layers to India’s “digital stack”, which is essentially government-backed APIs (application programming interfaces) on which third parties can build software.

“The first layer is identity. The identity card in India is known as Aadhaar. It is linked to biometric data which provides proof of identity.

“Over 90 per cent of the population has a card with a 12-digit unique identifier. About 700 million of the cards on issue are now linked to a bank account.

“The second layer is a unified payment interface, or UPI. It is essentially an instant payment system via mobile, which makes payments as easy as sending a message or scanning a QR code.

“There are now an estimated 10 billion transactions every month on the system.

“The third layer is a data exchange. For example, the government runs DigiLocker, which provides access to authentic digital documents linked to citizens. It might be a passport or a driving licence, or the ability to e-sign documents.”

Huge changes ahead

The approach has provided India with the building blocks for future innovation and services, Wimborne says.

“We are going to see huge changes in things like healthcare, and digital commerce. SMEs (small-to-medium enterprises) will have much greater ability to sell online.

“Some of the key benefits we’ve seen so far is for banks and mobile phone companies. It has reduced the time taken to do checks and massively cut costs.

“Some of the benefits accruing to the broader economy range from less tax avoidance, less cash in the economy and a reduction in general fraud and corruption,” Wimborne says.

“India has always had a strong services export economy based on software and services. This is going to kick things along even further. India is going to become an even bigger powerhouse.

“India has done well over the last few years in terms of economic growth and the equity market.

“These reforms and changes have increased the trend growth rate in India. There has been huge progress already, but the real benefits might be still to come over the next five to ten years.”

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About Pendal Global Emerging Markets Opportunities Fund

James Syme, Paul Wimborne and Ada Chan are co-managers of Pendal’s Global Emerging Markets Opportunities Fund.

The fund aims to add value through a combination of country allocation and individual stock selection.

The country allocation process is based on analysis of a country’s economic growth, monetary policy, market liquidity, currency, governance/politics and equity market valuation.

The stock selection process focuses on buying quality growth stocks at attractive valuations.

Find out more about Pendal Global Emerging Markets Opportunities Fund here
 
Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management.

Contact a Pendal key account manager here

Markets are pricing in a soft landing, but in a new Bloomberg webinar, Pendal’s head of income strategies AMY XIE PATRICK argues a US recession is not off the table

• Why bonds, why now? Pendal’s income and fixed interest experts explain
• Browse Pendal’s fixed interest funds
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THIS week I was asked about my highest conviction call for 2024 in a Bloomberg webinar discussing key market views for the coming year.

While markets are pricing in a soft landing, I argued there would likely be a US recession in 2024.

A lag in the impact of policy tightening has been evident in the slowdown of inflation and wages in recent months.

This can be seen particularly in shifting trends in the labour market.

The most obvious signal is a falling “quits rate”, signalling workers are becoming less confident about alternative job prospects.

In my view, lagged effects will continue to appear in the data next year — and as we all know from history, recessions happen slowly, then suddenly.

We will likely find a moment in the second half of next year where markets realise disinflation is no longer immaculate — and is being caused by recessionary forces.

A non-consensus view

When asked about my most non-consensus view, I can’t resist pointing out clear signals that the Fed’s Senior Loan Officer survey has been sending.

This survey asks US loan officers if they are tightening or loosening lending standards.

The data points to US default rates likely hitting double digits by the second half of 2024.

Unlike the interest rate charged on borrowings, lending standards refer to the criteria and restrictions placed on borrowers seeking finance.

The tighter those standards, the harder it is for marginal borrowers to access funding.

When small businesses can no longer access funding for every-day business needs, bankruptcies and defaults start to happen.

Rising default rates are already evident, yet high-yield credit spreads are still glued to the floor.

Even if my default rate outlook is overly pessimistic, the risk-reward doesn’t seem to be there for continuing to stretch down the quality ladder for that extra bit of yield.

Especially not when considering two-year US government bonds are now yielding almost 5%.

