Here are the main factors driving Australian equities this week, according to portfolio manager BRENTON SAUNDERS. Reported by head investment specialist Chris Adams

• Find out about Pendal MidCap Fund

THE approval of President Trump’s Big Beautiful Bill and stronger-than-expected US labour data saw bond yields move higher, imputed US interest rate cuts push out, and inflation expectations increase last week.

US two-year bond yields rose 14 basis points (bps) to 3.88% while 10-year yields were up 6bps to 4.35%.

Equity markets closed the week up 1.8% in the US (S&P 500) and 1.0% in Australia (S&P/ASX 300). Calendar year-to-date, those markets are up 7.5% and 7.1%, respectively, on a total return basis. 

Many equity indices are making new all-time highs, with the S&P 500 having rebounded 26% from the April/Liberation Day low.

Commodities had a reasonable week, but in the wake of the ceasefire with Iran – and a possible Gaza ceasefire – the heat has come out of the oil/energy markets.

It’s by no means an “all clear” on the Middle Eastern geopolitical front, but there is significant spare OPEC capacity that can be used to keep a lid on prices.

This is important for inflation, especially within the context of the issues central banks are facing globally.

We are seeing a material rotation within equity markets, probably exacerbated on the local bourse by trading activity around the end of financial year.

This saw notable moves last week away from banks, insurers, growth stocks, gold miners and other FY25 winners towards value stocks, resources and FY25 losers.

US macro data and policy

Most of last week’s developments were supportive for markets, with approval of the tax bill and strong headline labour data being the biggest drivers.

Activities data was mixed – while reasonable at a headline level it was weaker in composition, with softer demand and employment components offset by expectations and manufacturing.

The Big Beautiful Tax Bill 

This was a big win for President Trump. After just getting approved in the Senate earlier last week, the bill – to the surprise of many and despite all Democrats voting against it – passed the House of Representatives on the first attempt.

It was signed into law on Independence Day.

This should be broadly supportive for markets, if not the US budget deficit and the US dollar.

US labour data

US June non-farm payrolls came in strong at 147k jobs, ahead of 110k expected by consensus.

However, compositionally, the government sector accounted for most all of the beat while private payrolls were weak.

The unemployment rate also dropped to 4.1%, driven by lower participation rate.

Despite strength in payrolls, wage growth moderated – with total private hourly earnings growing at 0.2% versus 0.4% prior and below consensus expectations of 0.3%. This suggests little sign of labour market tightening.

There has been some focus on the “neutral employment rate” – the payrolls growth required to keep the unemployment rate unchanged.

The primary inputs into this are population growth and labour force participation, both of which have had wild gyrations through the Covid and post-Covid era.

The US requires a rising immigration rate to offset a declining population of working age.

This highlights the importance of potential consequences from possible changes to immigration policy under the Trump administration for employment, labour market tightness and inflation.

Work by Deutsche Bank suggests that the near-term breakeven rate is around 100k new jobs per month.

However, this could fall to as low as 50k per month, based on potential scenarios around labour force participation and population growth rates.

This suggests that wage costs have a high likelihood of being inflationary under most moderate economic conditions.

Elsewhere, JOLTS job openings rose to 7,769k in May from 7,395K in April and was well above the 7,300K consensus.

The jump in total job postings is at odds with a broad range of other indicators suggesting a waning appetite among businesses to hire more workers.

This discrepancy may be due to some businesses advertising jobs in order to replace workers that have unauthorised immigrant status.

The private sector quits rate edged up to 2.3% in May, from 2.2% in April, but remains in line with last year’s average.

Other US data

The US ISM Services Index rose to 50.8 in June, up from 49.9 in May and just ahead of the 50.6 expected by consensus. 

The increase was mostly in the expectations component, with weakness in the services employment and prices components

This suggests services activity has stabilised but is not likely to make a large incremental contribution to inflation.

The US ISM Manufacturing Index printed 49.0 in June, rising from 48.5 in May and marginally ahead of the consensus at 48.8.

In the detail, it appears that manufacturing production and imports have recovered from the worst of the tariff disruption with some modest price inflation – but that demand was soft, with weaker new orders and employment.

US Consumer Spending fell 0.3% in May, which was weaker than expectations – as was personal income growth at -0.4% versus +0.3% consensus. Revisions were also lower.

That said, May’s spending fall was driven by a 7% decline in spending on autos following a binge of auto buying in April, so there is some noise in the numbers.

US Mortgage Applications rose by 2.7% for the week ending 27June, with gains in both refinancing (+7%) and new home applications (+0.1%) as 30-year fixed mortgage rates fell.

The US housing market remains weak in most quarters, which is something only lower interest rates and mortgage rates can rectify.

US interest rates

Expectations around rate cuts moderated during the week and bonds sold off modestly in the wake of the Trump tax package approval and stronger-than-expected labour data – both of which point towards increased likelihood of an inflation increase.

