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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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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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.
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.
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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.
A monthly insight from James Syme, Paul Wimborne and Ada Chan, co-managers of Pendal’s Global Emerging Markets Opportunities Fund
ONE of the main drivers of global financial markets in 2022 has been the strength of the US dollar (and the weakness of other global currencies), driven by tightening US financial conditions.
The dollar is the preferred currency for international trade invoices and cross-border financial claims.
The global financial cycle is essentially a dollar cycle – and an aggressively tightening Federal Reserve has a chilling effect on non-US economies and non-US financial markets.
Emerging markets can generally be divided into two broad groups:
- Net exporters that tend to run current account surpluses (such as China, Korea and Taiwan, but also UAE and Saudi Arabia)
- Net importers that tend to run current account deficits (such as Brazil, Mexico, South Africa and India).
Historically, the first group have broadly tended towards high sensitivity to global growth and the second to global financial liquidity.
So it’s normally been the second group that has the worst currency and equity market performance in strong dollar/tight liquidity environments.
In 2013 the Fed announced an intention to reduce the buying of US treasuries.
The hardest-hit emerging markets were Brazil, India, Indonesia, South Africa and Turkey. They were dubbed the “fragile five” by one market participant.
This time it’s different
This year has decidedly not followed that pattern.
In the first nine months of 2022, the only major EM currencies to strengthen against the dollar were the Brazilian real and the Mexican peso.
The Indian rupee and Indonesian rupiah were also relatively strong, declining 6.8% and 9.4% respectively.
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Pendal Global Emerging Markets Opportunities Fund
By comparison, the Korean won fell 20.4%, the Taiwanese dollar 14.7% and the Chinese renminbi 12%, despite those economies running big current account surpluses.
This pattern is very interesting and points to a real change in leadership in the asset class.
We have previously commented on the positive effect high commodity prices have on commodity economies such as Brazil – and to a lesser extent Mexico and Indonesia.
This continues to play out in economic data. Recent PMI surveys are 51.1 in Brazil and 47.3 in Korea, for example.
Other drivers at play
The explanation is that there are other drivers at play.
One is the Japanese yen.
With ongoing monetisation of debt and low inflation, Japanese monetary policy remains very loose, leading to about a 25% depreciation of the yen against the dollar year-to-date.
Given the tight trade relationships between the four big East Asian economies (both as partners and as competitors), this has put significant downward pressure on the currencies of China, Korea and Taiwan.
Another driver is energy balances.
The huge moves in oil, gas and coal prices in the last two years have been a boost for energy exporters (or large consumers who also have large domestic production).
The value of Indonesia’s exports of oil and gas in the last three months were $US4.6 billion, compared with $US3 billion for the same period in 2019.
By comparison, the cost of Korea’s crude oil imports in the third quarter of 2022 was $US31 billion, compared to $US17 billion in the third quarter of 2019.
At a broad regional level, North America and the Arab Gulf are in extremely strong positions, while Europe and East Asia face a powerful drag on their external balances and their growth.
Although all four East Asian economies have very substantial ability to use their large foreign exchange reserves to support their currencies, their desire to support exports has meant this has been limited.
Japan did intervene last month, but the ongoing economic weakness in China and Japan mean major intervention was unlikely.
By comparison, both India and Indonesia have intervened, supporting their currencies, reducing imported inflation and facilitating economic growth.
Sign of change
We think 2022 is a sign of a change in market leadership in emerging markets.
The markets that might be expected to underperform instead may be the best performers.
We believe that can continue with either a stronger or weaker US dollar.
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.
In the current environment tightening must come from a big reduction in government spending to support private sector growth, says assistant portfolio manager Anna Hong
THE RBA’s Financial Stability Review sheds light on last week’s decision to limit the cash rate rise to 25bps.
It shows the Reserve Bank is keeping a close eye on the ability of households to absorb the impact of rate rises instead of blindly following other central banks.
In this world of instant gratification the effect of monetary policy is no different. If inflation has not reversed since the last hike, let’s go again, more this time.
