Where are we on inflation at the start of 2024? And how is Pendal’s team positioned? Here’s a quick overview from our head of government bond strategies TIM HEXT
- Inflation on track in the US
- Australian inflation still above target
- Why bonds, why now? Pendal’s income and fixed interest experts explain
- Browse Pendal’s fixed interest funds
WELCOME back to those returning from a summer break.
If you’ve been off since mid-December you could be forgiven for thinking nothing happened — since bond rates are largely unchanged.
Though there was some year-end excitement as the “everything rally” pushed yields lower and risk markets higher.
A notion of lower inflation potentially allowing US rate cuts seemed to change into a stronger narrative of imminent big cuts.
The new year has now sorted that one out.
Inflation outlook in the US
As always, the main market driver in 2024 will be inflation. Here’s a brief insight into where we are now.
I will talk more about the current pulse than just annual rates — since annual rates are quite backward-looking and take longer to reflect current conditions.
In the US the Fed’s preferred inflation measure is the core PCE (personal consumption expenditure) price index. This excludes food and energy.
The Fed prefers this measure over CPI because it better reflects changes in consumer spending — instead of relying on fixed weights that only change periodically.
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It also relies on business surveys which are more reliable than consumer surveys. And it has less exposure to rents (CPI includes the notion of owner-equivalent rents, which makes up 25% of the basket).
The good news is that in the US core PCE pulse is now running at 2%.
In other words Q4 — similar to Q3 (see below) — is expected to show the three-month annualised core PCE at 2%. That’s bang on the Fed target.
It was 5% in Q1 and 3.7% in Q2.
The main reason for this move is falling margins, as now fully-open goods and services markets see businesses become more competitive again.
The final impact of the pandemic is washing through the system.
US core CPI is now moving between 0.2% and 0.3% per month, indicative of a 3% annual rate.
This should also settle lower as leading indicators on rents suggest lower levels ahead.
Inflation Outlook – Australia
Australia’s fourth-quarter CPI will be released on January 31.
Thanks to monthly data we already know roughly two-thirds of the number. Expectations are for a 0.7% headline and 0.8% underlying quarterly outcome.
Three-month annualised this would see inflation near 3% as well, though rents in Australia are unlikely to provide the same relief as in the US.
Electricity subsidies (if and when they come off) are an added uncertainty in Australia. These softened the 20% price hikes down to only 10% in recent CPI numbers.
The hope is that falling wholesale prices might offset any removal of subsidies.
The RBA forecast of 3.5% inflation by mid-2024 looks reasonable.
Unlike the US, this would leave inflation still 1% above target, making the case for rate cuts more difficult.
But if inflation can stabilise closer to 3% in the medium term — as the current pulse suggests — then the need for tight monetary policy would lessen.
The hope would be wage outcomes could then moderate from the current 4% levels.
Portfolio positioning
Growth, labour markets, geopolitical events and the usual mix of factors will, as always, be in play in 2024.
For bond markets though, inflation outcomes are now on the “good news” side of the ledger for the first time since Covid.
We are running our portfolios from the long-duration side, though adjusting positions depending on market levels and probabilities of cuts priced into markets.
It also makes us favourably disposed to risk markets.
Though we note — and caution — that the long and variable lags of monetary policy will see a slower economy and more pressure on earnings than in 2023.
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.
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
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.
Here are the main factors driving the ASX this week, according to Pendal’s head of equities CRISPIN MURRAY. Reported by investment specialist Chris Adams
- Find out about Pendal Focus Australian Share fund
- Pendal’s Crispin Murray reviews the lessons from 2023 and outlook for 2024
MARKETS kicked off the year with a small sell-off, catching their breath from the November-December rally, before staging positive returns last week.
The S&P/ASX 300 rose 0.14% and the S&P 500 1.79%.
To recap 2023:
- The ASX rose 12%, with tech (+28%) and consumer discretionary (+21%) the lead sectors. Consumer staples (+1%), utilities (+3%), healthcare (+4%) and energy (+5%) all lagged
- Globally, the US rose 26%, Europe lifted 26% and Japan gained 29%
- US 10-yr Treasury yields ended up flat for the year at 3.88%, having peaked at 5.02% in October
- The AUD was flat and the DXY (a trade-weighted measure of the USD) fell 2%
- Iron ore rose 22%, gold increased 13% and copper lifted 2%, while oil fell 10% and lithium dropped around 80%
Markets start 2024 with a positive view that disinflation is proceeding faster than previously expected, growth will hold up, and the Fed has reinstated the “Fed put”.
Investors are positioned for this with a systematic strategies limit long in equities.
However, there is still a lot of cash on the sidelines, which may be squeezed into equities.
The breadth of the market is improving, which is usually a positive signal.
The liquidity environment is constructive in the near term, with reverse repurchase agreements (or repos) continuing to be drawn down and a limit on Treasury issuance. Both these factors are likely to reverse after Q1, however.
On the data front last week, we saw slightly negative US Consumer Price Index (CPI) data brushed off by the market.
The Producer Price Index (or PPI) was more positive, while jobless claims data indicated that the economy is holding up fine.
In Australia, inflation data was marginally positive.
We also saw conflicting signals from Fed speakers on the potential for quantitative tightening to be re-evaluated, but there is a growing suspicion this will occur to offset a tightening of liquidity in H2.
Middle East tensions escalated, with the US and UK both launching attacks on the Houthis in Yemen.
This had no sustained effect on oil prices, but freight rates have risen on the need to redirect shipping, which represents a risk to the disinflationary growth narrative.
The market continues to price for six-and-a-half interest rate cuts in the US, starting in March.
Current implied expectations are that the ECB and Bank of England will both start cutting in April and May, respectively.
The market is only pricing two cuts for Australia in 2024, the first occurring between June and August.
Five key questions for 2024
In our last note of 2023 we highlighted some key questions for markets in 2024. We can now assess these in light of recent data and developments:
1. Will disinflation continue to surprise to the upside?
Recent data has been mixed but is supportive of the market’s belief that disinflation will facilitate rate cuts.
US December CPI came in a bit stronger than expected, with the headline index up 0.3% month-on-month – driven, in part, by electricity prices.
However, there was sufficient ambiguity for markets to largely brush off the reading.
Looking forward, the continued drop in fuel prices and rents should help the headline CPI continue to fall.
Core CPI rose 0.31% month-on-month.
The Goods component was flat month-on-month following six months of decline.
The question is whether this signals an end to goods deflation, which has played an important role in positive inflation surprises.
New and used car prices rose, which may not be sustainable.
The recent weakening of the USD and the issues in the Red Sea may also be factors which could lead to an end of goods price deflation, so this remains an issue to watch.
Core Services ex-rents rose 0.4% month-on-month.
This, too, was higher than expected – driven by recreation services, airfares and medical services.
Airfare increases has been seen by a number of inflation bulls as unsustainable, partly due to fuel costs coming down.
These categories are also measured differently in the core Personal Consumption Expenditure (PCE) measure that the Fed prefers.
As a result, the market has not changed its expectations for the December PCE reading, which is that the three-month annualised Core reading could drop to 2.0%.
US PPI came in below expectations at -0.1% month-on-month and 1.0% year-on-year, making this three negative readings in a row.
