What can we learn as UK stocks outperform their global peers? We asked Pendal Group’s CLIVE BEAGLES

• Post-Covid — and five years after Brexit vote — UK market is outperforming
• British economy is growing fast as economy re-opens
• Australia’s re-opening is three-to-six months behind

FEDERAL treasurer Josh Frydenberg told Sydney radio this week that the United Kingdom’s approach to re-opening was “really instructive” for Australia.

Despite a high infection rate, the British economy is growing fast and its stockmarket is out-performing its global peers.

“They’re still getting 30,000-plus cases each day, but their rate of hospitalisation has fallen by 83 per cent since the peak at the start of the year,” Frydenberg told 2GB.

“As you know, they’re not turning back — they’re living with the virus and so should we here in Australia.”

UK data supports his view.

Last week the UK’s Office for National Statistics upgraded economic growth for the June quarter from 4.8 per cent to 5.5 per cent. The International Monetary Fund and the OECD expect the UK economy to expand at a 7 per cent clip this year, and around 5 per cent next year.

The FTSE100 gained around 1 per cent over the past month while other major indices in the United States, Japan, Germany and Australia were lower.

Five years after Britain voted to leave the European Union, the threat of a post-Brexit slowdown now appears to have well and truly passed.

“Whatever the reason, the conditions are right for the UK market to outperform,” says Clive Beagles, a senior fund manager at Pendal Group’s UK-based asset manager J O Hambro Capital Management.

What can Australian investors learn from the UK?

If Frydenberg is right, what can Australian investors glean from the UK’s re-opening experience?

“The fact that the UK is fully opened up now shows where Australia will go in three to six months,” says Sydney-based Pendal portfolio manager Tim Hext.

We’ll face similar issues such as demand outstripping supply and tighter labour — and we have similar stockmarket themes such as higher exposure to commodities and lower exposure to technology.

In the UK, “employment is the main driver of growth at the moment … the labour market is incredibly tight”, Beagles says.

Labour supply issues supply should be a shorter-term issue in Australia as borders re-open, says Hext. The UK faces a more structural challenge on that front, reckons Hext.

Beagles says “the UK is more openly talking about raising interest rates … and bond yields have gone from 75 basis points to 120.

“While there’s a short-term focus on the cost-of-living crisis because of energy prices, there’s also this huge pool of savings ready to be unleashed.”

Stockmarket themes

The UK’s economic pick-up underpins the stronger outlook for the FTSE. But several other factors that have worked against the UK market in recent years are now supporting shares.

The FTSE 100 has a heavy weighting to oil and gas and energy companies, including BP, Glencore, Anglo American and Royal Dutch Shell.

These have been less loved as support for environmental, social and governance (ESG) issues has grown. But as energy prices soar, hitting multi-year records, UK investors are again shifting into the oil and gas and coal companies, Beagles says.

The FTSE 100 gets around two-thirds of its earnings from outside the UK market, so it also depends on the global economy. But when the local economy gains momentum, sentiment for the bourse improves.   

“The UK market also has a bias towards value stocks (there are relatively few technology stocks) and financials,” Beagles says.

“These can benefit from higher rates. And there’s a weighting towards commodities. Mining and oil companies tend to do well when rates are rising as inflation hedge.”

Combined it means UK equities are an attractive place to invest, he says.

“The day in the sun for the UK market might finally be coming after five years in the doghouse since the Brexit referendum.”

Australian investors will be hoping for similar as we re-open and learn to live with the virus.

About Pendal Group

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

Find out about Pendal’s investment strategies

Contact a Pendal key account manager

Significant Features: The Pendal Global Select Fund is an actively managed portfolio of global shares.

Fund Objective: The Fund aims to provide a return (before fees, costs and taxes) that exceeds the MSCI ACWI NR Index (net dividends reinvested) in AUD over rolling 5 year periods.

Crispin is Head of Equities at Pendal, a fund manager within the broader Perpetual Group.