Listen to the full Bloomberg webinar featuring Amy Xie Patrick

Here are the main factors driving the ASX this week, according to Pendal investment analyst JACK GABB. Reported by portfolio specialist Chris Adams

• Find out about Pendal Focus Australian Share fund

IT WAS a Thanksgiving feast for the bulls in the US last week, with the S&P 500 up 1% (and 8.9% month-to-date) following the latest CPI print.  

A combination of factors — dovish minutes from the US Fed, seasonality, rampant “big tech”, and systematic investors (like commodity trading advisers) being underweight equities — all pushed the market to one of its strongest-ever Novembers. The week closed out near year-to-date highs.  

While higher-than-expected consumer inflation expectations provided a small note of caution, expectations remain high that the Fed is done hiking rates and will cut by mid-2024. 

Unfortunately, the same can’t be said of Australia, with the ASX falling 0.1% last week.  

If it’s “job done” for the Fed, it’s clearly not for the RBA – with comments from Governor Michelle Bullock underscoring a gulf in inflation and interest rate outlooks between Australia and the US.   

US treasuries were little changed given the Thanksgiving public holiday.  

The yield curve did push further into inverted territory, though it has been there for some time (and just how reliable this is as an increased indicator for a recession remains open to debate).  

The Fed and US rates

The implied probability of a Fed rate cut by mid-2024 has risen 15 percentage points over November and is now sitting above 60%. 

Central bank minutes published during the week provided little new information but were generally viewed as slightly dovish, given united caution on further rate hikes.  

There was a 50-basis point reduction in forecast headline PCE inflation to 3% by year end (with the core PCE forecast at 3.5%). 

By 2026, core and headline inflation rates are expected to be close to 2%. Officials also noted credit standards tightening in many sectors and some concern over rising consumer loan delinquencies.  

US economy

Most US data continues to support a dovish Fed outlook.  

For example, durable goods orders were down 5.4% in October – mostly on softer aircraft orders. Excluding aircraft, orders for non-defence capital goods still fell 0.1% and September’s order growth was revised to a decline.  

The outlier was the University of Michigan inflation expectations survey, where median year-ahead inflation expectations rose to 4.5% – the highest since April. Long-term expectations rose to a 12-year high of just above 3%. 

Where to for the US?

It’s clearly been a positive November for global equities and momentum suggests the rally has further room to run.  

Amid declining core inflation and rising rate cut expectations, US markets appear well supported, particularly as data continues to point to a mild slowdown rather than a recession.  

The Conference Board Leading Indicators index is a case in point. It is now showing signs of a possible bottom.  

Historically, this has occurred at a median of 61 days before the end of every recession since the 1969-70 downturn, with stocks gaining a median 23.4% in the year following a trough. 

Initial signs from Black Friday sales were also positive.  

Expectations heading into the traditional start of the holiday shopping period were relatively muted, with the first three weeks of November essentially flat year-on-year.  

However, Adobe Analytics estimated that Black Friday sales were up 7.5% year-on-year, while Salesforce estimated that spending in the US and across Australia and New Zealand was up 9% and 5%, respectively.  

Finally, S&P earnings expectations also continue to be revised higher, having bottomed in Q1 and Q2.  

It can be helpful to also remember that 2024 is an election year, which has historically tended to be positive for equity markets. An average annual return of 10.2% dates back to Roosevelt’s win in 1932. 

So, what could go wrong?

1. Possibility of recession: The current 7.6% fall on the Leading Indicators index would be the largest ever year-on-year decline without a recession. The yield curve remains inverted and the economy is slowing, with data for inputs like durable goods showing meaningful declines. If inflation expectations are correct, rates could stay higher for longer and risk more significantly lagging effects. We note that if the Fed cuts because of a recession, the equity outlook will be very different.  
   
2. Seasonality: This factor is undeniably less supportive in the near term. December, February and March have been softer for the S&P 500 over the past few years. 
   
3. Positioning is no longer as supportive. November has seen a shift in underweight equity positions. Commodity trading advisers have reduced 80% of their shorts in global equities in the past two weeks, buying $60-70 billion worth of shares. The pace of purchases is now expected to slow, though there is still potentially $30-40 billion to buy over the next fortnight. The S&P is also technically overbought (RSI >70). Over the past 12 months, the S&P 500 ETF has crossed this level six times and then, on average, fallen 1% in the following 20 days. Finally, measures of options pricing suggest that demand for downside and tail risk hedging have fallen materially.  

