Inflation should soon start to fall — but not as much as some expect. Inflation-linked bonds could be a good option, argues Pendal’s head of government bonds TIM HEXT
“The sun is shining, the weather is sweet, yeah|
Bob Marley
Make you wanna move your dancing feet”
A LONG overdue spell of warm and sunny weather has lifted spirits here in Sydney.
For the first time in three years everyone is out and about and looking forward to celebrating Christmas. Party invitations are issued and fingers are crossed on the health front.
However, the tone in markets is more sombre.
Cumulative central bank tightenings are starting to hit hip pockets and liquidity is worsening.
In simple terms a decade of low rates — and the associated investment structures built up around them — are starting to unravel. It’s increasingly looking partly structural not just cyclical.
This is what central banks intend to happen.
For years one of our major themes was the chase for yield. Now it is the chase for inflation protection — though too many remain stuck in the mindset of the last decade.
The ultimate aim of the superannuation industry should be to protect the spending power of their members —who defer consumption today for their retirement.
If the economy is productive, hopefully that money can grow a little faster than inflation to increase the standard of living.
A decade of low inflation and falling interest rates made that look easy.
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In 2022 with super funds down on average 5% and inflation close to 8%, the spending power of members has gone backwards by 13%. Not so easy now.
Inflation could settle at 3-4%
We expect US inflation will fall soon and Australia will follow by mid-2023.
“Risk markets may take some encouragement from this, but inflation is likely to remain around 3-4%.
“Goods prices may fall — or even go negative — but inflation on services will remain stubbornly high.
The markets may look for rate cuts, but inflation could prevent that. At least rates will stop rising. “
In this environment investors need the defensiveness of bonds, which have now restored their insurance credentials after this year’s hits, says Hext.
“My recommendation would be to buy inflation-linked bonds.
Returns from inflation-linked bonds are adjusted for inflation, allowing investors to protect real returns.
They’re not popular in Australia, which is something of a mystery to Hext.
“The mainstream investment community seems to prefer standard, nominal bonds — as evidenced by the nominal-only benchmark proposed for bonds in the Your Future Your Super guidelines.
“In my view this is poor policy, overlooking the benefit that inflation-linked bonds provide for retirees or those near retirement.”
While we enjoy summer in Australia, the wintertime blues of an energy-constrained northern hemisphere will mean summertime blues for markets in Australia.
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.
FOR a while now our attention has been focused on the timing of a central bank pivot.
That’s the much-anticipated moment when central banks change course and stop hiking rates.
But perhaps the more important pivot is in the hands of consumers — reining in our spending.
Our pivot needs to occur before central banks’ pivot.
The RBA is hiking rates to fight inflation which is driven by our desire to keep spending in an economy doesn’t have capacity to absorb that spending.
Most observers are surprised at how well retail sales are holding up even though consumer confidence is at recession levels.
This demonstrates the power of fiscal policy when stimulus is delivered to consumers versus the trickle-down impact of government spending through infrastructure projects.
The JobKeeper and JobSeeker schemes preserved (and in many cases improved) Australian household balance sheets and cash flows.
Once the lockdowns ended, pent-up consumption allowed a business boom that fed into record low unemployment.
That’s the main driver of a divergence in consumer confidence and retail spending.
We all have jobs — and though our purchasing power has diminished, having a pay cheque goes a long way.
The SEEK.com table below demonstrates the incredible growth in demand for labour in industries catering to consumer spending. It also highlights the difficulty those industries have had in filling vacancies without the international students and work holiday visa flow.
It’s unlikely that consumers will stop now, with the first fully open Christmas in three years just around the corner.
With Sydney-Melbourne return flights costing more than $1000 maybe bus transport will experience a revival. Time to put up those prices.
This may well be peak exuberance and it will come through in the January CPI numbers. It could be a very different story in 2023, with consumers staring at empty wallets.
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About Anna Hong and Pendal’s Income and Fixed Interest team
Anna Hong is an assistant portfolio manager with Pendal’s Income and Fixed Interest team.
Pendal’s Income and Fixed Interest boutique is one of the most experienced and well-regarded fixed income teams in Australia. In 2020 the team won the Australian Fixed Interest category in the Zenith awards.
With the goal of building the most defensive line of funds in Australia, the team oversees A$22 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 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 our head of equities Crispin Murray. Reported by portfolio specialist Chris Adams.
CHAIR Jerome Powell’s hawkish tone after the Fed’s 75bp rate hike weighed on markets last week.
Though signs that Beijing may getting ready to roll back zero-Covid by March prompted a Friday rebound, helping contain the damage.