Some inflation bulls have also cited the potential for more competition to drive corporate profits margins lower.
These rose substantially though the pandemic, and while they are no longer rising, they have not yet normalised.
While this is good for the rate outlook, it would be negative for corporate profitability.
One countersignal is wages data, which is proving to be more stubborn; the Atlanta Fed twelve-month wage tracker held at 5.2% in early January.
The market has priced a 65% probability of a March rate cut in the US, with 165bps of easing expected for the year.
European inflation was in line with the ECB forecast, but higher than consensus expectations (headline 2.9% and core 3.4%).
This may delay the first rate cut in Europe until May or June.
We note that Europe has experienced another warmer winter so far and gas prices have come in well below the assumptions made by the ECB.
2. Will the US economy continue to grow?
This question, alongside the first, is likely to drive the outlook for rates and corporate earnings.
US jobless claims have remained very benign, with initial applications near historic low levels and continuing to hold flat.
This reiterates constructive employment data from the week before and helps underpin the economy.
Anecdotes from retailers indicate there was a late surge in Christmas spending, which held up well overall as a result.
Early January sales are on the soft side, although this may be weather-related.
The consensus expectation is 0.7% GDP growth in 2024, but the upside risk comes from higher consumer demand – benefiting from real disposable income growth combined with the support from an easing of financial conditions.
If the Fed is comfortable with inflation, then it does not need to force the economy into sub-trend growth levels.
Some estimates suggest the potential impact of easier financial conditions could go from a GDP headwind to potentially adding 0.5% to growth.
3. The impact of geopolitics and elections
Threats to shipping via the Red Sea have seen a dramatic decline in traffic, with companies opting for the longer path around Africa.
This effectively reduces supply and impacts freight rates and has raised some concerns about the flow-on effect to the price of goods and the risk of slowing the rate of disinflation.
That said, the trade between Europe and Asia is most heavily affected, with a more limited impact on US routes.
There has also been a material increase in shipping capacity post-pandemic, so the impact will be far more muted than what we saw during Covid.
In Taiwan, the Democratic Progressive Party candidate Lai Ching-te won the party’s third consecutive Presidential term, as expected.
However, the party won 51 of 113 parliamentary seats and lost its majority for the first time since 2012 (again, expected, and unlikely to move the status quo in terms of the level of tensions).
4. China’s ability to sustain moderate growth
Real-time indicators suggest the Chinese economy has started the year softer.
Consumers continue to lack confidence, with the gap between retail sales growth and the pre-Covid trend continuing to widen.
This is tied to weak property market.
Inflation data also remains weak, which leaves scope for continued policy stimulus driven by a supportive fiscal situation.
5. Australia’s ability to engineer its own soft landing
Australian monthly CPI for November was lower than market expectations, up 0.33% month-on-month and 4.3% year-on-year (down from 4.85%).
Core inflation was also lower, up 0.25% month-on-month and 4.77% year-on-year (down from 5.05%).
Housing was the main contributor to inflation for the month, along with rents and new dwellings.
Electricity prices rose to a lesser degree, helped by new Victorian government subsidies.
Services inflation rose 0.7% month-on-month to 4.71%, after a similar fall the previous month.
The three-month trend is now 3.6%.
Goods rose 0.16% to 3.95%, held down by lower fuel, clothing and recreational equipment, with food higher.
December data should see another step down as the base effects fall out, fuel prices are lower, and Western Australian power subsidies kick in.
Last week, the December Politburo meeting and the Central Economic Work Conference took place, where key economic targets are set (but not announced until March).
Signals were for policy support focused on fiscal policy, though there were no major initiatives which was seen as slightly disappointing.
Australia
Employment data was much stronger than expected (up 61,500) despite a marginal rise in unemployment (to 3.9%) given the continued rise in labour supply.
Total hours worked were flat, which implies average hours worked was lower.
This indicates that businesses are looking to save costs by lowering hours rather than layoffs – possibly due to the difficulty of rehiring in the past.
Forward indicators on unemployment still indicate it should be set to rise further, though these signals have so far not been validated.
Markets
The Fed cutting rates is not necessarily a green light for equity markets, as in the end, the economy gets the final say.
If a recession were to occur, the de-rating of earnings would overwhelm the benefits that the lower rates would bring.
This is why GDP growth next year is key.
We are also seeing some interesting shifts in market internals on the back of this. Notably, mega-caps have done their dash and market breadth is rising.
This can be tracked in the relative performance of the Russell 2000 vs the S&P 500.
For small-caps, this is a particularly positive signal for them to outperform.
Another interesting disconnect is that the market has a very different perspective on the economy than some of the traditional leading indicators of growth, shown by the rotation away from defensives to cyclicals.
This makes early 2024 interesting, as the cyclicals would be sensitive to any weak growth.
In Australia, the ASX saw a broad-based rally with only utilities underperforming.
Rate-sensitive sectors such as REITs and tech led the market.
Energy was supported by the bounce in oil and the continued fallout of the potential STO-WDS merger.
Lithium stocks also had a strong bounce back given how oversold they have become.
Lastly, this environment looks to be positive for the AUD, which continues to look good technically.
About Crispin Murray and Pendal Focus Australian Share Fund
Crispin Murray is Pendal’s Head of Equities. He has more than 27 years of investment experience and leads one of the largest equities teams in Australia. Crispin’s Pendal Focus Australian Share Fund has beaten the benchmark in 12 years of its 16-year history (after fees), across a range of market conditions.
Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management.
The US election will take the spotlight, but EM investors need to keep tabs on dozens of other national polls this year. Here’s an overview from Pendal’s Emerging Markets team
- Elections to come in India, Indonesia, South Africa and Mexico
- Global geopolitics will significantly impact emerging markets
- Find out about Pendal Global Emerging Markets Opportunities fund
THIS is the biggest election year in history, with half the planet’s population due to elect a national leader.
More than 50 countries will hold national elections in 2024 – including many emerging markets.
“2024 has the highest concentration of elections, possibly in modern history,” says Paul Wimborne, co-manager of Pendal Global Emerging Markets Opportunities fund.
“And emerging markets are very much part of this line up. There has already been presidential elections in Taiwan and later in the year there will be elections in India, Indonesia, South Africa and Mexico.
Those countries represent 40 per cent of the MSCI Emerging Markets Index by weight and 1.9 billion people.
Investors will need to consider the ramifications of elections with the potential to affect the global macro environment that matters so much to emerging equity markets.
We’ve already seen the re-election of Taiwan’s pro-sovereignty Democratic Progressive Party draw the ire of Beijing.
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Financial markets continue to be directly impacted by sanctions on China; the impact of Russia’s invasion of Ukraine on commodity prices and trade; and an evolving set of overlapping conflicts in the Middle East and Red Sea.
Here’s a quick look at the elections that will affect EM investors:
Taiwan (Jan 13)
The Taiwanese election, held in mid-January, was won by Willian Lai Ching-te from the governing Democratic Progressive Party (DPP).
It’s the first time the same party has won a third Presidential term since direct elections were introduced in 1986.
“DPP is the more pro-independence of Taiwan’s main parties and it received just over 40 per cent of the vote,” Wimborne says.
“Taiwan also had a legislative election where the KMT, a more pro-Beijing party, won 52 seats out of 130. DPP won 51 seats. It means the winning President doesn’t have a legislative majority.”
