Demand looks strong in key EMs and our Pendal Global Emerging Markets Opportunities investment team believes US dollar softness – when it comes – will create conditions for strong returns

EMERGING equity markets are driven by two broad global drivers:

• Global end demand and trade
• US dollar interest rates and liquidity

Individual markets have their own business and credit cycles – as well as political environments – but these are always interacting with the main global drivers.

Right now, one of the challenges for emerging markets investors is interpreting differing signals from these drivers.

Global demand

Indicators of global demand look supportive for emerging markets.

In June, manufacturing data (measured by Purchasing Managers Index surveys) continued to look strong in many emerging countries, while Asian exporters Korea, Taiwan and Vietnam saw strength in new export orders.

June manufacturing PMIs were 52 in Korea, 53.2 in Taiwan and 51.1 in Mexico, with exports growing in all three countries.

A PMI above 50 suggests expansion, below 50 indicates contraction, and 50 means no change.

Recent PMIs also indicate growth in domestically driven emerging economies such as India (57.5 for May), Brazil (52.5 for June) and Indonesia (50.7 for April).

Consumer confidence also looks robust in these three markets.

China has two PMI data series with some conflicting messages, but both measures show weaker export and domestic orders.

In the Gulf PMIs look very strong. UAE, Saudi Arabia and Qatar were all above 54 for June.

US dollar

So far so good. But the other half of the story is the US dollar’s continuing strength and caution about the future direction of US monetary policy.

Against the US Dollar Index (DXY) basket of developed market currencies, the USD has strengthened by 3.5% year to date. Medium-and-longer-dated US government bonds have seen yields rise by about 0.4% over the same period.

No other major emerging market central bank has yet felt the need to follow Bank Indonesia’s surprise 0.25% policy interest rate hike in June.

But, following the US, yield curves across EM remain higher year-to-date, and the expected timing of policy interest rate cuts in markets like Brazil and Mexico keeps getting pushed out.

Meanwhile the stronger US dollar has seen corresponding weakness in emerging market currencies such as the Brazilian Real (-11.6% against the US dollar in the second quarter), Mexican Peso (-10.6%) and Indonesian Rupiah (-3.3%).

This reduces returns to international investors.

Although Mexico saw a surprisingly strong election win for the left-wing Morena party in the quarter, the Mexican Peso weakened alongside other similar emerging market currencies.

The strong US economy is good for emerging market exports (and remittances) but less good for US dollar liquidity.

In this environment we continue to find opportunity in some emerging markets where growth (particularly, corporate earnings growth) remains attractive, even if the current US liquidity environment is a headwind.

These particularly include Mexico, Brazil and Indonesia. Each has seen strong upward revisions to corporate earnings expectations this year.

Local currency weakness has been a drag on returns in each of these countries, but we remain confident US dollar softness, when it comes, will create the conditions for strong returns from these markets.

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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

Here are the main factors driving the ASX this week, according to portfolio manager RAJINDER SINGH. Reported by portfolio specialist Chris Adams

• Markets trying to identify beneficiaries of the US election, unmoved by UK election
• RBA could diverge from global central bank rate cuts
• Find out about Crispin Murray’s Pendal Focus Australian Share Fund

GLOBAL equity markets made a solid start to the second half of 2024, supported by easing rate pressures in the US.

A short week in the US due to the Independence Day holiday didn’t stop both the S&P 500 and NASDAQ finishing the week at all-time highs – breaking through the 5,500 and 18,000 levels, respectively, for the first time.

US Treasuries rallied on weaker macroeconomic data prints, with the release of softer numbers for jobs, unemployment and purchasing managers’ indices (PMI).

Overall, these indicators incrementally point to a US economy that is slowing and so reducing any ongoing inflationary pressures.

While the Federal Reserve continues wanting to accumulate more evidence, further softer data in line with the data released this week could allow the committee to consider interest rate cuts as soon as the September meeting.

There was plenty to interest followers of international politics, with ongoing developments in the US presidential election, French National Assembly voting, and the UK general election, though the implications for markets are not entirely clear and straightforward.

In Australia, we saw further evidence of economic resilience following last week’s strong CPI print, with May retail sales and building approvals data surprising on the upside – accompanied by continued strong price growth across capital city housing markets.

Some commentators continue to push the view that – unlike other central banks – the RBA’s next interest rate move will be up.

Overall views are mixed, as reflected in the latest RBA minutes.

Australian bonds fell in response, with ten-year yields up 9 basis points (bps). This contrasts with the 9bps fall in US ten-year yields, indicating different positions in the interest rate cycle for the two economies.

The S&P/ASX 300 gained 0.71%, lagging the 1.98% gain in the S&P 500 and 3.51% rise in the NASDAQ.

Commodity prices supported resource sector returns for the week. However, most ASX companies are now in black-out until August’s reporting season, so there was little news on the stock front.

US macroeconomics

On Tuesday, we saw the release of the Institute for Supply Management’s Manufacturing PMI, which showed the latest reading declining to 48.5 from 48.7.

This indicator has now been in contraction (i.e. less than 50) for 19 out of the last 20 months going back to October 2022.

Various components of the index such as Production, New Orders and Employment indicate broad contraction, so the briefly positive March 24 reading now looks the outlier compared to recent trends.

Jerome Powell, Chairman for the Fed, spoke at a European Central Bank (ECB) conference in Portugal.

He argued that the latest data shows evidence of continued disinflation and said he expects inflation to fall to the “low to mid-twos” a year from now.

He also argued that progress has been made in balancing the labour market and suggested that the Fed would respond to an unexpected weakening of the labour market.

Initial jobless claims continued their grind higher, printing 238k (up from 234k).

Importantly, the four-week trend is now at the highest level since August 2023, showing the degree of softening the labour market has experienced during the calendar year to date.

The JOLTS Quit Rate further supported the case that wages growth is easing towards historically average levels.

On Thursday, we saw the release of the other key ISM measure – the June Services PMI – which, at 48.8, significantly surprised to the downside.

This was well below the consensus of 52.7 and May’s reading of 53.8, and is the lowest level since May 2020 in the depths of Covid shutdowns.

While this series has been volatile, similarly to the Manufacturing PMI, numerous components showed broad weakness.

Interestingly, the prices component of the ISM Services survey continues to remain subdued.

This is important because it has been a pretty good lead indicator of one the Fed’s preferred inflation indicators, core Personal Consumption Expenditure (PCE) services ex-housing, in the past few years.