In Australia the RBA reinforced its more dovish rate path, choosing to take a risk on inflation to avoid triggering a damaging recession.
The S&P 500 fell 3.3% last week and is trading in the middle of the 3500-3900 range.
There was substantial rotation as growth and technology stocks suffered on the rate outlook. But cyclicals — and particularly metals and energy — did well on the signals from China.
Other global equity markets fared better, given a more cyclical skew.
The S&P/ASX 300 rose 1.6%. It is down 4.2% for 2022, versus -19.8% for the S&P 500 and -32.6% for the NASDAQ.
The medium-term outlook still depends on the degree of economic downturn and its impact on earnings.
There is some debate about the degree of leverage earnings will have to the downturn.
Historically, recessions have led to an average 20 per cent fall in earnings. Though this is often in a low-inflation environment, when nominal GDP (a proxy for corporate revenue) is low.
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In this instance the bulls argue that three factors may mitigate earnings decline:
- Companies will benefit from higher nominal growth, supporting revenue and helping cover fixed costs
- Materials and energy companies will see continued strong earnings, given lack of supply
- The potential re-opening of China may offset weakness in Europe and the US
The Fed
The Fed’s initial press release indicated a coming deceleration in the pace of rate hikes and an extension of the hiking cycle.
But Powell ensured this was not interpreted as the longed-for dovish pivot. The peak in rates would likely be higher than previous forecasts, he noted in a press conference.
This is expected to be released in December’s quarterly “dot plot” — likely 5% to 5.25% by the end of 2023.
This is 50bps higher than the September indication and 25bps more than consensus forecasts.
Two-year US government note yields rose 24bps and 10-year bond yields were up 14bps for the week in response.
Higher rates and a further hawkishness put a nail in the “pivot” trade and saw growth stocks underperform.
US economic data
October’s payroll data showed 261,000 new jobs, versus 193,000 expected.
This strong print was somewhat mitigated by a weaker household survey, which showed a decline in employment of 328,000 and an increase in unemployment from 3.5% to 3.7%.
Less helpfully, the participation rate for the “prime” age cohort fell from 82.7% to 82.5%.
Average hourly earnings were stronger than expected at 0.4% month-on-month versus consensus of 0.3%.
However this series has been softening. The three-month moving average is now down to 3.9% annualised, well below the annual rate of 4.7%.
All wage data series are rolling over, but growth is still too high at around 5%. It needs to fall to 4%.
Earlier in the week we saw job-opening data reverse the previous month’s decline.
A range of indicators show the labour market softening and lay-offs picking up. But the data is still too strong for the Fed to feel comfortable on inflation.
Finally, manufacturing data (the ISM index) weakened more than expected, though not enough to indicate a recession.
China
The week’s most significant surprise came from China with rumours of a shift in thinking on zero-Covid.
We saw:
- Rumours of a “re-opening committee” meeting
- People’s Daily articles dispelling concerns on long Covid
- German chancellor Olaf Scholz — on a visit with President Xi — speaking of an agreement to supply the Pfizer / BioNTech vaccine to foreign nationals living in China
- Rumours that Li Qiang, the next PM, supported mRNA vaccines which could be rolled out in the next 2-4 months
- A Chinese epidemiologist say Chinese mRNA vaccines are as effective as Western versions and express confidence in inhalable vaccines
Some of these stories were walked back at the weekend — especially after a surge in Covid cases, particularly in Guangzhou.
We are careful not to extrapolate too much from this. There is a view that it would make more sense for Beijing to roll back zero-Covid once the northern hemisphere winter has passed.
But the market reaction highlights how far consensus positioning was caught out by a shift in sentiment on China.
Chinese stocks moved about 18 per cent on the week. Resources stocks and the Australian dollar also moved sharply on Friday. There were moves in resources with oil and copper up.
This highlights the issue that Chinese re-opening could renew inflationary pressure.
Finally, Beijing also sent a message to Russia cautioning against the threat of nuclear weapons.
This was seen as an important attempt to reduce geopolitical tensions.
Australia
As expected, the RBA raised rates 25bp to 2.85% last week.
The message remains far more benign than the Fed. This is seeing a divergence in outlooks for domestic and internally-focused stocks within the ASX.
The RBA expects rates to peak at 3.5%, versus 5% to 5.25% in the US. Inflation is expected to peak at 8% this quarter and fall to 4.7% a year later, with GDP slowing to 1.4% in 2023.
The risk is inflation does not drop so quickly, given this level of growth.
Markets
The combination of a hawkish Fed and hope on Chinese re-opening led to a major rotation in the market last week.
There was a 9% relative move in the S&P 500 mining sector and 8% in the S&P 500 energy sector versus the NASDAQ.