For emerging market investors, an election like Taiwan’s is crucial in understanding where opportunities, and risks, lie.
“In Taiwan’s case, the President does not have a clear mandate, so that really suggests a status quo outcome.
“Clearly the election is very important from a geopolitical point of view with the relationship between the country and China the key issue.
“For investors, the holding of the election reduces the short-term uncertainty because we know what the outcome is.
“And it also tells us in the medium term, the cross-strait tension between Taiwan and China is probably here to stay.”
India (April-May) and Mexico (June 2)
Investors in emerging markets worry mostly about unexpected results which could move equities, bonds, property markets, currencies and other asset classes, Wimborne says.
“In India, there is an election in the next couple of months. The market has priced in continuity, and it would be a shock of Narendra Modi doesn’t win.
“In Mexico, the market is assuming the most likely result is the current incumbent AMLO’s (Andres Manuel Lopez Obrador) preferred candidate will win, and his party will retain power.
AMLO, having served a single six-year term, is unable to run again.
Russia (March 15-17)
March brings the presidential election in Russia.
The last election in 2018 is widely thought of as neither free nor fair. Incumbent Vladimir Putin received 77.5% of the vote then, and the political system in Russia has become intensely more repressive since.
Economic strain is substantial. Many Russians have seen their ambitions destroyed and the country may have taken more than 100,000 casualties so far in its invasion of Ukraine.
A Putin victory has to be the expectation, but there is the possibility of protests and crackdowns that may alter Russian policy.
Venezuela (sometime in 2024)
Similarly, the first half of the year should see a presidential election in Venezuela. Like Russia, the country is in no meaningful sense a democracy.
The leading opposition candidate Maria Corina Machado was barred from politics in June 2023 – so a victory for the governing coalition (probably for the incumbent Nicolás Maduro) has to be the expectation.
In the run-up to the election, Venezuela has made claims on almost all of the territory of neighbouring Guyana, with possible military action backed by Iran, Russia and China.
This would lead to a substantial worsening of global geopolitics with varying potential outcomes.
Israel
While Israel does not have an election scheduled, the current emergency government formed after the Hamas attacks in October 2023 may not last throughout 2024.
The country has undergone five elections between 2019 and 2022 in search of a viable coalition.
A snap election could lead to anything from a mandate to negotiate a political settlement to the current crisis to a shift to an even more overtly nationalist government that would deepen the conflict with both the Palestinians and with Israel’s neighbours.
United States (Nov 5)
The greatest ‘unknown’ in this election year for emerging markets is the United States.
“The US election is the one that has the potential to cause most uncertainty across emerging markets,” Wimborne says.
“It’s difficult to predict who is going to win — and then it’s also difficult to predict what policies would be, particularly if Trump wins.
“What would US policy be in terms of geopolitics and domestic priorities, as well as what that means for interest rates and the US dollar?”
UN Security Council (mid-2024)
In addition to these national polls, five non-permanent members of the UN Security Council are due to elected in mid-2024.
Although most of the power sits with the five permanent members (who have vetos), it is here where any attempts to resolve these conflicts will start.
Among the countries likely to be elected are Pakistan and Somalia.
Pakistan is close to China and Iran and in dispute with India. Somalia is in a dispute with Ethiopia which has the potential to further worsen the geopolitics of the Red Sea region.
Global geopolitics are fraught as we go into 2024 and all these elections have the potential to lead to a substantially better or worse world.
Investors will need to follow them closely and react accordingly.
Portfolio implications
For investors, all this uncertainty means they must stick to their strategies and processes, says Wimborne.
“Stick to your game plan and then react to changes if the outcomes aren’t as the market predicted.
“You need to build a resilient portfolio and know where the risks are being taken.
“Look at the portfolio as a whole and understand what would happen if the oil price moves or bond yields change, or currencies move.
“Have a cohesive portfolio where you understand the risks, and when the facts change, respond in the appropriate way.”
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.
Here are the main factors driving the ASX this week, according to Pendal’s head of equities CRISPIN MURRAY. Reported by investment specialist Jonathan Choong
- Find out about Pendal Focus Australian Share fund
- Pendal’s Crispin Murray reviews the lessons from 2023 and outlook for 2024
THERE was nothing to de-rail the market’s bullishness last week, after the US Federal Reserve signalled its inflation mission had been accomplished.
The reaction was very positive with the S&P 500 up 2.5%, now 25% higher year-to-date.
US yields also fell by 30 basis points (bps) and have now ended up where they started at the beginning of the year.
Market price action is positive, with breadth widening and momentum indicators breaking higher and indicating the pathway to moderate growth and falling rates (ie a soft landing) is in sight.
Near-term consolidation will likely occur in the short term before another move higher into the start of 2024, which bodes well for risk assets.
In addition, last week we saw mildly positive inflation data on a net basis, with US economic data supportive of no imminent recession.
In Europe, the ECB and BoE both took a more cautious stance on the prospect of rate cuts – with the former struggling with weak economic data and the latter more understandable given England’s inflation.
China’s policy meetings were mildly disappointing. There were no strong policy signals, but the background message appears to be that fiscal stimulus would continue to be used to prop up growth.
The S&P/ASX 300 was up 3.5% for the week. The Australian economy continued to signal that things were better than sentiment suggested with a strong employment report.
This was reflected in a break higher in the Australian dollar to more than 67 cents.
Economics and policy
Inflation data came in as expected and continues to trend downward on a net basis.
In November, US CPI was higher at 0.1% month-on-month and 3.1% year-on-year.
Core CPI was firmer at 0.28% month-on-month and 4% year-on year.
There was a bit for the bulls and bears – with core goods seeing material disinflation despite a strong auto inflation component, which should unwind.
The service component was not quite as favourable, with rent growth remaining higher than expected. This is somewhat discounted, as more real-time measures of rents are now flat year-on-year.
Core services ex-OER (Owner’s Equivalent Rent) and rent also saw a small re-acceleration over a three-month period.
Medical services and health insurance were the main drivers in this underlying core services pick-up, but it should be noted that these services are known to lag the most – suggesting that inflation is not, in fact, rebuilding.
This will make the next PCE print (the Fed’s preferred measure for inflation) important, as we are seeing a divergence here from the CPI.
We also saw weaker PPI data in the US, and Michigan inflation expectations also fell back down.
In other US economic news retail sales bounced back, up 0.3% versus expectations, though negative revisions reduced part of this.
The underlying trend looks to be around 2.5% growth, which is consistent with the outlook for a soft landing. This means the overall inflation trend is still supportive for the Fed to shift its policy signal, with the headline target of 2% now plausible.
The Fed
In its meeting, the Fed clearly shifted its policy bias.
The market was initially wary that Chairman Jerome Powell would seek to settle things down given a fall in financial conditions since he spoke, and a warning from Fed member Christopher Waller.
But we got a set of dovish signals:
- The dot-plots signalled a move from two to three expected cuts in 2024
- Powell noted there had been discussions on how long to keep rates on hold before cutting. This was expected to be a topic for a more detailed discussion going forward
- Powell noted good progress on inflation, including core and core services
- He also talked about the risk of over-tightening. This was an important shift, relating to the central bank’s desire to avoid having to cut rates too far this cycle
- When pushed about the current easing of financial conditions, Powell did not use the opportunity to diffuse the reaction.