It is now also back pre-Covid levels.

The last key economic release of the week was the June payrolls, which came in at 206k versus consensus of 190k. However, net revisions to previous months were a large 111k decline.

The unemployment rate edged up to 4.1% from 4.0%.

Interestingly, these numbers are getting close to triggering the Sahm rule – a measure to identify the start of a recession developed by former Fed economist Claudia Sahm.

It looks at the changes in the three-month average unemployment rate relative to recent lows and is triggered once it hits 0.5%. The latest unemployment figures reading takes this measure to 0.4%.

The Fed minutes also came out, highlighting that it is in no rush to ease but that it is open to changing quickly if inflation and employment moderates.

The minutes mentioned that modest progress towards reducing inflation in recent months though labour markets are normalising, with a watch on unemployment in response to weakening demand.

After this week’s macro data, the market is now pricing an 80% chance of a Fed rate cute by the September 2024 meeting, up from approximately 70% before this week.

A total of two rate cuts are expected by the end of 2024, and almost five full cuts for the next year to June 2025.

Global macroeconomics

Europe

Eurostat published June inflation for the Euro area of 2.5% headline and 2.9% core (year-on-year).

This, along with comments from speakers including ECB President Lagarde at the Sintra conference, indicate that it currently remains on track for a September rate cut.

China

We saw the release of various PMIs.

The Caixin Composite and Services PMI were 52.8 and 51.2, respectively, indicating modest expansion.

However, the widely watched Manufacturing PMI component surprised at 51.8 (versus 51.5 consensus). This is the highest level since May 2021 and the eighth consecutive month of expansion.

This helped support the 6.1% gain in iron ore prices last week.

New Zealand

New Zealand’s central bank meets on 10 July, with rates forecast to stay on hold. Expectations are for a first cut in August, given ongoing softness in recent data.

Australia

May’s retail sales surprised to the upside, up 0.6% month-on-month versus consensus at 0.3%.

Building approvals rose 5.5% in May versus expectations of 3.0%.

While both series can be quite volatile, these data points are notable as recent trends in both have been on the softer side.

House prices continued their recent strength, with the latest CoreLogic data showing the rate of growth of 0.6% month-on-month country-wide and 0.5% month-on-month among state capitals.

Brisbane and Perth remain strong while Melbourne looks lacklustre, which is in line with our anecdotal feedback on their respective economies.

The RBA released minutes from the June meeting and there were no major surprises, with forward guidance consistent with Governor Bullock’s post-meeting press conference i.e. “not ruling anything in or out”.

In particular, the discussion focused on the case for hiking rates or keeping them steady, rather than any reduction.

This reinforced the view of some forecasters that next direction or rate moves is up rather than the downward trajectory forecast for most other central banks around the world.

Markets

There are a few observations to make at the halfway point of the calendar year:

• Historically (since 1928), when the S&P 500 is positive in the first half of the year, it follows with a positive second half 74% of the time, with an average 5.70% return. After a first half with gains of 10-20% (remembering that it delivered 14.5% in 1H 2024), the second half has had positive returns 88% of the time with an even stronger 8.58% average return.
• The second half in presidential election years has delivered a positive return in 83% of years.
• In data going back to 1950, July has seasonally been a strong month, followed by weakness in August and September.
• Strong EPS growth estimates continue to support US equities and the 9% consensus EPS growth for 2Q 2024 is the highest since Q4 2021.
• There are no signs of any stress in credit markets, with US corporate BB spreads remaining subdued and at recent low levels.

On the political side, President Biden’s re-election odds have plummeted.

Markets are trying to identify beneficiaries of a Trump victory, and if history is a guide, the Financials sector was a clear winner in 2016/17.

There were no surprises in the result or market reaction to the UK election, with moves in equities, bonds and the currency all muted on Friday.

Australian equities

Australian equities gained last week but lagged global markets.

All the positive returns were driven by Resources, with Industrials generally flat to down.

Tech and Utilities were weakest, but this follows very strong 1H returns for both sectors.

Within Resources, Anglo American suspended production of its Grosvenor metallurgical coal mine in Queensland following an underground fire.

The mine was due to produce 3.5 million tonnes this year, which is 1% of the seaborne market but 20% of Anglo’s volumes – throwing a spanner into its plans to divest the business following the failed approach from BHP a few months ago.

The suspension, along with a fire at Allegheny in the US and against a backdrop of multiple production downgrades by BHP this year, had the effect of tightening the met coal market and pushing prices higher.

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About Rajinder Singh and Pendal’s responsible investing strategies

Rajinder is a portfolio manager with Pendal’s Australian equities team and has more than 18 years of experience in Australian equities. Rajinder manages Pendal sustainable and ethical funds, including Pendal Sustainable Australian Share Fund.

Pendal offers a range of other responsible investing strategies, including:

• Pendal Sustainable Australian Share Fund
• Crispin Murray’s Pendal Horizon Fund
• Pendal Sustainable Australian Fixed Interest Fund
• Pendal Sustainable Balanced Fund
• Regnan Credit Impact Trust
• Regnan Global Equity Impact Solutions Fund

Part of Perpetual Group, Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management. Responsible investing leader Regnan is now also part of Perpetual Group.

Contact a Pendal key account manager here

Here are the main factors driving the ASX this week, according to portfolio manager OLIVER RENTON. Reported by portfolio specialist Chris Adams

• Find out about Pendal Focus Australian Share Fund
• Tune into our latest on-demand webinar: Beyond the Numbers

THE final week of the financial year featured a bit of everything.

On the macro front, US data continued to point to a slowing – but still growing – economy, while inflation data also remained encouraging.

We also saw the first US presidential debate.

Australia was focused on the May Consumer Price Index (CPI), which came in hotter than expected.

Company-specific news drove individual stock volatility globally and domestically. Nvidia, for example, had a large drawdown on Monday, got it all back on Tuesday, but began losing steam again through the rest of the week.

However, equities in aggregate were flattish on the week. The S&P 500 returned -0.06% while the S&P/ASX 300 -0.25%.

The Aussie bond market saw some action, with yields up materially.

US macro

May’s Core Personal Consumption Expenditure (PCE) report showed that inflation rose 2.6% year-on-year – marking the lowest annual rate since March 2021, when inflation topped the Federal Reserve’s 2% target for the first time in this economic cycle.