President Trump again ramped up rhetoric around replacing Fed Chair Powell for not cutting rates, calling for his resignation – with Treasury Secretary Bessent seemingly seen as a preferred option.

Powell himself attributed the slower pace of rate cuts to uncertainty around the impact of tariffs.

The Fed’s June Summary of Economic Projections (SEP) for the year ending 2025 has a median estimate of rates at 3.9% versus 4.5% currently.

This is more or less in line with current market implied rates.

There have been moderations in the likelihood of July and September rate cuts, with close to no chance of a July rate cut given data flow and developments in the last week.

Tariff update

Tariff information is flowing thick and fast and in the days before the 9July deadline.

Several countries and regions are working towards framework agreements (e.g. EU, China, UK, India) before 9 July, with a view that extensions can continue until US Labour Day (1September) while the details are finalised.

Trump has threatened to impose full sanctions on any countries failing to meet the deadline.

Developments include:

• Canada scrapping its proposed digital tax, a sticking point in negotiations with the US.
• Indonesia announced it is set to sign a trade and investment pact with the US this week.
• The US announced an agreement with Vietnam, with the minimum tariff rate at 20%, down from 46% under the Liberation Day rates, and no tariff on US imports. There are higher tariff tiers for goods with Chinese-produced content. The US is specifically looking to counter moves by Chinese companies to reroute exports to the US via other countries to avoid maximum tariffs.
• The Administration seem to be suggesting that there is some “wriggle room” around the 9 July deadline and that although there is a relatively small number of deals signed, there are a number in the offing, notably with India. Japan continues to dig its heels in and is attracting the ire of Trump.   
• The process of applying Section 232 tariffs – linked to national security and being used as a means of circumventing legal challenges – is notionally well advanced and should be finalised by the end of US summer. This affects steel, lumber, copper, Al and semiconductors.

Australia macro data and policy

There is less ambiguity around the interest rate trajectory in Australia than in the US.

The domestic economy is in reasonable shape, though some segments are still weak as consumers are saving the additional disposable income flowing from interest rate cuts.

An expectation of two to three further rate cuts from the RBA in CY25 appears reasonable and should be supportive of both the economy and asset prices.

The market is pricing close to three 25bpts cuts by year’s end, though the probability of an August rate cut has decreased from 90% to 70% in the past week.

Housing

The Cotality Home Value Index rose 0.6% in June, with gains in every major mainland city.

Darwin led the list, rising 1.5%, with Canberra up 0.9%, Sydney 0.6%, and Melbourne 0.5%.

RBA Governor Bullock made it clear in May that rising house prices would not prevent rate cuts. That said, record-high house prices might stir discomfort in some quarters.

Residential building approvals rose 3.2% in May, softer than consensus expectations of 4.0%.

They are running at an annualised rate of 183k, which is a recovery from a rate of 177k in April, which was the lowest level since August 2024.

Retail sales

Retail sales rose 0.2% month-on-month in May, below an expected 0.5%.

The year-on-year rate slowed from 3.8% in April and is the slowest since November 2024.

Retail sales over recent months show momentum is still fading. This seems to confirm that consumers continue to save the proceeds from interest rate reductions to date.

China macro and policy

Beijing announced further population growth stimulus measures and a new programme to remove excess capacity from some manufacturing sectors, which the steel and iron ore markets interpreted favourably.

However, the economy remains challenged by low nominal GDP, PPI deflation, weak property prices and declining middle-income employment and wages growth.

Markets

Sector rotation

There was a significant rotation to value sectors and stocks that kicked off smartly with the start of July.

Trading associated with end-of-financial-year fund distributions has been elevated in the local market and contributed to a significant relative bounce in the FY25 losers across the June month-end.

In contrast, the big winners from that period were sold heavily post month-end.

While the drivers may have been different, we saw a similar trend in US equities, where the rotation from momentum to value was among the largest and sharpest in the last five years.

In Australia, this manifested in strong gains among the miners against a backdrop of modest improvements in iron ore, lithium and coal prices – some of which was driven by the Chinese government announcement to crack down on excess capacity in sectors like steel.

US equities

The breadth of the recent 25% recovery has been one of the narrowest on record.

While this still bodes well for markets, the next phase will likely be a broadening in the recovery and slowing in momentum which normally follows narrow rebounds.

The US quarterly reporting season begins on 15 July, with the S&P 500 trading at 22x price/earnings and expecting 4% year-on-year quarterly earnings growth, versus the 12% growth delivered in Q1 2025.

Weaker earnings growth expectations are being driven by commodity and cyclical sectors.

Tariff-driven margin compression for FY26 is the largest risk.

Most companies have been indicating that tariff increases will be largely absorbed through the supply chain with little evidence of tariff-driven price increases seen so far and many large US retailers vowing not to increase prices.