All up, the meeting was taken as a green light for markets.
The following day, Fed member John Williams of New York did try to diffuse the message – particularly given the move to March cuts by the market. But it was met with little reaction since the market believed the data would support a cut then.
The market is now expecting six rate cuts in 2024.
There is a concern from some that the Fed has been too dovish, which may prevent a proper slowdown – resulting in a resurgence of inflation.
European Central Bank
President Christine Lagarde took a more cautious stance than Powell, repeating her message of no cuts in the first half of the calendar year, but her message was largely ignored given the perceived weakness across Europe.
She said the ECB had not discussed the timing of cuts, though the market has been pricing in 150 bps of rate cuts in 2024.
China
November data looked better year-on-year.
For example, retail sales were up about 10%, though they have been weak sequentially.
The outlook remains consistent. GDP growth is steady in the low fives for 2023 and the market expects this slowing between 4.5% and 4.8% in 2024.
Last week, the December Politburo meeting and the Central Economic Work Conference took place, where key economic targets are set (but not announced until March).
Signals were for policy support focused on fiscal policy, though there were no major initiatives which was seen as slightly disappointing.
Australia
Employment data was much stronger than expected (up 61,500) despite a marginal rise in unemployment (to 3.9%) given the continued rise in labour supply.
Total hours worked were flat, which implies average hours worked was lower.
This indicates that businesses are looking to save costs by lowering hours rather than layoffs – possibly due to the difficulty of rehiring in the past.
Forward indicators on unemployment still indicate it should be set to rise further, though these signals have so far not been validated.
Markets
The Fed cutting rates is not necessarily a green light for equity markets, as in the end, the economy gets the final say.
If a recession were to occur, the de-rating of earnings would overwhelm the benefits that the lower rates would bring.
This is why GDP growth next year is key.
We are also seeing some interesting shifts in market internals on the back of this. Notably, mega-caps have done their dash and market breadth is rising.
This can be tracked in the relative performance of the Russell 2000 vs the S&P 500.
For small-caps, this is a particularly positive signal for them to outperform.
Another interesting disconnect is that the market has a very different perspective on the economy than some of the traditional leading indicators of growth, shown by the rotation away from defensives to cyclicals.
This makes early 2024 interesting, as the cyclicals would be sensitive to any weak growth.
In Australia, the ASX saw a broad-based rally with only utilities underperforming.
Rate-sensitive sectors such as REITs and tech led the market.
Energy was supported by the bounce in oil and the continued fallout of the potential STO-WDS merger.
Lithium stocks also had a strong bounce back given how oversold they have become.
Lastly, this environment looks to be positive for the AUD, which continues to look good technically.
About Crispin Murray and Pendal Focus Australian Share Fund
Crispin Murray is Pendal’s Head of Equities. He has more than 27 years of investment experience and leads one of the largest equities teams in Australia. Crispin’s Pendal Focus Australian Share Fund has beaten the benchmark in 12 years of its 16-year history (after fees), across a range of market conditions.
Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management.
What did investors learn in 2023? What are the main issues facing us in 2024? Here’s an overview from Pendal’s head of equities CRISPIN MURRAY
- Find out about Pendal Focus Australian Share fund
- Fixed income: Pendal’s 2024 outlook for bonds, credit and cash
2023 year in review
EACH year Pendal’s head of equities Crispin Murray outlines the major factors that will affect investors in the coming 12 months.
Here Crispin reviews the big issues of 2023 and how they played out.
Further down he outlines the major factors for 2024.
1. Inflation persistence and tightening of financial conditions
Inflation fell faster than hoped in 2023 and key exogenous factors such as oil broke the right way.
Core inflation looks set to fall below 3% by the end of 2023 — and is within striking distance of the RBA’s 2% target.
This has been achieved without the need for a more severe economic slowdown.
2. Scale of US versus domestic economic slowdown
Wages – one of the lead indicators of underlying inflation – fell in 2023 without the need for materially higher unemployment.
This was because job openings shrank quickly and participation rates increased.
One hypothesis is that those holding back from labour markets stepped back in as excess savings were deployed alongside higher immigration.
Meanwhile job openings shifted down as firms worked through post-pandemic shortages.
3. Earnings leverage to downturn
No downturn meant no leverage came through. US earnings per share (excluding energy) is forecast to rise 4%, while the 2024 forecast is around 5%.
4. Did markets price in an economic downturn?
This proved to be important. Sentiment and positioning were very negative at the start of the year.
Therefore, the impact of the economy growing with inflation falling was exaggerated. US markets are up some 25 per cent year-to-date.
5. China’s economic performance as it exits zero-Covid
This disappointed after a promising first quarter. A lack of recovery in the property sector continued to impact consumer confidence.
Contrarily, this probably helped global equities. With stimulus helping steel and iron markets, oil demand was not squeezed too much and contributed to a more benign inflation outcome.
6. Could the RBA engineer a soft landing in Australia?
Australia saw stronger-than-expected growth in 2023. The mortgage cliff has – to date – been navigated through higher immigration, an ability to work more hours, higher wages, more excess savings, and supportive fiscal policy.
Inflation remains a bigger issue in Australia than the US and Europe, so the RBA cannot yet declare victory.
Key questions for 2024
Let’s now look forward. Here are the questions to consider in 2024:
1. Where is the strength in the US economy?
Will the monetary-tightening lags eventually flow through and trigger a much-anticipated recession?
Or will the easing of financial conditions, combined with rising real wages and more fiscal support, help drive growth?
Consensus GDP is 0.7% growth while the Fed is indicating 1.4%. A US recession will knock earnings estimates and be negative for markets.
2. What happens to inflation?
Markets are focused on the challenge of the last mile – ie getting from 3% to 2% inflation.
The Fed acknowledges this may be tough, but to date it hasn’t been the case. The quicker this progresses, the more rate cuts we should get in the US. In turn, this is likely to drive PEs higher.
There is also a counter thesis. In this scenario the Fed repeats the mistakes of the Burns Fed, reading too much into shorter-term lower inflation, only to see inflation re-accelerate as growth holds up.
This would likely force the Fed to shift back towards a more hawkish stance – a clear negative for markets.
3. How will the US election (and others) impact markets?
The 2024 US presidential election is already billed as the most unpredictable and important for decades.
There remain questions as to whether Biden or Trump end up running, or whether a credible independent could impact the outcome.
There is a scenario where no one achieves the required majority in the electoral college.
With so many unknowns there is one conclusion we can draw. The Biden administration will throw everything at ensuring the economic backdrop will be as favourable as possible.
This may extend to the Fed itself and become part of their shift in stance.
We also have elections in Taiwan (Jan 13), UK (May), EU (June 6), India (April), Indonesia (Feb) and Russia (March).
4. What will US rates do?
This is tied to the first three issues. The market has now priced in up to six cuts. Has this gone too far?
5. Will the Chinese economy continue to muddle through?
Will the balance of negative structural issues offset by policy continue to deliver moderate growth with no material surprises? Or will we see structural issues alleviate or deepen?
6. In Australia, can inflation be muted, allowing the RBA to cut rates?
Will the increasing impacts of higher rates begin to squeeze the economy enough to lower inflation?