The June flash S&P Global US composite Purchasing Managers’ Index (PMI) rose a touch to 54.6, ahead of the 53.5 consensus expectations.

This is viewed as bullish, suggesting solid growth alongside cooling inflation.

Sales of existing homes in the US fell for a third straight month in May, underscoring persistent affordability challenges that hobbled the important spring selling season.

Existing housing inventory is well below historical averages, as people are reluctant to refinance mortgages at a higher rate. This has helped drive existing home prices higher, up 5.7% year-on-year – a trend which may complicate the Fed’s thinking.

Personal spending for Q1 2024 was revised down from 2% growth to 1.55%, while separate releases showed a decline in business equipment orders and shipments – a widening trade deficit and job market weakness.

The Atlanta Fed’s GDPNow forecast shifted expectations of Q2 GDP growth down from 3.0% to 2.7%.

US consumer confidence eased in June on a more muted outlook for business conditions, jobs and incomes. The Conference Board’s sentiment gauge also slipped to 100.4 from May’s downwardly revised 101.3.

Notably, consumer expectations of better business conditions dropped to the lowest levels since 2011, yet expectations of higher equity prices remained close to all-time highs – a good reminder that the stock market is in fact not the economy.

The big banks aced the Fed’s annual stress test, pointing to a financial system that remains generally strong and well-capitalised.

There was little to come out of the first presidential debate in terms of policy that affects markets. The NFIB Small Business Uncertainty Index is surging, but that is normal for election years.

It is interesting to note that 2024 is the first election in 30 years where Baby Boomers will not form the majority voting bloc – now being outnumbered by the combination of Millennials and Gen Zs.

Fedspeak

James Bullard, former President of the St Louis Fed, said that he expects the pace of easing to be slow because there is no sense of urgency provided by the economy.

Fed Governor Lisa Cook noted that she expects inflation to improve gradually this year, then more quickly in 2025.

Elsewhere, Fed Governor Michelle Bowman sounded a cautionary note on potential upside risks to inflation, with Covid-era supply chain dislocations largely resolved and limited labour force participation growth recently.

Looser financial conditions and geopolitical issues could also add to inflation, she said.

She also sees the need to keep borrowing costs elevated for some time and that – while there are a number of potential outcomes for 2024 – she does not expect rate cuts before the year end.

Finally, Atlanta Fed President Raphael Bostic continues to expect one rate before the end of the year, with recent inflation prints signalling some evidence of movement towards the Fed’s goal, and risks between the labour market and inflation becoming more balanced.

He is anticipating four rate cuts in 2025.

Australia macro

The number of job vacancies in Australia fell 2.7% quarter-on-quarter in May, equal to roughly 9,800 vacancies.

Job openings (as a proportion of job opening plus employment) remains well above pre-Covid levels, unlike in the US.

The Melbourne Institute’s “nowcast” for quarterly GDP growth remains muted at 0.2%.

Insolvencies continue to rise in Australia and business payment defaults at a record high suggests there is further to go, though new business formation remains on an uptrend.

Some economists have shifted to a base case of a rate hike in August following the May CPI print, which came in at 4.0% year-on-year versus 3.6% in April.

This was the fastest monthly print since November 2023 and the concern was an acceleration in underlying inflation, with the trimmed-mean measure rising 4.4% year-on-year (from 4.1% in April).

Service rose 4.8% year-on-year, while disinflation in goods has halted.

Housing and transportation were firmer, while growth in food prices eased, and insurance and health costs remained persistently strong.

CPI and energy

Several of the strongest categories for CPI growth in May – such as electricity, transport and automotive fuel – are linked to the price of energy.

A recent research trip to Asia, which looked at energy and the energy transition, highlights the importance of energy and the CPI and some of the longer-term risks we need to be thinking about.

Net Zero and the energy transition may have inflationary consequences – for example:

• Replacing coal with ammonia in power generation is inherently more expensive.
• Building out transmission and other infrastructure puts additional pressure on commodity prices.
• Transition targets, intervention in markets and regulatory uncertainty create dislocations and ultimately higher commodity prices through under-investment e.g. East Coast gas prices.
• The Safeguard mechanism imposes an additional cost on large emitters, which will be passed on where possible.

In Japan, the government is now incentivising coal-fired generators to run on up to 20% ammonia and gas plants to run on hydrogen. The higher input prices for power generation are likely to be passed on to the consumer.

There is also a debate around mandates for sustainable aviation fuel (SAF), which are already in place in Europe. Again, SAF is much more expensive that tradition aviation fuel, which is likely to be inflationary for airfares.

Energy is the cornerstone of all economies, and the energy transition appears to support higher inflation – and not the kind of inflation that central banks can control with monetary policy.

In fact, we probably need rates as low as possible given the capital-intensive nature of the investment required.

Markets

Most of the action was in the bond markets, with Australian two-year government bond yields rising 15 basis points (bps) to 4.17% as a result of the CPI print.

Equity markets, in aggregate, did not move that much into the end of the financial year.

On the global side, there were some updates which provided a snapshot on consumer demand:

• Carnival Corporation upgraded guidance off the back of record levels of demand for cruises, helped by the value of sailing versus land-based travel.
• Pool Corp, which distributes swimming pool supplies, cut its earnings forecast, citing cautious discretionary consumer spending on big ticket items such as swimming pools – with new pool construction activity estimated to be down 15-20% for the year.
• Fuel and convenience retailer Alimentation Couche-Tard missed Q4 estimates as same-store sales declined in the US, Europe and Canada, with management pointing to challenging economic conditions constraining discretionary spending. Levi Strauss and Nike also reported quarterly sales that fell short of expectations.
• General Mills disappointed the market with its sales outlook, noting that shoppers continue to reduce spending as prices rise.
• Walgreen Boots plunged after it cut guidance on a worsening retail environment and announced store closures.

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About Crispin Murray and Pendal Focus Australian Share Fund

Crispin Murray is Pendal’s Head of Equities. He has more than 27 years of investment experience and leads one of the largest equities teams in Australia. Crispin’s Pendal Focus Australian Share Fund has beaten the benchmark in 12 years of its 16-year history (after fees), across a range of market conditions.

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

Find out more about Pendal Focus Australian Share Fund here.  

Contact a Pendal key account manager here.