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US earnings season deteriorated to below long-term averages in term of beats and above in terms of misses.
Most telling was the poor performance of the technology mega caps, where there was a second wave down. As always, it seems “the generals are the last ones to be shot” in a bear market.
Apple unwound all the previous week’s performance.
Atlassian fell 28% post result and is now down 73% from its peak 12 months ago. Twilio fell 34% on its result, taking the decline from its Feb peak to 93%.
Both these companies are leveraged to the tech sector as service providers, so their slowdowns are compounded.
The rotation is also reflected in earnings.
Exxon quarterly earnings have now caught up to Microsoft. Though the energy sector’s proportion of the S&P 500 is back only to 2019 levels — still well below its highs of a decade ago. The Australian market’s sector mix and skew to resources/energy and financials continued to provide resilience.
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.
Our Emerging Markets team always starts with a top-down, country-level investing framework. Here’s how their framework applies to China right now.
This is a monthly insight from James Syme, Paul Wimborne and Ada Chan, co-managers of Pendal’s Global Emerging Markets Opportunities Fund
CHINA has undergone major political change recently with the consolidation of Xi Jinping’s power in his third term as leader.
Chinese equities have also aggressively de-rated in valuation terms this year.
As emerging markets investors, how has our view on China changed?
Our investment process is designed to be alert not just to market drivers — but also to changes and trends, surprises (positive and negative) and forecasts and surveys.
The philosophy behind that process emphasises a disciplined and repeatable country analytical process.
When reviewing recent develoment in China, we stick to our core five-point framework in reviewing the outlook for Chinese equities in USD terms over the next two years.
Here’s what that tells us.
What the data says
Growth in China is weak by historic standards. Strong exports are offset by very weak domestic investment and consumption.
Third-quarter GDP was up 3% year-on-year, with industrial production up 6.3% and exports up 10.7%.
But retail sales were up only 2.5% and property sales (for the 31 main listed players) were down 29% (all to September).
The crippling effect of China’s “Three Red Lines” restrictions on lending to property developers continues to have a devastating effect on the sector. Meanwhile ongoing Covid lockdowns hurt confidence-hit consumers.
The outlook does not seem to be improving either. October PMI surveys weakened to 48.7 for non-manufacturing and 49.2 for manufacturing.
Can fiscal policy drive growth?
This December’s Central Economic Work Conference can shift the emphasis of fiscal policy while keeping to agreed policy parameters.
Probably the most effective change would be to directly support for households, given the downturn in domestic consumption.
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Targeted fiscal measures to support consumption have been successfully used in previous downturns — for example subsidies for rural purchasers of home appliance in 2008, or support for car-buyers in 2014-15.
But given the weight of real estate and adjacent sectors in the economy, this is unlikely to do more than help specific industries.
The liquidity and credit environment will need to do some of the lifting. But the ability to enact monetary stimulus is constrained by weak private credit demand and concerns about the exchange rate.
The capacity certainly exists. Despite global inflationary pressures the Chinese economy is heading into deflation.
PPI inflation trackers dropped into negative territory in October (after a September print of just +0.9%). Household and corporate excess deposits continue to collect in the commercial banking system.
This is likely to eventually lead to increases in credit quotas and cuts in interest rates.
But these are unlikely to work for two reasons.
Dual challenges
Firstly, private sector credit demand is extremely weak. Simply making it cheaper and more available is unlikely to change that.
This is a classic crisis of confidence, in which the central bank can end up “pushing on a string”. Either policies change to create confidence, or fiscal policy must do the work.
Secondly, while the Three Red Lines restrictions on private sector property developers are still in place, the key sector that isn’t borrowing will remain unable to do so.
In fact, credit conditions continue to worsen for private sector developers. Bond yields are climbing steadily for even the highest-quality issuers, suggesting the situation will get worse before it gets better.
The currency was at its all-time real effective exchange rate in the first quarter of 2022.
Although it is notionally supported by net exports — and protected by capital controls — it is likely to weaken relative to the US dollar.
This is partly because of interest rate differentials, and partly because policy makers in East Asian exporters must keep their currencies reasonably in-line with the depreciating Japanese yen.
The Xi factor
Management and politics are the key, despite the previous three drivers.
President Xi Jinping has been appointed for an unprecedented third term. An overhaul of the Politburo Standing Committee saw market-friendly reformers (including Premier Li Keqiang) removed and replaced with members seen as Xi loyalists.
State media have begun referring to Xi Jinping as ‘Core’ leader while establishing his political views (Xi Jinping Thought) as doctrine.
This marks a move away from the ‘Collective Leadership’ system of Chinese politics that has been in place since the 11th Party Congress in 1978.