Or will inflation persist, forcing the RBA into further hikes, running the risk of a faster slowdown?
7. Is the market position becoming too positive?
We are in a very different place when it comes to sentiment and positioning compared to a year ago.
We are more vulnerable to a deterioration in the current benign outlook. But we still have room to rise if the rate cycle plays out as the market now expects.
The issue we resonate with the most is the shift in the Fed’s mindset to underpin the economy rather than build inflation credibility.
Combined with a preparedness to keep using fiscal policy to support growth, this means liquidity and growth are less of a headwind, supporting the market and favouring higher-beta names.
The risk is positioning, which suggest a lot of good news is priced in – making us vulnerable to any inflation surprises.
So, as ever, the market remains unpredictable. This creates opportunity and highlights the importance of thematic positioning.
About Crispin Murray and Pendal Focus Australian Share Fund
Crispin Murray is Pendal’s Head of Equities. He has more than 27 years of investment experience and leads one of the largest equities teams in Australia. Crispin’s Pendal Focus Australian Share Fund has beaten the benchmark in 12 years of its 16-year history (after fees), across a range of market conditions.
Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management.
ASX investors have seen a flurry of corporate transactions and associated equity raisings in recent months. Here Pendal equities analyst ANTHONY MORAN explains the opportunities
- Negative reaction to M&A can uncover opportunities
- Orora and Treasury Wine recent examples.
- Find out about Pendal Focus Australian Share fund
NEWSPAPER headlines have been full of merger and acquisition activity and associated capital raisings in recent months.
Chemist Warehouse-Sigma Healthcare. Brookfield-Origin. Newcrest-Newmont. Allkem-Livent. Woodside-Santos.
The activity is likely to continue in 2024, especially in the resources space.
Investors haven’t always been impressed with recent deals – but that doesn’t mean there isn’t opportunity, says Anthony Moran, an analyst with Pendal’s Aussie equities team.
Negative reactions and sell-offs following M&A deals can provide opportunities for investors, says Moran.
“Any deal that is large enough to be raising equity tend to be shareholder destructive in the short term,” he says.
“The market tends to over-react to the downside and that’s understandable because the market doesn’t like diluting the positive investment case for a company.
“M&A introduces a whole new element of uncertainty. There are going to be risks around the businesses being bought, and investors have to learn about them,” he says.
“Also, Australia’s track record of large M&A is extremely weak. It’s just a safer bet that a deal won’t go too well, almost regardless of the details.”
Opportunities from negative reactions
The negative reaction to M&A can provide potential investment opportunities, Anthony explains.
“Market over-reactions around M&A are exacerbated at the moment with fears that the economic cycle is rolling over.”
Investors are concerned that companies are buying businesses that may have puffed up earnings or been trading on a cyclical peak, he says.
“They are worried that the acquiring company has not done enough due diligence and that gives them a reason to sell off the acquiring stock.
“But if you can do the work on the acquired businesses and start to get an understanding and more informed perspective on the probability of the success of a deal, then the sell-off could be quite an attractive investment opportunity.”
Take a long-term view of M&A
Amcor’s purchase of US-based flexible packaging company Bemis in 2019 worked well with significant cost synergies extracted and an improved top line.
But initially, after the deal was announced, Amcor was sold off.
Pendal Focus Australian Share Fund
Now rated at the highest level by Lonsec, Morningstar and Zenith
A similar example was Boral’s 2016 purchase of US-based fly ash producer Headwaters.
Following the announcement of the deal Boral was initially sold-off – then bid up as investors got excited by the potential growth prospects of the Headwaters business.
Ultimately there were few natural synergies between the businesses and as the underlying low quality of the Headwaters business became apparent, Boral underperformed over several years.
It recent months, two ASX-listed companies — both held in Pendal equities funds — have acquired businesses and are now trading on historically low multiples.
“Packaging group Orora (ASX: ORA) bought a France-based specialty premium glass manufacturer that supplies high-end glass bottles for luxury spirits and is a global leader,” Anthony says.
“But investors are worried that post COVID, the growth in luxury spirits, in particular, is rolling over.
There are concerns Orora paid too much, the industry is going to become more competitive and the ESG burden of decarbonising returns will hurt returns,” he says.
Treasury Wine Estate (ASX: TWE) bought a US luxury wine company that has grown quickly in recent years.
Investors are concerned that the growth in earnings will not be sustainable, and that US consumer demand will wane.”
Anthony says that while it is much too early to tell whether the Orora and Treasury purchases are good deals, the kneejerk reaction from markets, selling off the companies, provides an opportunity for investors.
“Take the time to do the work on the underlying assets purchased. Talk to other industry participants and find out how these businesses are positioned, what’s sustaining their returns and what the outlook is.
“And bear in mind that doing the deals haven’t changed the underlying assets in the rest of the businesses.
“The de-rating has hit both the acquisition business and the legacy businesses. That means the legacy businesses have gotten cheaper.”
About Anthony Moran
Anthony Moran is an analyst with more than 15 years of experience covering a range of Australian and international sectors. His sector coverage has included Australian Industrials and Energy, Building Materials, Capital Goods, Engineering & Construction, Transport, Telcos, REITs, Utilities and Infrastructure.
He has previously worked as an equity analyst for AllianceBernstein and Macquarie Group, spending a further two years as a management consultant at Port Jackson Partners and two years as an institutional research sales executive with Deutsche Bank.
Anthony is a CFA Charterholder and holds bachelor’s degrees in Commerce and Law from the University of Sydney.
What lessons can fixed-income investors take from 2023 into 2024? Pendal’s head of income strategies AMY XIE PATRICK summarises the outlook with fellow PMs TIM HEXT, GEORGE BISHAY and STEVE CAMPBELL
- Pendal’s 2024 outlook for bonds, credit and cash
- Why bonds, why now? Pendal’s income and fixed interest experts explain
- Find out about Pendal fixed interest capabilities
I LOVE this time of year. Not only is there plenty of holiday cheer, there is also time to survey the landscape as we head into a new year.
Five key observations that stand out to me from 2023:
- Recession never arrived, though it was widely expected at the start of the year
- Inflation came off without a significant rise in unemployment
- Riskier assets saw healthy returns while bonds had another challenging year
- US 10-year real yields pushed past 2%
- Small and regional US banks have not solved their fundamental problems.
Interestingly in October, when the real yield on 10-year US treasuries tested 2.5%, the bond sell-off halted.
Perhaps the market was saying: “sure, growth is strong now, but the party won’t last forever”.
How we fared in 2023
Pendal’s fixed income team reassessed the situation when we saw the economic data wasn’t weakening.
We identified that, in Australia, the fixed-rate mortgage cliff was a red herring.
George Bishay, our head of credit and sustainable strategies, moved away from a more conservative stance and started to re-risk his credit portfolios.
From banks to utilities, industrials to infrastructure, George has been cherry-picking his way through the primary market since things calmed after the US banking crisis.
“As long as inflation can continue to come down, bond market volatility can be contained,” says George.
“As long as bonds are no longer aggressively selling off, I’m happy to be tactically raising my credit exposures.”
Tim Hext, Pendal’s head of government bond strategies, recognised that just because inflation had peaked, it didn’t mean the fight was over.