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

Will May’s monthly inflation data push the RBA to hike again? If it can be patient, says Pendal’s head of government bond strategies TIM HEXT, some relief is at hand

• Monthly CPI was higher than expected
• The annual inflation rate is around 4%
• Why bonds, why now? Pendal’s income and fixed interest experts explain
• Browse Pendal’s fixed interest funds

THE release of May’s monthly CPI data showed the annual inflation rate flatlining at around 4%. Excluding volatile items, it has – in fact – nudged higher this year.

Source: ABS – Monthly CPI Indicator

The word for inflation that springs to mind is stubborn. Too many items are significantly above the comfort zone.

Rents are 7.4%, insurance is 7.8%, and new housing construction and education are above 5%. Even tradables have picked up above 1%.

The higher monthly result was quite broad-based, though international travel had the biggest upside miss.

Underlying inflation is likely to print around 1%, which annualises at 4%. The RBA itself was expecting 3.8%.

You can see why many in the market are now calling for an August rate hike, though I’m not sure a 0.2% miss warrants another rate hike.

It’s what the RBA thinks that is important.

All eyes will now turn to the Q2 numbers out at the end of July, just before the RBA’s August meeting.

If our central bank can be patient, good news is at hand.

Subsidies will see inflation in Q3 nearer to 0.4% headline and 0.8% underlying. Recent minimum wage outcomes also point to wage relief.

While subsidies are temporary, and therefore dismissed by many, the second-round impacts are important. I also suspect the subsidies will be a more permanent feature in the transition economy.

Is this November all over again?

As the new RBA Governor, Michelle Bullock came in swinging on inflation last year – stating a low tolerance for upside surprises.

However, the Q3 inflation numbers surprised by 0.2%, putting the RBA in a corner and forcing it to hike in November.

Bullock has since avoided that phrase, now referring to vigilance on inflation. This leaves some optionality but will make the discussion at the August meeting very interesting.

It would be a brave call to hike.

The last time the RBA went against the global picture by hiking was in February and March 2008, which turned out to be major errors; there is usually some safety in the pack.

I think, given the international context where other central banks are cutting or leaning towards cuts, the RBA will sit out August and leave rates unchanged. This may be a close call.

The RBA currently expects trimmed mean (underlying) inflation to be 3.4% by year’s end. If we get another 1% in Q2 as we saw in Q1, it means the final two quarters will need to average 0.7%.

The second-round impact of subsidies may help the cause, but it will be a challenge.

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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

Pendal’s head of income strategies AMY XIE PATRICK joined Livewire Markets to answer some of the market’s quick-fire questions

• Why bonds, why now? Pendal’s income and fixed interest experts explain
• Browse Pendal’s fixed interest funds

PENDAL’S Amy Xie Patrick featured on Livewire’s Signal or Noise to discuss some of the burning topics impacting the Australian fixed income market.

 

Tune in to hear from Amy and fellow panelists Shane Oliver (AMP) and Michael Price (Ausbil) about the implications of a changing interest rate cycle, the future for term deposit returns, and why now may be the time for intelligent investors to consider some “out-of-consensus” income-paying opportunities.

See more on Livewire Markets

Here are the main factors driving the ASX this week, according to Pendal’s head of equities CRISPIN MURRAY. Reported by portfolio specialist Chris Adams

• Markets experience a moderate rally, led by growth
• Political fears in Europe weigh on bond markets
• Find out about Pendal Focus Australian Share fund
• Watch Crispin’s most recent Beyond the Numbers webinar

THE most constructive US inflation data this calendar year drove bond yields lower and helped the US equity market reach new highs last week, led by tech names.

The US Federal Reserve left rates on hold and was quite hawkish, signalling only one rate cut this year in its dot plots. However, the market wasn’t buying that given the better CPI print.

Apple’s developer day also helped tech sentiment; AI and all that it touches seems to be the only narrative that matters.

The S&P 500 gained 1.62%, but equity markets fell elsewhere.

The Euro STOXX 50 fell 4.17% on political concerns triggered by France’s snap election, while Japan’s TOPIX 500 was off 0.47% as the Bank of Japan struck a hawkish tone, possibly mindful of a weaker yen.

The S&P/ASX 300 fell 1.71% – led by Resources, with battery metals weaker and iron ore down again.

We also saw some FY25 downgrades feeding through the market, reflecting a softer economy.

Domestic employment data was better; underlying trends indicating a softening economy but nothing too severe and certainly no window for rate cuts. As with the US, the growth part of the market continues to outperform.

US: the Fed issues a hawkish statement that the market sees as backward-looking

Inflation

The headline Consumer Price Index (CPI) returned 0% month-on-month, versus the 0.1% expected.

The Core CPI measure was up 0.16%, which was well under the 0.3% expected and the lowest reding since August 2021.

This was well received by the market and supports the case that higher inflation data in recent months was tied to backward-looking factors, such as annual price hikes and insurance.

For example, half of the difference between the expected and actual Core numbers was related to insurance – which had been running at 15%-20% annual increases and turned negative in May – as well as lower airfares.

Some of these factors may partially unwind, but the signal is positive.

The preferred “super core” number – which excludes rent and owner’s-equivalent rent – fell 0.04% month-on-month, helped by Core services falling to 0.22%. Rent inflation does remain more persistent than expected.

The measures of “sticky” inflation, as measured by the Atlanta Fed Sticky Core CPI, are also falling materially.

This good news was compounded by lower Producer Price Index (PPI) data, with Headline falling 0.2% in May, versus expected growth of 0.1%. Core PPI was flat month-on-month, versus the 0.3% forecast.

This data can be used to project May’s Personal Consumption Expenditure Index (PCE) – the Fed’s preferred measure – coming in at 0.11% to 0.13% month-on-month, which is well below the 0.32% average in the first four months of the year.

Year-end expectations for annual PCE are being shaved down by 0.1% to 2.7%.

Inflation bulls believe the economy has slowed enough to reduce corporate pricing power and return to more traditional promotional activity which supports this lower year-end forecast.

Bonds rallied and the market has shifted back to two rate cuts in 2024 on this data.

Fed meeting and interest rates

The Fed left rates unchanged and issued a hawkish statement which saw the median dot plot of rate forecasts shift to imply only one rate cut in 2024.

Chairman Powell reinforced the notion that the Fed would need to see a series of better inflation data.

He also noted that the Fed had increased the non-accelerating inflation rate of unemployment (NAIRU) by 0.1% to 4.2% and that the unemployment rate would only impact its decision if it went above its expectations.

On face value this was negative, implying a higher bar for cutting rates.