An economic focus on technology and quality of life adopted at the 2017 Congress remains in place.
The main changes at this Congress were on governance and national security, with emphases on international relations, geopolitics and reunification with Taiwan.
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 an independent, global investment management business focused on delivering superior investment returns for our clients through active management.
Investors should continue to find attractive opportunities in Brazil after the transition to a new government, argue James Syme, Paul Wimborne and Ada Chan, co-managers of Pendal’s Global Emerging Markets Opportunities Fund
BRAZIL has been one of our favourite emerging markets since late 2020.
Over that time it’s delivered strong USD total returns despite a significant negative return from the MSCI Emerging Markets Index.
October’s election has returned Luiz Inacio Lula da Silva (Lula) as the president, a position he held from 2002-2010.
Lula is from the left-wing PT party, which may raise concerns after recent, sharp negative market reactions to left-wing electoral successes in Chile, Colombia and Peru.
How has this affected our view on Brazil?
We remain very positive on Brazil in both absolute and emerging market-relative senses.
We do not see a Lula administration as a material risk to Brazil’s economy or financial markets. We continue to find attractive investment opportunities there.
Why are we sanguine about Brazil’s political shift to the left?
Here are four reasons:
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- The Brazilian economy remains in a relatively strong economic position, helped by commodity prices and recovery from the previous downturn.
These conditions are similar to when Lula previously was in power, which was a good period for equity investors. (During his previous presidency, MSCI Brazil returned an annualised 36.9% in USD terms. This is unlikely to be repeated, but it’s evidence that a left-wing president isn’t necessarily a problem).
Export prices and the trade balance remain strong in historical terms. This supports growth and the currency, while the domestic economy continues its recovery from the deep 2014-16 downturn (a recovery that is extended by the 2020 Covid-driven dip in activity).
PMI surveys show continued expansion in both manufacturing and non-manufacturing activities. - Brazil’s core institutions remain strong and market friendly. This will constrain the more populist desires of the incoming administration.
The central bank remains deeply orthodox regarding inflation-fighting, while the elections have skewed Congress and Senate towards centre and right-wing coalitions.
Right-leaning coalitions have seen their share of seats increased from 46% to 49% in the lower house and from 31% to 44% in the upper house.
The fiscal spending cap (which Lula has indicated he would like lifted) is a constitutional measure, so any reform would have to pass both houses. - Since the start of 2021 monetary policy has been aggressively employed to reduce inflation with policy interest rates lifted from 2% to 13.75%.
With reported inflation and inflation expectations trending down, 2023 should see Brazil become one of the first major countries to move into a rate-cutting cycle. This should support its economy and equity market. - Equity valuations in Brazil are attractive historically and compared to other similar-size emerging markets. The price/earnings ratio on 12-month forward consensus earnings of MSCI Brazil is just 6.6x.
This compares to a long-term average for Brazil of 11.2x and current levels of 21.6x for India, 14.6x for Saudi Arabia and 12.6x for Mexico. These levels seem to price in a lot of political and policy risk.
In an emerging market-relative sense — and even in a global sense — Brazil’s reasonably good conditions are extremely attractive.
Net energy exports, a central bank that seems to have got on top of inflation, fiscal orthodoxy, moderate economic growth and attractive market valuations are conditions enjoyed by few countries anywhere.
Given the above, we think investors can live with a more left-wing government in Brazil.
We certainly can.
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 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 portfolio manager OLIVER RENTON. Reported by portfolio specialist Chris Adams
MARKET sentiment continued to pick up last week despite a big sell-off in US mega-cap tech names last week.
About 71% of S&P companies have beaten EPS estimates in US Q3 earnings season and 63% have beaten on sales.
S&P 500 earnings have beaten expectations by 5.8% in aggregate so far — slightly ahead of the historical average of about 5%. Though FY23 earnings estimates have been revised lower in recent weeks.
The S&P 500 gained 4% last week and the S&P/ASX 300 lifted 1.7%, capping a strong month of gains.
The S&P 500 returned 8.9% for the month (with a day to go), and the S&P/ASX 300 was ahead 4.8%. That leaves the US index down 17.1% for 2022 to date and the S&P/ASX 300 off 5.7%.
US GDP rose 2.6% (annualised). The core Personal Consumption Expenditure price index — a key measure of underlying US inflation, excluding food and energy — held firm at 0.5% month-on-month. But the data showed reduced breadth.
The market is pricing in a 75bp hike in the Fed Funds rate later this week.
China
Equity risk premiums for offshore-listed Chinese equities rose following President Xi Jinping’s consolidation of power at the National Party Congress last week.