Our collective impatience meant the Reserve Bank’s decision to hike 25bps stuck out like a sore thumb in a sea of 50bps and 75bps rate hikes from other central banks.
These consecutive rate hikes ignore the fact that the cash rate target is a blunt instrument that requires time to trickle into the economy.
Its ability to control demand in a supply-shocked environment is made even harder by large-scale Covid stimulus programs we’ve seen in most of developed economies.
In Australia, the fiscal stimulus – JobKeeper, JobSeeker – was effective because it skipped part one of the song and went straight to part two – the household balance sheet.
Interest rates alone will not be sufficient to unwind demand supported by the lingering effects of the stimulus.
The federal government will need to deliver a sensible budget to help the RBA keep the Australian economy on track.
Despite signs of a roaring economy – real GDP growth, low unemployment, strong business conditions – household nerves about the future have led to near-historic lows in consumer confidence.
A never-ending increase to interest debt-servicing costs will only make consumers more pessimistic, eventually hurting business profitability in the form of lower consumer demand and higher cost of credit.
Fiscal policy is the circuit breaker required to stop that trajectory.
Productivity drives real growth. That comes from private sector growth.
In the current environment, tightening must also come from a large reduction in government spending so the private sector can take over.
A productivity-driven expansion will ensure the economy stays on the right track with a lift in real wages, ultimately creating sustainable growth.
Are we still the lucky country? The upcoming federal budget will paint a better picture of what’s ahead.
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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 our head of equities Crispin Murray. Reported by portfolio specialist Chris Adams.
THE sharp equity market rally last week was fuelled by very bearish positioning and ignited by weak job opening and manufacturing data. There were also hopes that emerging financial strain would prompt a Fed pivot.
But the “good is bad” phase proved short-lived. Solid US employment data emphasised a tight labour market, while OPEC+ quota cuts sent the price of oil higher.
The S&P 500 ended the week up 1.56% and sitting at a key technical support level of 3500-3600.
There is scope for the bear market bounce to continue back to the next technical level of 3900-4000, but data trends are not supportive.
The US economy remains resilient with insufficient signs of weakness. Meanwhile inflation remains stubbornly high – with the additional risk that fuel prices are rising again.
The S&P/ASX 300 was up 4.5% last week and continues to outperform. It’s down 6% for 2022, while the S&P 500 has lost 22.7%.
This is due to currency moves, the index sector mix and a defiant RBA.
Our central bank raised rates only 25bps. It’s crossing fingers and toes that the rest of the world fixes the inflation problem and it won’t have to induce a recession here.
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US job openings were a lot weaker than expected, which is good for markets. The ratio of openings to unemployed remains very high, but the quarterly downward trend is encouraging.
There was also a fall in job “quits” which is a signal people see less opportunity to move.
Job layoffs remain low, which is also constructive. The best scenario is one where the job market loosens via less hiring (ie less labour demand) but layoffs remain limited (ie more supply). A big increase in layoffs is more likely to trigger a recession.
The US is now 50% of the way to reducing the gap between jobs and workers to a level where wages should slow sufficiently, according to a Goldman Sachs indicator.
Wage growth appears to be running over 5% annualised on most measures and needs to drop below 4%.
However the relief on this data was short-lived. Payroll and employment data reinforced the tight labour market.
This is the Fed’s key policy problem, since they risk recession in bringing this down.
There is much focus on the lessons of the 1970s, where the Fed heeded political pressure and loosened too soon. This meant it had to go through three phases of tightening to finally solve the problem.
US payroll data was in line with expectations (+263k jobs). The household survey was a bit stronger than consensus, with the unemployment rate falling to 3.5% due to a 0.1% drop in the participation rate.
The market did not like this because:
- Other data points had been weaker – and the market was hoping for more of that
- A tight labour market supports wage growth, reinforcing the Fed’s need to tighten rates further and potentially risk recession
- The participation rate looked to be increasing, but it fell this month as hopes of greater labour supply faded. The gap in participation compared to pre-Covid levels is mainly in older people and this is unlikely to return
Payrolls need to get down to 50-75k per month to be at a level where wages may slow to the target level.