Australian equities

The S&P/ASX 300 eked out small successive gains most days to end up 1% for the week.

Midcaps were the biggest movers on a market cap basis (S&P/ASX Midcap 50 +2.2%).

At a sector level, resources (+2.3%) and REITS (+3.0%) were the biggest winners at the expense of banks (-1.6%), insurers and growth stocks.

The domestic economy, and potential rate cuts, augur well for mid and small caps. But investors need to be selective about what they buy, argues portfolio manager BRENTON SAUNDERS

• Domestic macro-outlook positive for mid and small caps
• REITs, select retailers and quality growth companies to benefit most
• Find out about Pendal MidCap Fund

THERE is now a helpful macro tailwind for domestic focused companies driven by the prospect of more interest rate cuts and high fiscal spend, says Pendal portfolio manager Brenton Saunders.

“The main issue outstanding, from a domestic perspective, is valuation. That’s a constant nagging question in the back of investors’ minds”, he says.

The S&P/ASX200 in recent days has hit a new record and some stocks, notably market leader Commonwealth Bank, are trading are historically high multiples.

Domestic outlook

“The international landscape remains complex, but the domestic economy is panning out pretty well,” Saunders says.

“We are through the election and companies that don’t have unanswered questions around tariffs can be reasonably confident about the second half of 2025, particularly if the playbook sees a couple more rate cuts.”

Sustainable, self-funded growth companies

With that macro-economic backdrop, what types of stocks should investors be looking for?

“It comes back to a few key thematics. Companies with reliable growth, that are self-funded, in growth parts of the economy,” Saunders says.

“We will play the interest rate cycle through selected REITs (real estate investment trusts) and growth stocks that have longer duration and benefit from lower discount and interest rates.”

He nominates tracking company Life 360 and software group Technology One as examples of well-run, high-quality companies with a positive, sustainable earnings outlook. Buy now, pay later group ZIP is another example.

“ZIP is growing very strongly, and it currently has very low penetration in the US so there is opportunity,” Saunders says.

Discretionary retailers

Discretionary retailers should also benefit from the interest rate environment, but Saunders cautions investors need to be discerning about what they buy.

“In this space you need to be a little bit more circumspect. Apparel is very tough. There’s a lot of discounting and plenty of competition. There’s also a couple of new apparel and sportswear retailers wanting to come to Australia.”

By contrast, car dealership group Eagers Automotive has done very well in 2025 and should benefit from lower interest rates, Saunders says.

“There have been two specific things going on in that stock. The biggest one is BYD volumes, and secondly, margins haven’t fallen as precipitously as expected in both new and used car sales.”

REITs

The real estate investment trusts (REITs) benefit from lower interest rate cycles, Saunders says, and should do well in the second half of the year. He says investors are slightly wary of data centre operators, in part due to outsized capital raisings last year and early this year.

“Also, the pace of writing new contracts stalled somewhat with the advent of the Deep Seek AI platform. This caused hyper-scalers like Microsoft to pause and rethink their infrastructure intensive approach.”

Life360, Technology One, Zip and Eagers Automotive are held in various Pendal portfolios.

The price of gold has seen an uptick in recent times, but how much higher can it go? Portfolio manager BRENTON SAUNDERS explains

• ASX gold index up 20% this year
• Two stocks to watch: Capricorn Metals and Genesis Minerals
• Find out about Pendal MidCap Fund

GOLD is up more than 40 per cent over the past year and plenty of analysts see more records ahead.

Can it keep going? And how best to gain exposure through the ASX?

“Gold is being helped by elevated inflation and strong liquidity,” says Pendal portfolio manager Brenton Saunders

Brenton manages Pendal MidCap Fund and is also a geologist with experience in gold mining and gold-related equities investing.

While no one knows for sure how far gold will run, Saunders notes that the rising price has “very quickly repaired some of the issues with balance sheets in the gold sector and elevated dividends in some cases.

“Gold companies have very high profit leverage to higher gold prices. This makes them very cash generative and, in turn, they become acquisitive.”

Saunders has long been an advocate for selected stocks in the ASX-listed gold sector.

“Gold has worked well in our portfolio.

“The gold price is up 9 per cent in Australian dollar terms year-to-date and the ASX Gold Index is up around 20 per cent. That’s been incredibly helpful to our portfolio.

“We have held positions for a long time, and it has all come together in the last three months.”

Stock examples

Saunders highlights several ASX gold stocks held by Pendal’s midcap fund including Capricorn Metals (ASX: CMM) and Genesis Minerals (ASX: GMD).

“Capricorn is a reliable, low-cost, highly cash-generative producer permitting a new project in the Murchison to effectively double production by FY 2027-28,” says Saunders.

“Strong gold price exposure and growth make it an ideal midcap stock. 