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Crispin Murray’s Pendal Focus Australian Share Fund
Hopes that the meeting might signal an inflection in policies such as Covid-zero appear to have been dashed.
Entrenched support for Xi may signal further development of the current policy direction.
This suggests no near-term policy relief for property markets. Growth stimulus may be used more sparingly and surgically going forward.
Geopolitical risk has also increased. As a result, the market-implied equity risk premium for Chinese equities is at levels not seen since 2008, according to research firm CLSA.
Cyber security
Cyber security is in focus after news that Medibank Private’s (ASX: MPL) data breach was more serious than first thought — following the Optus breach several weeks ago — and coupled with news that Australian Clinical Labs (ASX: ACL) had also suffered an attack.
MPL experienced a sharp decline in share price, which seems driven more about the risk of customer losses than the cost of addressing the breach. Whether this eventuates remains to be seen.
Historical analysis by Sustainalytics suggests companies that experience data breaches typically see most of the stock downside in the first couple of weeks after an announcement. Most of the impact is recovered within three months on average.
Federal Budget
The Budget did not contain much of relevance to markets.
But the focus on energy pricing and policy was important. The Budget highlighted the potential impact of high electricity prices on cost-of-living pressures — and by implication, inflation.
There was little detail on how it may be addressed, but the risk of intervention is material.
The future of more than a dozen carbon capture and storage projects is also up in the air after the government cut $250 million in funding in this area.
Europe
The energy situation in Europe is better than many fared, with storage near full and a mild start to the winter. Natural gas futures have plummeted in response.
The situation could change. But it implies some of the steam may come out of coal and LNG prices.
This in turn is beneficial for inflation, bond yields and potentially equities.
Markets
There’s been an interesting divergence in US quarterly earning season.
Some $250 billion in market cap disappeared after softer results from Microsoft, Alphabet, Meta and Amazon. Meta was down 24% last week.
But Visa and Mastercard noted no discernible impact on spending patterns. Traditional industrials such as Caterpillar, McDonalds and General Motors all delivered strong results.
There was a big move in bond yields last week as US 10-year Treasury yields fell 20bps to 4.02%. The Australian equivalent fell 46bps to 3.74%.
The market’s best performers were generally driven by macro considerations. Gold miners such as Evolution (EVN, +15.5%) and Northern Star (NST, +12.2%) did best.
Asset-based bond-sensitives such as REITs and infrastructure did well as bond yields came off.
Miners were generally weaker, which may be in reaction to the outcome from China’s National Party Congress.
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.
Here are the main factors driving the ASX this week according to portfolio manager Brenton Saunders. Reported by portfolio specialist Chris Adams
EQUITY market remain volatile and driven by macro factors.
Last week we saw a +4.8% rebound in the S&P 500 and +5.2% in the NASDAQ. The S&P/ASX 300 fell 1.2%, but may catch up this week after strong moves in the US on Friday.
Markets remain intent on buying any suggestion that the rate of rate increases will slow, despite limited evidence.
Nevertheless, comments from Minneapolis fed president Neel Kashkari were taken as dovish. The UK’s U-turn on economic policy and intervention to support the Japanese yen also helped buoy sentiment.
Global equity market strength came despite bond yields and the US dollar moving higher.
Major support levels in the S&P 500 continue to hold. Along with heavily bearish market positioning this may provide a base for further short-term recovery in equities.
US economic and policy
US building permits came in at 1.4% higher month-on-month, versus consensus expectations of -0.8%. But overall trends in the housing market remain weak, with mortgage rates topping 7%.
Kashkari – a voting member of the Federal Open Market Committee which determines the direction of US monetary policy – highlighted signs of a slowing global economy and a possible peaking in headline inflation.
But he also noted there was no evidence that core and services inflation had peaked. This is as dovish a statement as the Fed dares venture at this point. The inflation landscape (as revealed in Evercore surveys) remains confusing.
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Crispin Murray’s Pendal Focus Australian Share Fund
Sectoral surveys of rents, wage expectations, freight, retail pricing power and commodities suggest inflation may be rolling over.
But this is not reflected in core inflation, which remains supported by tight labour markets.
Bank deposits continue to decline as consumers dip into savings to underpin spending and pay mortgages.
Business health is declining, but still strong, according to company surveys. Although demand remains stubbornly strong, company CFOs expectations around labour costs are declining.
China economics and policy
Confirmation of Xi Jinping’s third term as China’s leader was not surprising, but the degree of his apparent control is greater than most expected.
The new standing committee of the Communist party’s politburo – the key decision-making body – will be only seven members, all of whom are seen as Xi loyalists. There was some hope of broader factional representation.