He joined the funds management business of BT Financial Group, now Pendal, in 1994, initially responsible for European equities and served as Head of European Equities from April 1998.

Crispin was subsequently appointed to his current role in January 2003 overseeing Pendal’s Australian equities business, one of the largest fundamental equity boutiques in the market based on team size and funds managed.

He is responsible for managing a number of our flagship Australian equity funds, which under his watch have outperformed the market over multiple periods since his appointment in 2003.

Prior to Pendal, Crispin worked for Equitable Life in London.

Crispin is a Director of the Anika Foundation and served as a Director of Football Federation of Australia from 2015-19.

He holds an Honours degree in Economics & Human Geography from Reading University.

There’ll be a lot of talk at this month’s climate change conference in Glasgow. Pendal’s MURRAY ACKMAN explains what Australian investors should pay attention to

IN TWO WEEKS world leaders — maybe even our ScoMo — will fly to Glasgow for the 26th UN Climate Change Conference of the Parties (or “COP26”).

There will be a lot of talk — but Australian investors should watch a few things closely, says Pendal Credit ESG analyst Murray Ackman.

“This is not your typical gab-fest,” says Ackman.

“The pressure on countries to act is very real as we’ve seen recently with the Morrison government’s turnaround on a 2050 emissions target.”

Murray says Aussie investors should pay attention to three things:

1. End to coal power

Coal accounts for about half of energy-related CO2 emissions and will have to be phased out to reach net zero emissions by 2050. Many are pushing for this COP to include a commitment on ending coal power.

Increasing uptake of renewables in Australia is coinciding with reduced coal use — but we still export a lot of coal.

Businesses that produce coal (eg Whitehaven), transport it (eg Aurizon) or ship it (eg Port of Newcastle) would be severely impacted by a global decision to phase out coal, Murray says.

2. Australia as a pariah

New national targets to cut greenhouse emissions by 2030 will be announced at Glasgow — as required under the Paris Agreement.

Many developed countries have already flagged stronger targets.

But Australia has been without a substantial climate policy for nearly a decade — which could start to cause problems for us, says Ackman.

“The carbon intensity of an economy may be a differentiator for future investments.

“We’ve already seen some investors avoid businesses and government bonds due to a perceived weakness in climate policy.

“They’re now known as ‘brown markets’ as opposed to ‘green markets’.

“If Australia’s national targets are not regarded as ambitious enough, this divestment trend may continue.”

3. Investment opportunities

A faster shift away from fossil fuels presents obvious challenges for Australia, since they relate to a quarter of our exports.

But change can also lead to significant opportunities.

“There is a very clear path to reduce Australia’s domestic emissions which will require substantial infrastructure investment,” says Murray.

“There will be a lot of spending on the electricity supply of the future with transmission lines, interconnectors and energy storage.

“There are also opportunities for export, whether that’s green hydrogen (produced by renewables), minerals required for electric vehicle batteries and even copper.”

 

Significant Features: The Pendal Focus Australian Share Fund is an actively managed concentrated portfolio of Australian shares.

Fund Objective: The Fund aims to provide a return (before fees, costs and taxes) that significantly exceeds the S&P/ASX 300 (TR) Index over the medium to long term.

The RBA’s Melbourne Cup day meeting will be closely watched after Wednesday’s inflation numbers. TIM HEXT explains why.

IN AUSTRALIA we only get inflation data quarterly, so the number is keenly anticipated.

For the inflation hawks Wednesday didn’t disappoint. For the RBA it looks like a decade of over-estimating inflation has now moved to a new decade of under-estimating.

The headline inflation number was on forecast at 0.8% for the quarter and 3% annually. However it was the underlying number that shows a more concerning picture.

Underlying inflation strips out the top and bottom 15% of moves, usually including fuel and food. Here the number was 0.7% for the quarter.  This is the highest since 2014.

While that is only 2.1% annually, markets will usually annualise the latest quarter to get a more current read.