However, while this happened after the CPI release, it was clear from the press conference that the latter had not been factored into the dot plot.

Given that eight members of the FOMC still expect two cuts – with Powell widely perceived as one of them – the inflation data trumped the Fed’s statement and the market moved to price in more cuts.

The implied probability of zero or one cut in 2024 has shifted from 55% on 7 June to 30%, with the chance of two or more cuts rising to 70%.

This has been good for bonds, which are now seeing positive signals in terms of technical price action.

It has also been important for equity sector rotation.

Finally, we note that the hit that Trump’s betting odds took following his conviction has unwound and the RCP Betting Average now has his chance of election back above 50%.

Europe: political concerns weigh on bond markets

French President Macron’s snap election – which came after the right-wing National Rally (RN) trounced his own centrist grouping party’s in the European elections – triggered a mini bond crisis in Europe.

French bond spreads widened 25 basis points (bps), which cascaded through to EU periphery nations and raised concerns of a more general flight to safety.

The key concern is that RN have historically had policies which are market unfriendly, such as nationalising private roads, as well as looser fiscal settings as a result of tax cuts.

The reaction looks overdone at this stage, given the degree of unknowns.

We note that national parliamentary elections follow a very different structure, with two rounds of voting (occurring on 30 June and 7 July), and that it is also effectively 577 small elections – that is, local candidates running in a “winner beats all” approach.

Voter turnout will likely be a lot higher; there is apathy toward European elections as they have less bearing on day-to-day life. However, some potential outcomes include:

1. Status quo, with a coalition of centre-right parties securing sufficient seats to run government.

2. A hung parliament, which could end with either a minority far right, a centre left/right coalition, or a minority left-wing government.

3. A right-wing majority, which concerns the market, but appears a lower risk at this point.

Fear is driving markets in the short term, as this was a risk that few were expecting. But on a probability basis, pricing looks to have gone too far.

It is a salient reminder of the unpredictability of politics and relevant given the upcoming US election.

Australia: stronger-than-expected jobs data underpins expectations of no rate cuts

Employment rose 40,000 in May versus the 25,000 expected – with full time employment up 42,000. Unemployment fell from 4.1% to 4.0%.

The underlying trends are slowing, with three-month annualised job gains at 25,000 versus 51,000 in April.

Hours worked also fell from the previous month, indicating slowing domestic activity.

All this paints a picture of an economy slowing, but not falling into a hole, and on track to delivered subdued growth.

This means rates look set to remain on hold for the balance of the year. 

Markets: conditions suggest continued moderate rally led by growth stocks

The combination of lower inflation driving lower bond yields as well as subdued economic growth and falling pricing power limiting earnings growth, is supporting companies with their own earnings growth dynamic.

This is primarily US tech names and utilities on the AI power demand story.

Looking at year-to-date in the US, there are some interesting observations.

The divergence between the outperforming tech sector and the broad-based Russell 2000 has widened in the last seven weeks and accelerated further last week.

Japanese equities, which had been a leader this year as they reflected a more positive outlook for global growth, have begun to stall.

This highlights how the market is getting more wary of industrial earnings relative to tech – a view reinforced by the fact that the financial and industrial sector did not participate in the S&P 500’s breakout to new highs last week.

There is a lot of debate about the lack of breadth in the US market as a sign of building weakness in the rally. This is a fair concern as historically, breadth is a lead indicator of markets though the lag can take a lot of time.

The data on concentration is clear.

In 2019, one company moved to more than 6% of the S&P 500 – the first time this had happened in a data set running back to 1990. There are now three companies weighing more than 6%.

On a calendar-year basis, 2024 is second only to 2007 in terms of top ten index weight concentration in years with positive performance (76.5% concentration versus 78.7% in 2007). The year 1999 was another example of high concentration (54.5%) driving performance.

Both years led into bear markets.

However, looking at the ten historical instances in which 40% or more of S&P 500 calendar year returns are attributable to the top five contributors, only 1999 and 2007 preceded falls the following year.

Markets continued to rise in remaining eight instances.

So, in our view, breadth is not a clear signal for the following year.

The alternate perspective is that we are seeing a unique market event with a small number of stocks demonstrating significant sustainable earnings power and real cash flow being generated, as opposed to just speculation, and that this is a platform for material continued earnings growth.

We note that the basket including Microsoft, Nvidia, Amazon, Alphabet and Meta has seen 38% growth in consensus 2024 EPS since June 2023, versus 0% for the S&P 500.

Apple’s developer day was the latest example of how companies with a coherent AI strategy are being rewarded.

It has described its strategy as “AI for the rest of us”, mirroring the successful 1980s Mac campaign of a “computer for the rest of us”.

Apple proposed embedding AI in productivity features, proofreading, mail prioritisation, text to image (including “genmojis”) and so on.

While some of these features are already available on Android, Apple’s appeal lies in consumer privacy, as the company plans on using an Apple data centre with Apple chips – or the phone itself – rather than relying on the public cloud.

The expectation is that this will drive a faster upgrade cycle as it requires the chipsets from the most recent models, which led to a 3-6% EPS upgrades. The stock broke to new highs, helping the broader market reach new highs. 

This narrative, plus the earnings appeal, is reinforced by ETF flows into the sector.

This dynamic appears unlikely to break in the next few months, as liquidity remains supportive and valuations are not yet at historical relative extremes.

The key risk is inflation forcing rates to stay higher for longer and hurting the economy or the AI theme to run out of steam. Neither appears to be occurring.

Australian equities

The ASX was soft relative to other global markets, with Resources off 4.17% and Industrials also weaker (down 0.9%) as the market began to factor in lower 2025 earnings.

Previous expectations of close to 10% FY25 earnings-per-share growth in Industrials are looking stale given the softer economy.

Battery metals was the weakest part of Resources as lithium prices look to be rolling over again – with supply returning from China and Africa and demand a little lighter as the popularity of hybrids grows relative to battery electric vehicles.

Growth stocks continue to outperform, reflecting the appeal of companies generating growth in a more subdued economy.

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About Crispin Murray and the 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

In their latest quarterly report, Tim Hext, Amy Xie Patrick, Terry Yuan and Murray Ackman explain the trends affecting Australian fixed income investors right now

• Download Pendal’s June quarter income and fixed interest report (PDF)
• Why bonds, why now? Pendal’s income and fixed interest experts explain
• Browse Pendal’s fixed interest funds

Pendal’s income and fixed interest team has just published its quarterly deep dive into the themes driving Australian markets (PDF).