Most commentators suggest this is a worst-case outcome in terms of concentration of power. It’s likely to embolden Xi to continue pursuing his regional and global geopolitical ambitions.
A change to the constitution officially ruled out Taiwanese independence.
Details of a five-year plan will be forthcoming. But it appears the main aim will be to replace the “successfully achieved” Moderately Prosperous Society with a Modern Socialist Society.
This is seen as part of China’s ambitions as a technology powerhouse and ability to project power and influence.
This may suggest the economy remains on a relatively austere pathway by historical standards. Stimulus could be used in a more surgical manner to achieve economic goals where needed.
The potential outcome is the property market remains muted. This is a headwind to economic growth and demand for steel-making materials beyond the short-term.
UK economic and policy
Political turmoil continued in the UK as Prime Minister Liz Truss resigned. Chancellor Jeremy Hunt reversed course on the Truss government’s policy of unfunded tax cuts, which helped stabilise the UK bond market and the pound sterling.
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The Bank of England retains a hawkish mindset given high inflation, despite intervening in the bond market to help liquidity for UK pension funds. The latter issue continues to lurk.
Australia economic and policy
The monthly unemployment and participation rates remained essentially unchanged at 3.5% and 66.6% respectively. This week’s CPI data will help inform the size of the RBA’s next hike.
The implied peak rate for Australia is now back to 4.3%, having fallen to 3.2% in early October on the RBA’s surprise 50bp hike.
US Q3 earnings
About 20% of the S&P 500 market cap reported last week. Earnings have largely been in line with expectation, though EPS beats are running at 39% versus a 48% historical average.
Some weakness in consumer appliances and in companies with European exposure is evident. This suggests a downturn may be on the way.
Netflix bucked the trend with better-than-forecast new subscription growth.
Another 46% of the market will report this week.
Markets
European and North American gas prices continued to decline given a mild start to the winter and high levels of storage.
The market remains watchful of the weather. This will determine the degree of re-stocking needed next year, which may see market tighten again.
US equity investors are at extreme levels of shorting – back to similar numbers prior to the June/July rally.
Macro positioning is also fairly aligned with ongoing trends of higher rates, stronger USD, weaker markets and rising inflation.
Any surprise to these “negative” trends will likely result in a short-covering rally in risk assets.
The S&P/ASX 300 fell 1.2% last week and is down 7.2% for 2022. It underperformed US markets last week due to weakness in large-cap miners and some industrial cyclicals.
Lithium stocks continue to run hard.
About Brenton Saunders and Pendal MidCap Fund
Brenton is a portfolio manager with Pendal’s Australian equities team. He manages Pendal MidCap Fund, drawing on more than 25 years of expertise. He is a member of the CFA Institute.
Pendal MidCap Fund features 40-60 Australian midcap shares. The fund leverages insights and experience gained from Pendal’s access to senior executives and directors at ASX-listed companies. Pendal operates one of Australia’s biggest Aussie equities teams under the experienced leadership of Crispin Murray.
Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management.
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.
Next year is when rate hikes fully kick in and the resilience of the real economy will be tested, writes Pendal’s head of government bonds TIM HEXT
IT’S been an extraordinary year. It’s tiring to think it still has more than two months to go.
The fiscal and monetary policy induced wild asset price party of 2021 has become the mighty hangover of 2022.
Industry super fund advertisements are now boasting about their 10-year returns, not three-year returns.
Clear air is needed in 2023, but will it arrive?
Policy makers have gone from patience in 2021 to playing catch-up in 2022. For now they’re on message that they are happy for the pain to continue until actual – not anticipated – inflation turns.
Of course the problem is that inflation is a lagging indicator – often by six to 12 months.
However, central banks view an inflation policy mistake as worse than a recession.
Demand destruction is required, even though it means people losing jobs and in some cases forced out of homes.
Waiting for supply to solve the problem is proving too much.
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Pendal’s Income and Fixed Interest funds
The NZ CPI this week again highlighted the stubbornness of high inflation, stuck above 7%.
The main driver this time was transport, with airfares up 25%. Not surprisingly after lockdowns everyone is trying to visit family not seen for years.
Out of interest I looked at trans-Tasman airfares. Wow! The Kiwi diaspora in Australia (and indeed the world) is huge, with a quarter of Kiwis living overseas at any one time.
They all seem to want to visit home at once. But it’s almost cheaper flying to Europe now.
Fixing will take time
These pockets show supply/demand dynamics in many industries will take time to fix.
Australia is less exposed given our larger size. But the themes are similar.
Clear air is unlikely until 2024 when a “normal” economy returns.