Of course 0.7% means 2.8% — above the RBA target.

Looking under the hood a number of factors were at play.

Fuel prices were up 7%.  We knew that already but  they have gone up further in October.

New dwelling purchase prices, or building costs, are losing the dampening effect of Homebuilder subsidies. These costs had risen around 5% over the last year but until now this was offset by the subsidy.

Property rates were also up 3%.  Household items, usually flat or down, were up 3 to 4%. Maybe its transitory but time will tell.

The RBA next meets on Melbourne Cup day. What could have been a “nothing to see here” pre-race statement will be keenly watched.

Three days later the Statement on Monetary Policy comes out which will provide their updated forecasts.

No doubt the RBA will play down the impact of one number but inflation is already above their forecast for 2022.

Some upgrades will be required. The confidence in their “no rate rise till 2024” outlook will either be toned down or removed. It will be a step too far for now for 2022 to be in play for rate rises but surely 2023 should be.

In terms of their current policy actions there will be no changes for now. However Quantitative Easing is reviewed in February, before which we will have the Q4 CPI print.

Also, whether they keep the April 2024 bond at Yield Curve Control at 0.1% is debateable. They can change that any time and given they actually have to put their money where their mouth is with that policy, it may be reviewed sooner.

Overall we continue to hold inflation bonds in portfolios where we can and will continue to do so until the market prices in 2.5% inflation.

After these numbers that day is getting closer.

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About Tim Hext and Pendal’s Income & Fixed Interest boutique

Tim Hext is a Pendal portfolio manager and head of government bond strategies in our Income and Fixed Interest team.

Tim has extensive experience in banking, financial markets and funding including senior positions with NSW Treasury Corporation (TCorp), Westpac Treasury, Commonwealth Bank of Australia, Deutsche Bank, Bain & Co and Swiss Bank Corporation.

Pendal’s Income and Fixed Interest boutique is one of the most experienced and well-regarded fixed income teams in Australia.

Find out more about Pendal’s fixed interest strategies here

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About Pendal

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

In 2023, Pendal became part of Perpetual Limited (ASX:PPT), bringing together two of Australia’s most respected active asset management brands to create a global leader in multi-boutique asset management with autonomous, world-class investment capabilities and a growing leadership position in ESG.

Contact a Pendal key account manager

It looks like investors believe the RBA is wrong on its inflation outlook — and they could be right, says Pendal’s Tim Hext

MARKETS and most central banks have spent most of October talking about higher inflation and potential or actual rate hikes.

The RBNZ hiked in early October (delayed from August). The Bank of England looks like moving soon. The US Fed have signalled likely hikes in H2 2022.

Only the RBA is holding their line from earlier in the year — they see no need to hike until 2024. Inflation may creep higher but they don’t see it hitting their 2.5 per cent target until 2024.

Usually on the hawkish end of the spectrum, the new RBA is firmly down the dovish end.

So which market has seen the biggest move higher in five-year bond yields over the last month?   

Australia.

Even this week the RBA did not change sentiment in their minutes. I suspect they are even more perplexed by recent moves than us.

Whenever things like this happen we try and find a rational explanation. Often it isn’t rational but here goes.

The first one is duration positioning, which was longer in Australia than others because of RBA rhetoric. Painful stops have been apparent.

The second one is the market thinks the RBA will revert to previous modus operandi and hike before inflation reaches its target.

This would be wrong. The RBA knows its credibility is on the line and Governor Lowe has been at pains to say there will be nothing pre-emptive this cycle.

For economic reasons the only explanation may be that the market thinks the RBA is wrong on its inflation outlook.

On this one I agree. I think inflation will hit their target in 2022 and hikes will follow in early 2023.

On our portfolios we remain overweight inflation bonds where we can.

We have covered duration shorts and current levels leave us considering whether there is value in short-end yields.

Long-end yields however will need to see 2% before we ask the same question.