In the latest edition, head of government bond strategies Tim Hext explains how the RBA’s liquidity system affects investments – and why Australians need to honestly appraise the liquidity of their funds.

Head of income strategies Amy Xie Patrick explores which kind of income funds are best suited to the likely economic landing scenarios. (Hint: not one-dimensional funds)

Senior credit analyst Terry Yuan writes about a recent transformation in the credit bond issuance market which has led to a number of deals becoming heavily over subscribed.

An unprecedented shift from a buyer’s market to a seller’s market has led to significant changes in pricing dynamics, Terry says.

Lastly, senior ESG and impact analyst Murray Ackman has a quick guide to the key questions investors should ask about sustainable investing opportunities

About Pendal

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

The team won Lonsec’s Active Fixed Income Fund of the Year award in 2021 and Zenith’s Australian Fixed Interest award in 2020.

Find out more about Pendal’s fixed interest strategies here

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

• Find out about Pendal Focus Australian Share Fund
• On-demand: tune into Crispin Murray’s bi-annual Beyond the Numbers webinar

EQUITY and bond returns were strong last week, with the local market leading the charge.

The S&P/ASX 300 gained 1.97%, while the S&P 500 rose 1.36%.

Commodities had it tough, with the oil price falling through US$80 for the first time in four months.

This provides some comfort around the near-term direction for headline inflation, which flows through to interest rates, policy, the dollar, and the performance of mega-cap growth stocks.

The global central bank easing cycle was kicked further into gear, with the Bank of Canada and European Central Bank (ECB) both cutting rates.

With that said, the ECB cut felt hawkish, with President Lagarde at pains to suggest the scope and pace of the rate cutting cycle from here is far from certain.

Economic data has been plentiful but lacking in real substance ahead of the US CPI this week, though Friday’s blow-out US jobs data print – which drove US bond yields up 15 basis points (bps) – pointed to a resilient labour market which continues to be a unique feature of this cycle.

Another feature is the bifurcated spending patterns of young versus older consumers, which is making the central banks’ job of navigating policy a whole lot harder.

The market has been oscillating between “bad news is good news” and fears that major economies are beginning to show signs of consumer stress based on the maxim that “monetary changes have their effect only after a considerable lag and over a long period”.

It seems the market is okay with bad news provided that news is not too bad.

Australia macro and policy

Reserve Bank of Australia (RBA)

RBA Governor Bullock delivered testimony to the Senate, which struck a government-friendly tone.

She noted that that the RBA’s estimate of the non-accelerating inflation rate of unemployment (NAIRU) was currently 4.3%, only 20bps above the current unemployment rate of 4.1%.

This was caveated by significant uncertainties around the estimate.

The RBA expects new energy rebates to reduce headline inflation by about 50bps in the next financial year, but that it won’t have a material impact on underlying trimmed-mean inflation or boost consumer spending given the relatively small size.

Bullock also pointed out that the RBA thinks monetary policy is taking about 18 months to flow through, suggesting in “a general sense that there is about 50bps of policy tightening to come”.

Q1 GDP

Economic growth was subdued in the first quarter, rising 0.1% quarter-on-quarter and 1.1% year-on-year. It is running at 0.9% on a six-month annualised basis.

This reflects a broader slowdown in the economy as the 2023 softness in households – in response to higher taxes and interest rates crimping real incomes – has expanded to public and private investment.

Both declined in Q1 and saw a smaller contribution to annual growth.

Public investment does remain at high levels, despite falling for the second consecutive quarter.

State and Federal budgets suggest that the spending pipeline peaks in FY25, as some major transport projects also reach completion.

Dwelling investment fell 0.5% to be 3.4% lower year-on-year. This is expected to continue falling, with detached housing projects falling steeply as the Homebuilder Subsidy boost falls away.

Other data

The Fair Work Commission raised Award and Minimum wages by 3.75% from 1 July 2024, which was largely as expected and below the 5.8% increase in 2023.

Dwelling prices across the eight-city average rose 0.8% month-on-month in May, up from 0.5% in April, representing the largest monthly gain since October 2023.

According to CoreLogic, national rents rose 0.7% month-on-month in May, down from 0.8% in April, representing the lowest monthly gain since December.

The slowdown is probably attributable to lower net migration and the impact of affordability on rental patterns, they noted.

Retail volumes have fallen below the pre-Covid trendline, though price remains well above it.

Conditions in Victoria look particularly weak, with anecdotes that events such as the Australian Open, the Grand Prix and Taylor Swift concert have masked underlying softness.

There are suggestions that changes to state taxes are taking a toll on sentiment.

US macro and policy

Non-farm payrolls rose 272k in May, versus 180k consensus expectations and 175k in April.

The three-month moving average is running at 249k per month, only modestly down from 261k per month in the preceding three-month period.

There was a strong skew to the “experience” pasts of the economy, where spending remains strong – potentially supported by older cohorts – with leisure and hospitality adding 42k jobs versus 26K in the good-producing segment of the economy.

Government jobs also strengthened following a weak April.

Average hourly earnings rose 0.4% versus the 0.3% expected and 0.2% seen in April. It is running at 4.1% year-on-year, which is still too high for the Federal Reserve’s comfort.

Unemployment is running at 4.0% versus the 3.9% expected. This is the first time at 4% in two years.

April JOLTS job opening came in at 8.06 million versus the 8.35 million expected and the 8.25 million seen in March.

This means the job-opening-to-unemployed ratio is at 1.24 – the lowest since January 2020 and down from 2.0 when rates began rising in March 2022.

The Quits rate – seen as a lead indicator for wage pressures – held steady at 2.2% and continues to suggest the employment cost index (ECI) should moderate over the next six months.

The ISM Manufacturing Index fell from 49.2 in April to 48.7 in May, driven by weakness in the new orders sub-index, which suggests ongoing weakness in manufacturing.

The ISM Service Index hit 53.8, up from 49.4 in the previous month and ahead of consensus sat 51.0.

While strong, this index has been in a range and has not been a strong indicator of spending habits.

Central banks

The Bank of Canada became the first G7 central bank to cut rates, shifting down 25bps to 4.75%.

The Chair left the door open to further cuts, saying they are confident inflation is heading to the 2% target.

The ECB reduced rates from 4% to 3.75%, however, the accompanying commentary was clearly designed to discourage expectations of a near-term continuation of cuts.