While keeping duration positions small during the year, volatility threw up many opportunities in the physical bond space that he was able to take advantage of.
“You can’t ignore the fact that they’ve continued to pump out fiscal stimulus in the US,” says Tim.
“Australian bond markets have been passengers in the US-led sell-off.
“However patient the RBA wants to be, CGLs (Commonwealth Government Loans) couldn’t fight the strong tide of US Treasuries.”
Steve Campbell, our head of cash strategies, has had similar views, but was able to position a little differently in his portfolios.
“The cash funds were predominantly longer than the benchmark over 2023, despite the Reserve Bank continuing to tighten monetary policy,” Steve says.
“The additional yield and the steepness of the curve helped protect the cash funds’ performance from the move higher in yields over the period.”
As Pendal’s head of income strategies, I have the privilege of all this expertise around me.
The income funds benefited from the wisdom of my peers, positioning at first defensively and then risking up on credit.
Positioning long enough in duration earlier in the year in time for the Silicon Valley Bank crisis, then pulling back in to weather the bond storm.
Find out about
Pendal’s Income and Fixed Interest funds
In more defensive moments, Steve made sure extra cash in the income funds kept up with or beat offerings on term deposits – with the added advantage of liquidity.
I’ve enjoyed having that liquidity at my disposal this year. The income funds can take on exposures in Australian equities and emerging markets.
Although both those asset classes generated positive returns this year, there was plenty of volatility along the way.
Thanks to liquidity provided by Steve, the high yield he has offered on cash and our active asset allocation process, the income funds have been able to take advantage of this environment.
Where to from here?
Here’s a quick 2024 outlook on bonds, credit and cash from our income and fixed interest portfolio managers.
Bonds
Bonds have had three challenging years in a row – will there be a fourth? I ask Tim Hext.
That’s very unlikely, he argues.
“My framework for 2024 is for falling inflation and yields. Though as always, I’ll be flexible within the framework, since it likely won’t be a straight line down.”
That’s a good point to remember, I believe. It’s been a while since we’ve had straight-forward, unequivocal bond rallies.
“If the US Fed cuts rates as expected, markets will price in cuts here,” says Tim. “Though the RBA will likely be slow to react, since they rely on the lagging indicator of inflation to set policy.
“I’m watching the new RBA monetary policy board and how that works.
“Also, don’t forget stage-three tax cuts come in July.”
And the line I like the most from Tim: “Even if policy is on hold here for most of 2024, markets will not be standing still.”
This paints a backdrop against which our active investment process can shine.
Credit
Would rate cuts mean bad news for riskier assets like credit?
“Not necessarily,” says George Bishay.
“Like the past year, if the market can feel that inflation can be contained and the growth picture holds up, that’s basically a Goldilocks scenario and equities should do fine.”
Where Australian credit goes is largely led by where US equities have gone before, George often reminds our team.
If the Goldilocks picture can continue, George will be happy to hold on to the risk he now has. But he’s also ready to act if that isn’t the case.
“That’s why I’ve been very discerning in the type of risk I’ve been adding over the year,” George says.
“You can’t ignore the tail risks out there. As the US banking crisis showed us earlier in the year, sentiment can sour very quickly.
“I’ve kept to top-quality issuers, stayed in senior positions in capital structures and always had an eye on liquidity when I’ve been adding risk this year.”
Thanks to George’s nimble approach, I’m not worried about the income funds’ ability to pull credit risk in at the right time.
Cash
Will cash still be in vogue if a new cutting cycle starts in 2024? I ask Steve Campbell.
“Let’s not confuse the RBA with the Fed,” Steve reminds me.
“I expect fourth-quarter inflation to be lower than the RBA’s forecast. That should mean the Reserve Bank is done hiking.
“But any talk of a new RBA rate-cutting cycle is premature. Inflation is still too high and the labour market is still too tight.
“I expect the cash rate to remain unchanged over 2024, though with bouts of volatility.
“Significant global monetary policy tightening since early 2022 and related spill-overs will become more obvious in the coming year as economic growth slows further.”
Because of the uncertain environment ahead, Steve argues that “highly liquid cash strategies rather than term deposits are a better way for investors to capitalise on any bouts of volatility.”
If things go south and bonds still can’t protect you, it’s critical to have a deeply experienced cash manager by your side.
If Steve is right about bouts of volatility, our active and tactical return booster levers – which buy equities or emerging markets – should continue to get a work-out in 2024.
But if he is also right about a further slowing of economic growth, I expect tactical forays into riskier exposures in the income funds will become less frequent.
Recession odds for 2024
The consensus on US recession stands in stark contrast to this time last year.
Economies have been far more resilient than markets anticipated – and markets in turn have adjusted their expectations.
Soft-landing is now the narrative.
Worryingly, fundamentals have deteriorated as the lagged effects of monetary policy tightening play through.
There doesn’t need to be another Silicon Valley Bank-like shock to send the US economy into recession in the second half of next year.
In fact, I’d put the odds at about two-thirds.
It just takes the continuation of the same economic trends we’ve witnessed in recent months.
Slack is coming back into labour markets. Fewer people are quitting, fewer employers are saying it’s hard to find workers.
Lending standards have tightened, meaning credit growth will keep contracting and default rates will keep climbing.
Delinquency rates in consumer loans have risen for seven quarters straight (not months).
The concentrated exposure of smaller US banks to the commercial real estate sector is an unresolved tail risk.
Nothing in that list is dramatic, but the collective force is more likely than not to bring on a recession in 2024.
For much of 2023, the narrative was about too much supply and not enough demand for US government bonds.
If a recession hits next year, demand for safe-haven assets will overwhelm supply, even if the fiscal taps remain on.
Equity markets tend to peak about six months ahead of a recession.
The next few months is a chance to get your house in order.
Consider rotating back into fixed income and cash – and look for good active management.
About Amy Xie Patrick and Pendal’s Income and Fixed Interest team
Amy is Pendal’s Head of Income Strategies. She has extensive experience and expertise in emerging markets, global high yield and investment grade credit and holds an honours degree in economics from Cambridge University.
Pendal’s Income and Fixed Interest boutique is one of the most experienced and well-regarded fixed income teams in Australia. Pendal won the 2023 Sustainable and Responsible Investments (Income) category in the Zenith awards. In 2021 the team won Lonsec’s Active Fixed Income Fund of the Year Award.
The team oversees some $20 billion invested across income, composite, pure alpha, global and Australian government strategies.
Find out more about Pendal’s fixed interest strategies here
About Pendal Group
Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management.
Here are the main factors driving the ASX this week according to portfolio manager JIM TAYLOR. Reported by portfolio specialist Chris Adams
THE constructive narrative was unchanged by last week’s US data.
November’s non-farm payrolls and average hourly earnings data — along with surveys of inflation expectations and Job Openings and Labor Turnover (JOLTS) — all told a story of modest slowdown. There was no significant evidence that consumers or businesses were walking off a cliff.
The short end of the US Treasury curve sold off – perhaps reflecting a realisation that the market was a touch over-optimistic on the potential pace of monetary easing.
Ten-year US yields were relatively flat for the week, while yields rose at both the long and short end of the Australian curve.
Oil remained under the pump, with Brent crude down 3.9% for the week and 20.4% lower over the quarter to date. This is starting to translate into some relief at the fuel pumps for consumers.