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About Tim Hext and Pendal’s Income & Fixed Interest boutique

Tim Hext is a Pendal portfolio manager and head of government bond strategies in our Income and Fixed Interest team.

Tim has extensive experience in banking, financial markets and funding including senior positions with NSW Treasury Corporation (TCorp), Westpac Treasury, Commonwealth Bank of Australia, Deutsche Bank, Bain & Co and Swiss Bank Corporation.

Pendal’s Income and Fixed Interest boutique is one of the most experienced and well-regarded fixed income teams in Australia.

Find out more about Pendal’s fixed interest strategies here

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About Pendal

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

In 2023, Pendal became part of Perpetual Limited (ASX:PPT), bringing together two of Australia’s most respected active asset management brands to create a global leader in multi-boutique asset management with autonomous, world-class investment capabilities and a growing leadership position in ESG.

Contact a Pendal key account manager

AT THE END of September we were trying to understand market pricing versus what the Reserve Bank was saying.

Governor Lowe had been at pains to say the RBA would not hike rates until inflation was sustainably at its 2.5% target.

Yet markets were pricing for higher rates, while expecting inflation at only 2%.

Unless your view is Governor Lowe will change his mind, something must be wrong. Given his term is up in September 2023, an about-face is not likely.

The question is whether rate rise expectations are too high or inflation expectations too low?

How will the circle be squared?

As mentioned many times before, our view is inflation will rise to 2.5% in late 2022 and into 2023 — so we expect higher rates in 2023.

We also own inflation bonds against being underweight in nominal bonds (in portfolios where they are allowed).

Of course it pays to remind investors that a nominal yield is made up of a real yield and inflation.

A fixed rate bond “fixes” a level on both of these. An inflation bond fixes the real yield but the inflation component is floating — that is, actual inflation.

So the higher inflation goes, the more inflation bonds outperform nominal bonds.

This past week has seen bonds continue their sell-off on global inflation fears.

Expectations are now for cash rates to hit 1% in 2023, consistent with our view. We have closed underweight duration positions but will be leaving our inflation bond position on for now.

Equity markets and credit markets continue to adjust to a world of lower monetary support. So far moves have been modest and largely well behaved, consistent with a relatively smooth transition.

If we are right and inflation moves modestly higher it won’t upset the overall positive outlook for risk markets.

Maybe what’s happening is markets are beginning to price a risk, albeit a low one, for a world where inflation pushes far higher than 3%.

Stagflation always gets wheeled out at these times.

There is a chance of short-term stagflation on supply issues, but it is certainly not our medium-term base case.

Just don’t expect double-digit returns on risk assets going forward.

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About Tim Hext and Pendal’s Income & Fixed Interest boutique

Tim Hext is a Pendal portfolio manager and head of government bond strategies in our Income and Fixed Interest team.

Tim has extensive experience in banking, financial markets and funding including senior positions with NSW Treasury Corporation (TCorp), Westpac Treasury, Commonwealth Bank of Australia, Deutsche Bank, Bain & Co and Swiss Bank Corporation.

Pendal’s Income and Fixed Interest boutique is one of the most experienced and well-regarded fixed income teams in Australia.

Find out more about Pendal’s fixed interest strategies here

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About Pendal

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

In 2023, Pendal became part of Perpetual Limited (ASX:PPT), bringing together two of Australia’s most respected active asset management brands to create a global leader in multi-boutique asset management with autonomous, world-class investment capabilities and a growing leadership position in ESG.

Contact a Pendal key account manager

Here are the main factors driving the ASX this week according to Pendal investment analyst GRAEME PETRONI. Reported by investment specialist Chris Adams

• The Fed and BoE cut rates by 25bps, the RBA remains unchanged
• Economists modelling various scenarios for Trump’s policies
• Find out about Pendal Focus Australian Share Fund

IT was a big week for markets following the US election.

The S&P 500 rose 4.69% on pro-growth policies around tax cuts and deregulation.