The rate-setting committee “is not pre-committing to a particular rate path” and rates are “not close to neutral”, according to accompanying statements.

This was reinforced by April core inflation in the EU ticking up from 2.7% to 2.9%. ECB President Lagarde noted a “strong likelihood” of further cuts in the months ahead, but stressed that “the speed of travel and time it will take” are very uncertain.

Markets

We observe that there has been a significant increase in demand for upside exposure among professional investors in the past week.

The funding spreads – the cost to fund a levered long position in futures, swaps or options –jumped to 70bps, the highest level since January 2018.

Most sectors in the S&P/ASX 300 gained for the week, led by Financials (3.88) and Consumer Staples (3.40%).

Information Technology fell 0.67%, while Materials was off 0.50% on some weakness in the resource sub-sector.

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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

Australia has joined other sovereign nations in issuing an inaugural Commonwealth green bond. Senior ESG and impact analyst MURRAY ACKMAN explains what it is and why Pendal invested in it

• Australia has joined 30 other sovereign issuers by issuing its own green bond
• Investors willing to pay a premium for the bond, market oversubscribed
• Why bonds, why now? Pendal’s income and fixed interest experts explain
• Browse Pendal’s fixed interest funds

THE Commonwealth Government just issued its first green bond.

It has a June 2034 maturity with $7 billion issued.

The Green Treasury Bond also came with a “greenium” (meaning investors were willing to pay a premium to hold it) of around two basis points, which is roughly consistent with global peers.

Green bonds are meant to finance solutions for climate change and environmental challenges, but not all bonds are equal.

At Pendal — and at our specialist sustainable investing business Regnan — we’ve seen quite a few green-labelled bonds that don’t have any meaningful impact. Some are simply doing business as usual.

For governments, this is a particular risk.

At Pendal we are not interested in green bonds made up of already-completed projects that they were going to work on anyway, such as public transport or other infrastructure projects.

But we were very active in buying this bond – mainly across our sustainable funds, through which investors expect the majority of bonds to finance specific projects in the environmental or social space.

How did we judge this new bond? We asked a few questions:

• Does this green bond fund new things?

We want the first Commonwealth green bond to support new projects.

This is known as additionality – that is, funding something that would not have been funded but for this green bond.

Half the proceeds will go towards existing commitments and half will go towards new commitments.

In our view, this is quite reasonable and is better than some other green bonds from governments.

Ideally, we would like to see completely new projects, but we recognise that there are complications in doing this for a first issuance.

• Does it fund revolutionary projects?

Government has a different risk profile to the private sector and that gives it an opportunity to fund catalytic change — things that lead to a step change.

The list of projects funded include some that will help with the transition to a low-carbon economy – with the focus on renewable energy, clean transport, climate change adaptation, and a circular economy.

Electricity generation is the biggest source of emissions in Australia, so upgrading the grid to allow greater renewable energy connectivity will be essential in reducing emissions.

Electrification using renewable energy will significantly reduce emissions. The green bond includes investments in modernising the electricity grid and developing new transmission infrastructure through concessional financing.

This bond also funds projects that relate to this – from community batteries and electric vehicle charging infrastructure to loans for energy-saving home upgrades.

However, there are some sectors that cannot easily switch to electricity – for instance, industrial activity, which requires certain inputs for chemical reactions.

Taking a page from Joe Biden’s Inflation Reduction Act, which has made hydrogen use and production more viable, this bond will also help fund the development of regional hydrogen hubs.

We would like to see more catalytic change, but for the very first Commonwealth Green Bond, we are pleased with the scope of projects.

• Is clear reporting available?

The Commonwealth’s commitment is to distribute an annual impact report no later than 18 months after first issuance.

This will be reporting at a portfolio level rather than each bond line, which is fairly typical.

The government has also made the commitment to have independent verification of allocation and impact reporting.

This will assist in establishing annual reporting with independent verification as industry standard.

We are hopeful that this bond will demonstrate what the minimum requirements are for clear and transparent reporting for green bonds in Australia.

What else do we know about this bond?

A green bond should be a reflection of an issuer’s philosophy — not an apology for their actions.

Prior to issuing, the government announced funding to progress leadership on climate action in Government operations, which includes financing to support all Commonwealth entities in publicly reporting on their climate risks, opportunities and management.

This bond is consistent with recent government action to respond to climate change as well as engage in environmental repair through this bond.

The government has put in a lot of effort to make sure it got its inaugural green bond right.

The market has agreed, being nearly three times oversubscribed.

We anticipate that there will not be a new green bond for at least a year or two, so we believe it should perform well in the secondary market.

It provides integrity to the Australian green bond market and will provide a clear example of expectations for the market in future.

Here are the main factors driving the ASX this week, according to Pendal’s head of equities CRISPIN MURRAY. Reported by portfolio specialist Chris Adams

• Equities quiet, may see period of consolidation
• The Fed unlikely to cut rates in June/July
• Find out about Pendal Focus Australian Share fund
• Watch Crispin’s most recent Beyond the Numbers webinar

EQUITY markets have been quiet and were down marginally last week.

Combined with a lack of follow-through on the Nvidia result and weakness in US software, this suggests we may see a period of consolidation.

The S&P 500 fell 0.49% while the S&P/ASX 300 was off 0.34%.

In the US, Personal Consumption Expenditure (PCE) inflation data was marginally lower than expected, which kept the chance of a pre-election rate cut alive.

Economic growth data was a touch softer than expected, but this week’s employment data should provide a clearer picture.

Australian inflation data was worse than expected and – despite softer retail sales – the prospect of rate cuts seems remote.

BHP’s attempt to take over Anglo American has ended for now. UK rules mean it can’t try again for another six months.

US inflation outlook

April’s PCE data was incrementally positive for the inflation outlook, but the Fed remains in “wait and hope” mode.

It is unlikely to cut rates in June or July.

The PCE – the Fed’s preferred measure of inflation – was in line with expectations, with Headline up 0.26% and Core up 0.25% month-on-month (or 2.8% year-on-year), versus a 0.3% run-rate in the last two months.

The market read this as marginally positive as the “super core” data – which adjusts for some of the imputed service components – fell from 0.3% month-on-month in March to 0.17%, which is consistent with 2% inflation.

But it is too soon to be bullish on inflation, as the trend remains too high – with three-month and six-month annualised growth at 3.5% and 3.2%, respectively.