By then permanent and student migration numbers should be near 2019 levels, providing relief in the important area of employment and wages.
For now markets are in a holding pattern.
Next year is when rate hikes will fully start to kick in and the resilience of the real economy will be tested.
Maybe finally we can buy bonds as a defensive asset class again. We remain vigilant.
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.
IT’S almost a year to the day since NSW and Victoria exited lockdowns.
NSW premier Dominic Perrottet declared “freedom day” on October 11 last year as millions of Australians celebrated at pubs and restaurants in Sydney and Melbourne.
Today’s headlines couldn’t be further from that optimism. Recession. Inflation. Strikes. Oil prices. War.
A stream of bad news has led to near-historic lows in consumer confidence.
With central banks unusually coordinated in rapid-fire rate hikes, it’s reasonable to be concerned.
RBA deputy governor Michelle Bullock’s speech yesterday was a timely reminder of the central bank’s objectives: currency stability, full employment and the welfare of the people of Australia.
That differs from the US Federal Reserve’s dual mandate of price stability and maximum sustainable employment.
Welfare of the people. A small but important difference.
This objective influenced the RBA’s discussions, leading to an earlier slowdown in rate hikes this month.
Recessions bring a real human toll that can lead to a prolonged economic slowdown.
Research has shown that people out of work for extended periods become so disconnected from labour markets, that they struggle to find jobs even after the economy has recovered.
The effects of recession on labour force shrinkage is evident in Europe and the US. Participation rates in the US have barely budged despite some of the tightest labour market conditions on record.
In Australia the belt-tightening has started with consumer goods spending growth flat-lining in 2022.
In the RBA’s latest Financial Stability Review, the Reserve Bank stress-tested the impact of a 3.6% cash rate target. About 40% of people would experience a -20% to 0% reduction in cash flows, with almost 15% going into negative cash flows.
The psychological impact of watching savings buffers evaporate would likely increase the pace of decline in consumer spending as rates increased.
The peak rate could very well be lower than the market pricing of 3.6%.
Markets will remain choppy with upcoming CPI releases.
As consumers head into the first fully open Christmas in three years, many will travel to visit families they have not seen in years.
Anyone booking travel will be aware of the high prices of airfares, particularly across the Tasman.
These will feed into CPI – as possibly a last hurrah before belt-tightening in 2023.
Find out about
Pendal’s Income and Fixed Interest funds
About Anna Hong and Pendal’s Income and Fixed Interest team
Anna Hong is an assistant portfolio manager with Pendal’s Income and Fixed Interest team.
Pendal’s Income and Fixed Interest boutique is one of the most experienced and well-regarded fixed income teams in Australia. In 2020 the team won the Australian Fixed Interest category in the Zenith awards.
With the goal of building the most defensive line of funds in Australia, the team oversees A$22 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 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 portfolio manager Jim Taylor. Reported by portfolio specialist Chris Adams
THE US CPI print, which dominated headlines last week, reminded markets to expect the unexpected.
The highly anticipated data point came in hotter than expected and even the most dovish will now expect 75bps moves in November and December.
The federal funds rate predictions also shifted to just a tick under 5% in Q1 2023, resuming the debate on the likelihood of a recession.
Inexplicably, on the day of the print the market went bottom-left to top-right – which no one foresaw but plenty rationalised.
These theories were swiftly discarded as markets reversed back into the red on Friday.
The situation in the UK highlighted that material policy errors need to be near of mind when forming expectations in this highly unpredictable environment.
Australian markets fared quite well despite a down week for commodities.
The flat performance was mainly attributed to the positive earnings outcomes in the financials sector.
Economics and policy
The Fed’s stance was split in two last week.
At the start, the commentary was somewhat conciliatory and balanced, indicating that past short-and-sharp rate rises will need time to work through the economy.
Current moderation in demand was due to economic tightening being “only partly realised so far”, added Fed vice-chairwoman Lael Brainard.
Chicago’s Fed president Evans warned of the cost of “overshooting” rate rises.
But after the CPI print, the Fed took a more hawkish tone. Key members flagged the prospect of a 5% fed fund rate at the end of 2023.
These latest Fed minute show a greater degree of differing opinions than usual. This is evident in opinions on goods and services, noting relief in key pressure points such as shipping costs, delivery, and rising inventories. This suggests supply bottlenecks have passed their peak.
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Crispin Murray’s Pendal Focus Australian Share Fund
The hawks, however, claim this small improvement does not offset continued elevated rates in core goods prices.
Labour markets appear to be moving towards a better balance, with a lower rate of job turnover, moderation in employment growth and increase in labour force participation rate.
Concerns of a wage-price spiral weighed on sentiment since some expect this may occur sooner rather than later.