Bond markets stabilised after sharp moves higher in the lead up to the election, with the outcome suggesting a lower trajectory for US rates.

Trade tensions dragged on Europe, while China benefited from optimism in the lead up to the NPC meeting, which ultimately failed to deliver on expectations.

The Australian market echoed the US with respect to financials, tech and cyclical industrials outperforming, while taking a more cautious approach to resources – with the S&P/ASX 300 closing the week up 2.23%.

While macro moves dominated, there was a fair amount of news flow, particularly from bank reporting season.

Banks reported solid results but without any further follow through on the positive thematics that had been building around margins and balance sheet.

US election

The US election is widely regarded as having been won on the economy. The catch cry “are you better off than you were four years ago?” clearly resonated.

It looks likely to be a clean sweep of the popular vote, electoral college, Senate and House, potentially giving Trump a mandate for reform. However, the House is close and the Senate lead is slim, which may put some constraints on passing legislation.

Trump talked about some big policies throughout his campaign, like a significant lift in tariffs (50-60% on China, 10-20% rest of world), tight immigration controls (15-20 million deportations) and lower taxes (extend 2017 cuts, no taxes on social security, overtime and tips).

But in his post-election speech, there was no mention of tariffs or China and references to immigration were dialled down (“we’re going to have to let people come into our country… but they have to come in legally”).

This illustrates significant uncertainty on the extent to which Trump’s campaign policies are implemented.

Economists have modelled various scenarios.

If tariffs are limited to 20% for China and 5% for the rest of world, and if net migration only moderates to 500,000 per annum, the inflationary impact is contained to 0.5 percentage points (ppt).

There is also a negative growth impact, but this would potentially be offset by taxes and deregulation.

The end outcome for the Federal Reserve (the Fed) is estimated to be two to three fewer cuts in 2025, potentially implying US cash rates don’t fall much below 4%.

However, this will depend on the degree to which campaign policies are pursued.

The directional impact of Trump policies is clear: bad for bonds, supportive for equities (at least in the near term), some volatility risks, positive for financials, and negative for property, resources and US homebuilders.

Markets have moved a long way in a short space of time and there are still a lot of unknowns to play out.

US interest rates

The Fed played a straight bat, continuing with a 25-basis-point (bp) rate cut (4.50%-4.75%) and making only minor changes to statement wording.

In response to questions about post-election policy impacts, Chairman Powell made it clear that the Fed would not pre-empt changes, saying “we don’t guess, we don’t speculate, and we don’t assume”.

On the outlook, Powell noted that the labour market had cooled and that the Fed was alert to any further deterioration.

There was also confidence expressed that inflation would reduce to target.

Against this, economic growth has been stronger than expected, and Powell said the Fed was starting to think about when to slow the pace of cuts.

This suggests consecutive cuts for now, slowing into 2025.

US economic data

US economic data remains reasonably strong, though there are some mixed signals for the labour market:

Initial jobless claims were benign, with 221k per consensus, continuing to moderate.

• The Michigan Consumer Sentiment Survey was published, covering the two weeks before the election. The index resumed its uptrend, lifting from 70.5 to 73.0 over the month (above consensus of 71.0). This was despite a 0.5 ppt dip in current conditions to 64.4 – more than offset by a surge in expectations to 78.5.

• The ISM Services Index lifted from 54.9 in September to 56.0 in October, which was above consensus of 53.8 and could suggest a pickup in the economy. However, the index appears more consistent with stability in Services spend rather than an acceleration. And within the ISM Services data, the price paid index remains supportive of a moderation in inflation.

• Non-farm productivity increased 2.2% (annualised) in the third quarter. This slightly missed consensus of 2.5% but the prior history was revised up, pointing to strong post-Covid productivity gains. Within the data, unit labour costs increased 1.9% (annualised) in the quarter, which is a potential concern for inflation. But the index has tended to be heavily revised over time and other indicators point to a softening of the labour market.