The RBA and Australian rates

In contrast to the US, expectations for a February rate hike in Australia have nearly doubled since its last meeting.  

Governor Bullock’s speech was interpreted as laying down hawkish credentials, arguing that the inflation problem facing Australia is largely domestically driven – not the global problem that many have believed.  

As such, we are arguably not on the same path as others.   

Inflation is seen as broad-based, with 66% of the CPI basket running at greater than 3%. It is only lower than average for a few items, such as fresh food and holiday travel.  

More generally, services demand is continuing to exceed supply, and with limited labour market spare capacity, inflation is expected to take longer to come back down to target.  

We note that the next CPI print is Wednesday, with consensus expecting a 5.2% annualised increase versus 5.6% in the last reading.   

It is also worth noting the impact of rent. According to SQM (a residential property research group), rental inflation is set to grow 7-10% in 2024, down from 15.5% in the year to mid-November but still at high levels.  

Eurozone

Inflation data due on Thursday is expected to show CPI dropping to 2.7%, which is the lowest since July 2021. However, officials have cautioned that it may pick up again in the short term due to statistical effects. 

According to European Central Bank President Christine Lagarde, rates are at a level that will help bring inflation back to the 2% target if maintained for long enough. That target is expected to be hit in 2H 2025.  

However, the economy is already showing stress, with GDP down 0.1% in Q3. Data on PPI during the week also showed a contraction to 47.1 – the sixth consecutive month below 50.   European bonds also slid on concerns of higher supply, with Germany announcing the suspension of its constitutional limit on net new borrowing for a fourth consecutive year.                          

China

Over the past few months, there has been a renewed focus by authorities on growth, with a range of measures announced to support construction in China.  

Last week, it was revealed that authorities would allow Chinese banks to offer unsecured short-term loans to qualified developers for the first time – a major push to ease the property crisis.  

The previous funding shortfall has been estimated at US$446 billion.  

Time will tell whether this latest measure is sufficient to turn the tide when previous efforts have failed. But over the short term, the impact has been positive for developer shares and bonds, as well as iron ore.    

Commodities wrap

Iron ore: The lack of material Chinese steel production curbs this half – on contrast to previous years – have seen demand remain strong. Coupled with inventories, which are at a five-year low for this season, prices have been driven up 6.4% month-to-date. With further regulatory moves to boost the property sector and strong seasonality ahead of Chinese New Year, our view is that demand and pricing will remain well supported into early next year.  

Oil: It was a quieter week for oil, which remains 7.8% lower month-to-date. Uncertainty continues to cloud the upcoming OPEC+ meeting, which has been delayed until 30 November while US stockpiles continue to grow.  

Lithium: Prices continue to decline on weak demand and rising inventories, with the latter now accruing more at upstream producers rather than at converters and battery manufacturers. Chinese carbonate futures are down 37% over three months to 125,000 RMB/t, but they remain above marginal cost at about 80,000 RMB/t. Given the ongoing inventory build and that we’re heading into a typically weaker period for demand, there remains a high risk that prices continue to decline unless, or until, we see production or project curtailments.   

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About Jack Gabb and Pendal Focus Australian Share Fund

Jack is an investment analyst with Pendal’s Australian equities team. He has more than 14 years of industry experience across European, Canadian and Australian markets.

Prior to joining Pendal, Jack worked at Bank of America Merrill Lynch where he co-led the firm’s research coverage of Australian mining companies.

Pendal’s Focus Australian Share Fund has an 18-year track record across varying market conditions. It features our highest conviction ideas and drives alpha from stock insight over style or thematic exposures.

The fund is led by Pendal’s head of equities, Crispin Murray. Crispin has more than 27 years of investment experience and leads one of the largest equities teams in Australia.

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.

Find out more about Pendal Focus Australian Share Fund  

Contact a Pendal key account manager

 

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