The household survey of wage growth among production and non-supervisory workers is seen as a better proxy of underlying wage growth. It was stable month-on-month, landing at 5.8% year-on-year. This is consistent with inflation running between 4 and 4.5%.
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Mixed signs on the state of the economy are another challenge for markets.
The bears can point to measures such as housing and trucking as signs the economy is slowing sharply. But consumers continue to hold up – as do hiring intentions.
One of the signals from the employment report is that nominal incomes continue to grow – and in fact are picking up in real terms as inflation slows. This makes the Fed’s job harder.
Underlying resilience in the US economy is also evident in a pick-up in the Atlanta Fed GDP Now tracker. It’s re-accelerated in the last couple of weeks, driven by net exports and the consumer.
The Cleveland Fed inflation tracker is another real-time indicator not helping the case for a pivot. It continues to indicate inflation running at 0.4-0.5% month-on-month.
We will see the CPI print released on Wednesday. This will be a key determinate of market direction.
Oil
OPEC+ surprised the market with a bigger-than-expected quota cut of 2 million barrels per day.
It is worth bearing in mind that many members are already producing below their quotas. By a rough estimate the real production impact would be about half of that announced. The market is expect 0.8 to 1.2m barrels to be taken out of the market.
There will be another meeting in early December to review the impact, so this will be in place for at least two more months.
This was not designed as a direct attack on the US, despite the latter’s reaction.
Instead, OPEC is concerned about the impact of recession on demand – and also that the oil price appears to have disconnected from fundamentals.
When you compare the oil price to inventory levels there is probably a US$20 gap.
OPEC also believes the inability to reach production quotas shows a lot of countries are not investing in capacity – which will make the oil supply-and-demand balance more precarious in the future.
This requires higher prices to incentivise investment. In response to rhetoric from the US, OPEC is also pointing to factors such as levies, carbon taxes and fuel standards as reasons why petrol prices are so high in the west. These, they say, are in the hands of western governments to resolve – if they want to.
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There is now upside risk to the oil price because:
1. Chinese refinery production is ramping up (counter to OPEC’s concern over recession)
2. Another round of sanctions on Russian oil will start in the next few months, creating more friction in oil markets
3. SPR releases will slow from 1m barrels per day to about 500k through to the year’s end.
In combination, these could have an impact of 1.5m to 2m barrels a day on oil supply-and-demand balance, more than offsetting any slowdown.
Australia
The Reserve Bank got global attention last week as people thought the lower-than-expected 25bp hike might signal the beginning of a small pivot from central banks.
We find it hard to draw any broader global conclusions from the RBA’s move.
It could be slowing rate rises to gather more information and gauge the effect of tightening to avoid a policy mistake and recession. The likely rationale includes the notions that:
1. Australian wages have not risen as quickly as other nations, so the RBA has less to do at the moment in loosening the labour market
2. Australia has more short-rate sensitivity due to floating-rate mortgages
3. The RBA has more meetings than the Fed, so they will get the opportunity to re-appraise in early November with more data.
4. They are probably anticipating a reasonably tight federal budget, ie no fiscal stimulus, unlike the UK
5. They will be expecting the tightening in the ROW to help contain inflationary pressures
Also, the RBA has already tightened more than other regions in Europe and Canada, though not as much as the US.
There is some risk to the RBA stance.
While wages growth is slower than the US, surveys indicate it is still rising, unlike the US.
Should this continue – and the Australian dollar weakens – we could see inflationary pressures build, forcing the RBA to go harder again.
For now the ASX can take comfort from the more benign approach from the RBA, with strength across all sectors and resources and domestic cyclicals running. Consumer staples was the laggard.
Markets
The trifecta of higher bond yields, oil prices and the USD is a challenge for equities.
Friday’s sell-off leaves the US market in a finely balanced position in the near term.
The bounce earlier in the week had all the hallmarks of the start of at least a bear market rally, with some extremes in terms of buying / selling ratios.
On average, these rallies are 15% over 32 days, so the 6% in 4 days looked like it should have had legs.
Wednesday’s CPI print is likely to have a large bearing on whether the S&P 500 gets back to 3900 in the near term.
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.