• Initial jobless claims were benign, with 221k per consensus, continuing to moderate.

UK interest rates

As widely expected, the Bank of England Monetary Policy Committee cut the official rate 25bp to 4.75%.

Growth and inflation forecasts for 2025 lifted sharply following the UK Budget.

While guidance was retained for a gradual approach to policy easing, this is now subject to “evolving data” rather than “absent material developments”.

This suggests a pause in December and modest pace of cuts through 2025.

However, trade tensions could pose a risk to growth and increase the case for cuts over the course of 2025.

Australian interest rates

The RBA left the cash rate unchanged at 4.35% (in line with consensus) and made minimal changes to its outlook.

From the RBA’s perspective, restrictive policy settings are having their intended effect, with inflation moderating.

Household consumption has slowed, but with an offset from public spend.

The RBA made the point that local rates had never risen as much as in other developed countries, and even with cuts offshore (from the US, UK, EU, Canada, New Zealand), rates here remain less restrictive.

Reflecting this, it noted that inflation hasn’t moderated as sharply as offshore and labour markets remained relatively tight.

The market continues to debate when the local rate-cutting cycle will begin – whether early or mid-2025.

The RBA is not expecting inflation to reach the top of its band until late 2025, with the middle to be reached in late 2026.

But there is potential for US tariffs on China to have a negative flow through domestically, depending on China’s response.

China policy

If the US imposed the full 60% tariff on China, the impact to China is estimated at -2ppt of GDP.

This would fall to sub -0.5ppt in the event of a 20% tariff, with the potential for this to be offset by currency depreciation and fiscal policies. However, we have yet to see a fiscal response.

On Friday, the National People’s Congress (NPC) Standing Committee announced a RMB 10 trillion increase in the local government debt resolution over the next four years.

This should reduce local government interest costs and gradually improve infrastructure investment.

But there was nothing on the RMB 2 trillion worth of fiscal initiatives that had been speculated on in the press to cover bank recapitalisation and stimulate consumption.

Perhaps this is not surprising; the NPC is designed to approve pre-proposed policies – not launch new ones.

Policymakers will review fiscal budgets at the Economic Work Conference in December. Any announcement would then be communicated at the Two Sessions meetings in March 2025.

Given domestic weakness, in addition to any export threats, there is clear pressure to act.

US reporting season

Some 84% of S&P 500 companies have reported, with the largest stock – Nvidia – yet to come.

The frequency of beats returned to a more normal 51%, down on recent quarters.

Consensus EPS revisions are also back to a more normal trend.

Typically, consensus is downgraded as the year progresses, which we’re starting to see again for the “S&P 493”, excluding the Mag 7 stocks.

By sector, tech and financials were among the better performers while real estate, materials and energy struggled.

Markets

Australian non-bank financials reacted more positively than banks to the US election result, given more direct earnings leverage.

Effectively, the election helped solidify a 60-80bp move in bonds, which had yet to be reflected in share prices.

Among the banks, ANZ and CBA fared slightly better as they previously had more to lose from a fall in cash rates, given ANZ’s unhedged exposure to US institutional deposits and CBA’s very profitable domestic deposit book.

As a sector, banks could yet benefit from a rotation away from resources given disappointment on China stimulus, but reporting season was not particularly inspiring.

Bank reporting

Heading into results, the market was looking for upside on margins and/or the balance sheet, but neither came through.

Core margins were flat to down slightly, with guidance for similar outcomes given the ongoing mix shift in business deposits and emerging mortgage competition.

Credit quality deteriorated, most notably for NAB, where provisions are now being released to offset problem loans instead of being released to profits, as was hoped.

Capital initiatives were piecemeal, with sizeable buybacks appearing a 50/50 proposition given stretched payout ratios and the limit now being reached on optimisation initiatives.

Overall, there was nothing untoward, but no bottom-up catalysts for further sector outperformance.