Gold pulled back from its highs (down 3.8%) while iron ore rose 3%, and its resilience is likely to persist into Q1 2024.
US equity markets delivered their sixth straight week of positive returns – the best run since November 2019 – though returns were relatively modest in the context of what we have seen over the last couple of months.
The S&P 500 gained 0.24% while the S&P/ASX 300 was up 1.69%.
This week, we have the Fed Open Monetary Committee meeting (December 12-13) as well as the November US CPI report.
On the latter, consensus is looking for a 0.05% month-on-month rise in headline inflation but a steep step-up to 0.3% month-on-month in core inflation.
US macro and policy
October JOLTS came in at 8.73 million versus September’s 9.35 million and consensus expectations of 9.3 million.
It paints a picture of broad-based slowing in the labour market, but not the plunge some feared given the scale of rate increases. For every employed person, there are now an estimated 1.3 jobs available (down from 1.5).
The largest declines in job openings come from private sectors such as education (down 238,000) and financial services (down 217,000).
The Quits rate remained at 2.3%. (The three-month moving average in the private sector is running at 2.6% and falling).
This has historically provided a strong six-month lead on the direction of private-sector wages and salaries in the US Employment and Cost Index. It suggests growth in the latter should continue to soften.
November payrolls rose 199,000, which was a touch above consensus of 185,000. This helped by an end to the auto worker strike.
The unemployment rate fell 0.2% to 3.7% versus consensus of 3.9%. This rise was driven more by an increasing workforce rather than more unemployed people.
Average hourly earnings rose 0.4% versus consensus at 0.3%. The three-month annualised rate of 3.4% versus 4% previously seems to be heading in the right direction.
With commodities, goods and rent inflation all seemingly under control, wages remain one of last areas to address.
The US Federal Reserve is focusing on wages growth, which is the main driver of core non-rent PCE services inflation. Because of low productivity growth in many services, wage growth can quickly change price inflation.
Wage growth between 3% and 3.5% should be enough to see core non-rent PCE services inflation at 2.5% and overall medium-term core PCE inflation at 2%.
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Pendal Horizon Sustainable Australian Share Fund
Lower petrol prices and higher stock markets played an important role in the December Michigan consumer sentiment index hitting 69.4 – up from 61.3 in November and ahead of consensus of 62.
In the same survey, one-year inflation expectations fell 1.4% percentage points to 3.1%, which is the largest single drop in a month since Covid.
Meanwhile, expectations over the five to ten-year timeframe also fell from 3.2% to 2.8%.
This is all good news for the Fed, which closely watches consumer inflation expectations.
RBA leaves rates on hold
As expected, there was no Christmas Grinch from the RBA – with rates unchanged at 4.35%, as expected.
However, the forward-guidance of data-dependency and the evolving assessment of risks was maintained.
On the labour market, the statement noted that “wages growth is not expected to increase much further and remains consistent with the inflation target, provided productivity growth picks up. Conditions in the labour market also continued to ease gradually, although they remain tight”.
We see some risk to this view. Recent data suggests there may be further persistence in wage growth in contrast to other economies.
The Board will next meet in February, after monthly and quarterly CPI data (due on January 10 and 31 respectively) and labour market updates.
Comments from the RBA’s head of financial stability Andrea Brischetto last week were consistent with the feedback we’ve received from banks: the cohort of borrowers that are under severe financial stress is unexpectedly very small given the magnitude of the rate rises we have seen.
Brischetto’s observations included:
- around 95% of variable-rate owner-occupier borrowers still have spare income after meeting their mortgage payments and essential expenses
- around 5% find their income insufficient to cover their mortgage payments and essential expenses, however, many of these mortgagees do have savings in their mortgage offset and redraw accounts
- this leaves less than 2% of all variable-rate owner-occupier borrowers who have both an income shortfall and low savings buffers, and so could fall into severe financial stress within six months assuming interest rates remain around current levels.
This suggests an aggregate level of the economy is getting through the great variable-rate reset without falling off “the mortgage cliff.”
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Crispin Murray’s Pendal Focus Australian Share Fund
The RBA and government’s conduct of monetary policy statement included a key change towards a shift to greater emphasis on the midpoint of the 2-3% inflation target, less emphasis on financial stability, and a requirement of the RBA to provide a more detailed assessment of full employment.
It also outlined changes to improve communications and accountability, such as publishing unattributed votes after each meeting and requiring external Board members to give public speeches.
Australian macro
Third-quarter GDP growth was softer than expected at 0.2% and 2.1% over 12 months.
Due to the increasing cost of living, consumption is growing at its slowest yearly rate since Q1 2021 while the savings ratio dropped to its lowest point since Q4 2007.
There were positive drivers from government expenditure (up 0.2%), investment (up 0.2%) and inventory growth (up 0.4%), which helped offset a drag from net exports (down 0.6%).
Productivity improved, rising 0.9% after a 1.6% fall in Q2. This was in a response to hours worked falling 0.7% (a level that is down 2.1% year-on-year).
Unit labour cost growth slowed to 1.2% for the quarter and is up 6.4% year-on-year, down from 7.4% in Q2.
While high, it is heading in the right direction.
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.
Here are the main factors driving the ASX this week, according to CRISPIN MURRAY. Reported by portfolio specialist Chris Adams
MARKETS have been emboldened by several factors: continued signs of slowing inflation with a soft landing, signals from policymakers that possible rate cuts are on the horizon, and a failed meeting between OPEC+ constituents which drove oil prices back to recent lows.
This growing confidence in slowing inflation, combined with the unwinding of bearish positioning in the markets, has driven the S&P500 to calendar-year highs.
Since the end of October, the US Dollar has fallen about 3%, while US 10-yr Treasury yields are some 70 basis points (bps) lower, and oil is down about 8%.
This has all contributed to the S&P 500 rallying 8.9% in November.
This risk-on rally has led to the Goldman Sachs US Financial Condition Index easing the most in any single month for over forty years. And the VIX – a measure of volatility – has fallen from 19 to 13, which is a post-pandemic low and also signifies market confidence.
Interestingly, US Federal Reserve (the Fed) board member Christopher Waller’s comments last week fuelled rate cut expectations – sentiments Chairman Powell chose not to reverse in his speech on Friday.
The S&P/ASX has lagged the US, but still posted a 5% return for November.
It still sits about 7% below 2023 highs, reflecting a worse inflation/growth trade-off than in the US, which leaves policy risks higher here.
The S&P/ASX 300 returned 0.53% for the week, while the S&P 500 was up 0.83%.
Economics and policy
Inflation data continues to trend in the right direction.
The US Personal Consumption Expenditures index (PCE) was in line with expectations, with the headline measure flat month-on-month and up 3% year-on-year.
Core PCE was up 0.2% month-on-month and 3.5% year-on-year, while the core services ex-housing PCE (the Fed’s preferred measure) rose 0.1% month-on-month versus 0.4% in the previous month.
This shows we are back to a clear, slowing trend.
The weakness in oil has also helped reinforce these positive signals, while US macro data has also been softer – though not to a point that could fan recession concerns:
- There were some softer signals in the labour market, with continuing claims ticking higher. US payroll data is due later this week.
- US Real Consumption growth has slowed, rising 0.2% month-on-month and 2% year-on-year, even with demand bolstered by a fall in gasoline prices.