The year-on-year reading is in the high 2% range, and in the past few months the outlook for inflation at the end of 2024 has also shifted there from the sub-2.5% range.

As a result, the Fed remains on hold – waiting for three months of data that indicates inflation is fading again.

We note that the base effect of slowing inflation in the second quarter of 2023 will also work against readings in the second half of 2024.

Digging into the details, core services inflation is moderating again but is still above the trend of late 2023, suggesting it sticks in the 3% range.

Meanwhile, goods deflation has now ended.

The bull case here is that retail margins, which are materially higher than pre-Covid, will be driven lower by competition in a softer economy, which could help bring inflation down.

The upshot of all this for markets is that we are unlikely to see rate cuts in either June or July. The question is, then, whether the Fed will cut ahead of the Presidential election.

The market is currently implying a 4% chance of a cut in June, 17% in July, and 63% in September.

US economic growth

Here, the incremental news was softer, though it remains on trend for somewhere around 2% in 2024.

Headline first-quarter GDP was revised down from 1.6% to 1.3% (as expected) – driven mainly by lower consumption growth and lower net exports and inventory accumulation, while investment was stronger.

However, the drag from inventory and exports overstates economic softness.

Final sales to private domestic purchasers is a better indicator, which rose 2.8% versus 3.1% in the initial estimate.

Data on personal consumption was also softer, with consumer spending up 0.2% in April following 0.7% growth in March.

Personal incomes rose 0.3% and the savings rate was steady at 3.6%.

Real consumer spending – adjusted for inflation – was weaker than expected (-0.1% in April), continuing the signal of a slightly weaker consumer.

Services remains the strongest component, but this is fading. Spending on goods is down 1% on a three-month annualised basis.

This has seen second-quarter GDP forecasts reduced, though this is only the first month of the quarter.

The Atlanta Fed GDPNow estimate has shifted from the 3% range into the high 2% range. Market consensus is at 2%.

Anecdotally, in some sectors, US corporates are still constructive.

Booking.com and Airbnb are saying leisure travel demand is solid, while Uber is seeing no “trade-down” activity in restaurant delivery. Demand for digital advertising is also holding up.

The conclusion at this point is that US economic growth is decelerating at a moderate pace, but still heading for about 2% in 2024.

News of Trump’s conviction has led to a small shift back towards Biden in the betting odds, with the Real Clear Politics Betting Average showing Biden at about 39% and Trump at about 48%.

Europe

The European Central Bank (ECB) is expected to cut rates for the first time in this cycle this week.

The markets are pricing two-to-three rate cuts by the year’s end.

However, growth data, wages and inflation have been stronger than expected in last couple of months, so ECB President Lagarde may be cautious in the press conference and not commit to cut rates again in September.

Australia

The April Consumer Price Index (CPI) rose 0.73% month-on-month, taking it to 3.6% year-on-year, versus 3.4% as expected.

Core CPI rose 0.24% to 3.8% year-on-year.

This pushes out expectations around rate cuts. Inflation is falling, but it remains too high for the RBA’s comfort.

The food, clothing and health components drove the upside surprise.

Construction costs have accelerated in the past few months.

High construction costs are a structural issue for Australian inflation, as it leads to a lack of supply of housing, retail space, distribution centres and other physical capacity.

Subsidies are helping ease some pressure, with the electricity component down 1.9% month-on-month and rent inflation slowing due to higher Commonwealth rent assistance.

Elsewhere, retail sales for April were softer than expected at 0.1% month-on-month and 1.3% year-on-year.

The read-through is messy due to the timing of Easter and school holidays, but the trend is flat-lining and has been reliant on population growth, which is now slowing.

On the positive side, there has been a pick-up in credit growth on the back of rising house prices.

This suggests that the stabilisation in interest rates is feeding through, and policy may no longer be as restrictive as it was.

The takeaway is that Australian inflation looks stickier than most countries and is being held up by structural problems. Even though the consumer is softening, rates look set to stay on hold for some time.

Markets

Markets appear to be consolidating and there are signs of deteriorating breadth.

Despite the S&P 500 being up about 11% calendar-year-to-date, 45% of stocks are down.

Higher bond yields are weighing on equities and ten-year bond yields are rising towards key resistance levels.

Positioning is getting more extended. Cash levels in US equity mutual funds are as low as we have seen in decades, though hedge fund exposure has room to rise further.

At this point, we see markets in something of a holding pattern and we believe liquidity can continue to support them through the September quarter.

The Magnificent Seven have become the “Fab Five” of Amazon, Apple, Microsoft, Google and Nvidia.

Indicators suggest that mutual and hedge fund managers are still underweight these stocks in aggregate, so there is still potential for them to squeeze higher.

When the 27% year-to-date index return of these stocks is removed, the roughly 6% or more return from the rest of the S&P 500 looks closer to a roughly 3% return from the S&P/ASX 300.

The AI thematic helping drive the Fab Five is also seeing bifurcation in the tech sector.

This can be seen in the divergence between the iShares Semiconductor ETF and the Global X Cloud Computing ETF, which have traded largely in tandem in 2022 and 2023.

However, the AI theme has seen semiconductors materially outperform since early 2024 – a trend which has accelerated in the last two weeks.

In this vein, the US Software sector was down 5.4% on Thursday, which was biggest day of underperformance in more than 10 years.

This was on the back of a quarterly result for Salesforce.com, which was in line with expectations but saw softer revenue guidance – leading the stock to drop about 20%.

The key debate is whether slowing revenue is company-specific or a broader macro issue.

We have seen this divergence in an Australian context in the performance of Goodman Group (GMG), which has also decoupled from a previously close correlation with a fellow industrial property company in the US, Prologis.

GMG has outperformed massively since Q3 2023 on the back of GMG’s pivot towards data centres.

Australian market

The S&P/ASX 300 rose 0.85% in May.

The thematic winners included aluminium/alumina names like Alumina and South32, as prices caught up with copper, as well as AI-related names such as Goodman Group and NextDC.

Other good performers such as Aristocrat Leisure, Xero, Technology One, Bendigo & Adelaide Bank, and AGL were driven by stock-related news.

Thematic losers were discretionary retailers such as Super Retail, Bapcor and Nick Scali as anecdotes of softer trading came out.

Some caution around the outlook for corporate travel saw Corporate Travel Management and Flight Centre softer.

The market was relatively quiet in the last week, with limited rotation. A weaker iron ore price saw some of the miners underperform.

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About Crispin Murray and the 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