Meanwhile it was a tumultuous week in the UK.
The Truss administration backflipped on several key economic policies it defended weeks prior – most notably scrapping plans to freeze UK tax next year.
This was an attempt to settle the markets and allow pension funds to extricate themselves from the recent liquidity crisis.
Attempting to salvage the situation, the PM sacked the treasury chief and back-peddled on her vision for a low-tax environment.
This fanned the political flames, stressing an already nervous market.
US CPI Print
The US CPI rose +0.4% MoM and 8.2% YoY, which was above the consensus of 0.2% and 8.1%.
Core CPI (ex food & energy) surged another 0.6% to 6.6% versus 0.4% and 6.5% consensus.
Shelter and medical care prices also saw big increases.
US inflation is still elevated, though longer-term expectations are fortunately still anchored.
For the first time in two years we saw core services inflation (6.7% YoY) exceed the core goods inflation (6.6%).
This indicates that goods inflation is passing the baton to services. This is alarming for markets, since inflation in services tends to be far more persistent than goods.
Services make up about 75% of the core index, meaning it triples the influence of core goods.
Overall, core goods inflation was relatively flat, with a 1.1% drop in used car prices offsetting a 0.7% increase in new cars. There were smaller gains in tools, tobacco and other recreational goods.
In contrast, core services inflation was up 0.8% MoM – the highest reading of the cycle and the biggest increase in 40 years.
This was largely due to prices (ex-energy) increasing by 0.8%, acceleration in rents and hefty increases in health and vehicle insurance components.
Shelter continued to anchor core inflation, rising 0.75%/6.6% MoM/YoY – accelerating from the July and August run rates.
Owners Equivalent Rent rose 0.8% which was the highest rise since 1990. When looking at current climate however, data suggests rents are beginning to roll over.
Excluding shelter, services still were up 0.9% Additionally, transportation services inflation was up 1.9%, medical care up 1% and airline fares rose 0.84% MoM.
The PPI also rose above consensus (+0.4%), with a 1.2% jump in food prices and 0.7% increase in energy prices.
Similarly with the CPI, the core increase was primarily in services, up 0.6%, while goods remained flat. One positive note is we are not seeing a continued escalation of margins.
Additional non-CPI data was also released last week. Notably, the Michigan consumer sentiment index rose to 59.8 from 58.6 which was slightly above consensus. This suggests the covid-induced savings bubble has continued to support spending, despite it being depressed overall.
Five-to-ten-year inflation expectations rose to 2.9% from 2.7%, reversing the August drop. The one-year expectations rose more materially by 0.4% MoM to 5.1% YoY, the first rise since March.
These increased expectations could pose troublesome for those wanting the Fed to start putting their foot on the breaks, given how closely the policy makers watch this number.
Australia
Similar to the rest of the world, consumer sentiment in Australia remains firmly in a recessionary environment.
Despite this, consumer behaviour continues to contradict with business conditions remaining very robust throughout Q3.
Importantly, low consumer confidence is not driven by labour as Australians remain highly active in the jobs market. Unemployment expectations are reaching all-time lows with no real slowdown in sight for the hiring movement.
Selling price inflation and wage costs dipped slightly but remain strong overall. Measures of price pressures eased somewhat in September but remained elevated in levels terms.
Labour costs eased 30bps to 3.1% QoQ after peaking in July. Purchase costs eased 60bp to 3.8% QoQ while final product prices eased 40bps to +2.1% QoQ.
These data points all point towards robust economic conditions despite inflation remaining elevated.
Markets
Volatility was the name of the game last week. The day of the CPI print was only the fifth time in history the S&P500 has opened down 2% and finished up 2%. It was also the first time the Dow has fallen 5% and risen 8% in a single session.
The gains were short lived as a sharp reversal occurred on Friday.
Bond yields were choppy, ending up for the week. Brent oil was up 2.4% alongside copper which bounced down and up 1%. The AUD traded down to 61.7c, was swept in the CPI euphoria and ended back at 63c.
It is predicted that inflation concerns will not be conclusively taken off the Fed agenda until corporate margins/earnings start coming down. As of now, there is not much evidence of broad-based margin/earnings issues yet.
The Australian market was supported last week by the performance of the major banks (Financials +3%) and Consumer Staples (0.4%). Large-cap miners were flat for the week with the brunt of the pain in resources felt in the mid and small-cap space.
The REITs (-2.2%) sector struggled due to big discounts to book value and too much gearing. It is becoming increasingly hard to identify the circuit breaker to this valuation down spiral.
Information Technology (-3%), Health Care (-2.9%) and metals had another tough week.
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.