- Real disposable income growth picked up 0.3% month-on-month, the fastest rate in five months. This highlights one of the potential supports for the US economy into 2024, as wages catch up and inflation falls.
- The rundown of excess savings has supported consumption. Though this month savings rates improved slightly to 3.8%, this is still down from 5.2% six months ago.
- The Fed’s “Beige Book”, which includes anecdotes at a regional level, is also highlighting slowing activity and softer labour markets.
- The US ISM Manufacturing PMI data was slightly weaker than expected, staying flat month-on-month at 46.7 versus consensus at 47.6. The production and employment components both fell month-on-month, while orders improved.
All these signs of slowing are validated by the Atlanta Fed GDPNow tracker which – in previous quarters – has been a good predictor of economic growth proving more resilient than consensus expectations.
Now, it is slowing sharply.
Elsewhere, eurozone inflation was weaker than expected too.
Core CPI fell 0.15% month-on-month. The three-month annualised rate is 0.65% and is running at 4.9% year-on-year. Services inflation is rolling over, albeit with some one-off drivers, such as packaged tour prices.
The Fed
These signals are fuelling a bond market rally, which has been reinforced by Fed speakers.
Waller really fired things up, saying that if the data was to continue on the current trend for the next three-to-five months, then the Fed would have to consider rate cuts on the premise of keeping the real rate flat.
This was the first signal that the March meeting could be “live” for a cut.
Though he is not seen as central bank leadership, Waller has been hawkish through this inflationary cycle.
On Friday, Chairman Powell chose not to offset Waller’s comments – noting that policy is restrictive and putting downward pressure on growth and inflation, that the full effects of tightening have not been felt, and that the Fed remains “data-dependent”.
However, Powell also said it was premature to speculate on when policy may ease.
This has all been taken positively by a market that is keen to pull the trigger on a peak in the rate cycle. The first market-implied rate cut has been brought forward from June to April and the number of cuts for 2024 has increased from three to five.
There is a risk that the market is getting ahead of itself here, as it did in March and April of this year.
There is a self-regulating aspect to the US economy in that the rally in bonds and a weaker US Dollar already provide looser financial conditions, reducing the need for actual rates to be cut this quickly.
Markets
November’s equity market displayed some of the hallmarks of a liquidity-driven rally.
For example, the more speculative end of the technology sector outperformed the NASDAQ, suggesting some rotation away from larger tech names.
Within Australia, small-caps outperformed larger caps.
Commodities
Gold has been a key beneficiary of the shift in rate expectations, testing all-time highs.
Gold mining stocks, which lagged the gold price move in October, are now catching up and made gold the best-performing sector last week.
Copper also showed signs of life last week, despite the outlook for slowing growth.
This partly reflects supply disruptions, with the First Quantum Cobre Panama mine contract (which represents 1.5% of global supply) being ruled as unconstitutional and the President saying the mine would be closed.
First Quantum have taken the matter to the International Court of Arbitration.
Oil is testing its lows for the year, after the OPEC+ meeting failed to result in a new target for 2024 production cuts; instead, there is to be a deepening of existing voluntary cuts into Q1 2024.
Theoretically, this implies 700,000 barrels-per-day (bpd) of additional cuts.
Saudi will roll its existing voluntary cut through to March and Russia said it would raise its cut from 300,000 from 500,000 bpd. Elsewhere, the UAE, Iraq and Kuwait have all offered to cut by an additional 163,000, 223,000 and 153,000 bpd, respectively.
But the issue is that the market has no conviction in these cuts being met.
For instance, Russia is cutting exports – not production – and sanctions have not worked. The same is true for Iran. Meanwhile, Angola said it wouldn’t follow the deal and Brazil, which was added to OPEC+, said it would not be party to quotas.
The scale of the cuts, the limited impact on prices, and the prospect of a seasonally weak Q1 leave the market believing the additional cuts may prove to be less than 100,000 bpd and insufficient to offset weakness in oil.
We note that oil price weakness relates more to incremental supply in 2023 from US shale and Brazil – plus more supply from Russia and Iran reaching the market – than any demand weakness.
The concern is that any slowing in the economy could compound the imbalance.
About Crispin Murray and Pendal Focus Australian Share Fund
Crispin Murray is Pendal’s Head of Equities. He has more than 27 years of investment experience and leads one of the largest equities teams in Australia. Crispin’s Pendal Focus Australian Share Fund has beaten the benchmark in 12 years of its 16-year history (after fees), across a range of market conditions.
Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management.
India may have fallen short in the 2023 Cricket World Cup, but it’s been on a winning run since last hosting a world cup in 2011
- India now an attractive EM for investors
- Digital infrastructure has strengthened economy
- Find out about Pendal Global Emerging Markets Opportunities fund
INDIA hosted the ICC Cricket World Cup in 2023 for the first time in 12 years.
The result was not what local fans wanted to see, unlike 2011 when India last hosted — and won — the tournament.
But the country is certainly winning in other ways, points out Paul Wimborne, who co-manages Pendal Global Emerging Markets Opportunities fund.
In the intervening 12 years between the two tournaments, the country changed massively, becoming a more attractive location for emerging markets investors, says Wimborne.
“The most significant changes have been in internet connectivity and digital infrastructure.
“India now has the second-highest number of internet users in the world. An estimated 60 per cent of the population are connected so we are talking about hundreds of millions of people.
“They have high-speed internet access particularly in the urban areas and that’s a massive change since the 2011 World Cup,” he says.
How India became a digital giant
In 2015 the Narendra Modi government launched Digital India, a program designed to digitise government services and provide internet infrastructure across the country.
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The successful project altered India and became a blueprint for developing nations, Wimborne says.
There are three layers to India’s “digital stack”, which is essentially government-backed APIs (application programming interfaces) on which third parties can build software.
“The first layer is identity. The identity card in India is known as Aadhaar. It is linked to biometric data which provides proof of identity.
“Over 90 per cent of the population has a card with a 12-digit unique identifier. About 700 million of the cards on issue are now linked to a bank account.
“The second layer is a unified payment interface, or UPI. It is essentially an instant payment system via mobile, which makes payments as easy as sending a message or scanning a QR code.
“There are now an estimated 10 billion transactions every month on the system.
“The third layer is a data exchange. For example, the government runs DigiLocker, which provides access to authentic digital documents linked to citizens. It might be a passport or a driving licence, or the ability to e-sign documents.”
Huge changes ahead
The approach has provided India with the building blocks for future innovation and services, Wimborne says.
“We are going to see huge changes in things like healthcare, and digital commerce. SMEs (small-to-medium enterprises) will have much greater ability to sell online.
“Some of the key benefits we’ve seen so far is for banks and mobile phone companies. It has reduced the time taken to do checks and massively cut costs.
“Some of the benefits accruing to the broader economy range from less tax avoidance, less cash in the economy and a reduction in general fraud and corruption,” Wimborne says.
“India has always had a strong services export economy based on software and services. This is going to kick things along even further. India is going to become an even bigger powerhouse.
“India has done well over the last few years in terms of economic growth and the equity market.
“These reforms and changes have increased the trend growth rate in India. There has been huge progress already, but the real benefits might be still to come over the next five to ten years.”
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.