“Genesis has taken the best of the successful Saracen (ASX: SAR) team and packaged them into a high-growth, very well-run WA gold company.

“The company is turning a series of highly systematic acquisitions in WA, made at lower gold prices, into an integrated production complex with strong growth and cash flow.”

Opportunities in cyclical industrials

Elsewhere, market focus has turned to opportunities in ASX-listed cyclical industrials, Saunders believes.

“Some stocks are looking quite attractive on a valuation perspective and cyclical headwinds associated with high interest rates are starting to abate.

“In some cases it comes down to company specifics. If stocks can address specific issues they can do well.

“During results season Domino’s Pizza Enterprises (ASX: DMP, not held in Pendal MidCap Fund) was an example. They have started to address some of the headwinds they’ve had in the last couple of years and the market was very receptive to that.”

Wall Street’s recent earnings season was reasonably strong and the current reporting season in Australia has “so far been strong too”, Saunders says.

“The share market has been strong so far this year. Share price appreciation has been relatively broad-based, though the main drivers are banks, gold stocks and consumer discretionary stocks.”

Saunders is also closely watching how potential Trump administration tariffs might impact ASX stocks.

A number have potential exposure but there is limited clarity of how and where tariffs will land.

“So far what markets were most worried about hasn’t really eventuated, and investors have just gotten on with it.”

Sweeping policy changes under a unified US Republican government signal shifts for investors, with traditional energy and nuclear set to benefit, argues Pendal’s BRENTON SAUNDERS

• Unified Republican government means significant policy changes
• Traditional energy and nuclear set to benefit
• Find out about Pendal MidCap Fund

SWEEPING policy changes in the US are expected to bring shifts for investors, with traditional energy and nuclear set to benefit amid a slower path to rate cuts.

That’s the view of Pendal PM Brenton Saunders, who has more than 25 years of experience in resources and started his career as an underground mining geologist.

Brenton leads Pendal MidCap Fund, which offers exposure to fast-growing ASX sectors.

Unified Republican control of the US House, Senate, and presidency is set to drive rapid policy changes that will shape market performance over the coming year, says Saunders.

Donald Trump’s decisive victory delivered a clear Republican mandate, defying expectations of a tight race and threats of a hamstrung administration.

The sweep of all three arms of government paves the way for significant shifts in energy policy, a renewed focus on nuclear power, and has heightened expectations for a slower path to interest rate cuts and higher-for-longer bond yields.

“For a long time, it looked like the election was going to be tight but that hasn’t happened.

“We’ve had a convincing Republican win which gives them a broad mandate for change,” says Saunders, who manages the Pendal MidCap Fund.

Energy and renewables

The new Trump administration signals a sharp shift in US energy policy, with implications for global energy markets and the renewables transition, says Saunders.

“As a broad brush, you could see a more of a reversion to traditional energy. There’s an expectation for more traditional oil and gas production, certainly in the US and the Gulf of Mexico,” he says.

“That should keep energy availability relatively elevated, which ultimately should benefit economic growth and the consumer.”

In Australia, engineering group Worley and industrial services group SGH, formerly Seven Group Holdings, should be beneficiaries.

Worley plays a key role in the design and engineering of oil and gas facilities. SGH has first and second derivative exposure to energy through its direct investments and portfolio of heavy equipment suppliers.

The Trump administration may also accelerate the global shift to nuclear energy, says Saunders. This should benefit ASX-listed Canadian uranium developer NexGen Energy.

“Nuclear has risen to prominence and acceptability in most circles as a source of power under the decarbonisation banner – previously it was thought of as very old world,” he says.

The changing energy environment should also benefit local refiners Ampol and Viva Energy and should bolster Whitehaven Coal as metallurgical coal demand continues.

Gold is another sector set to benefit.

“We hold a considerable amount in the portfolio through companies like Capricorn Metals, De Grey Mining, Bellevue Gold and Genesis Minerals. Despite doing very well the whole year, gold has had a bit of a breather in the last month or so and we see that as a useful opportunity to buy the dip.”

On the downside, Saunders says he is cautious about the consumer discretionary sector as it battles high interest rates.

“Despite the fact that companies like JB Hi Fi have done well, most of the other discretionary categories are reasonably depressed, and potentially more so in the next six months or so until we see the effect of lower interest rates come through and help consumers.”

Diversification the key

The US is somewhat unusual in having such a lengthy period between November elections and the January inauguration of a new administration. This interregnum presents uncertainty for investors as markets speculate on what changes the political transition will bring, says Saunders.

“We’re again seeing binary macro scenarios being debated. That’s where the benefit of diversification comes into play – not taking big macro bets in your portfolios is key because the outcomes are likely to be more extreme than normal.

Geopolitics remains a significant driver of risk, with events in Russia, China, Ukraine, the Middle East, Israel and Iran all carrying the potential to disrupt markets, from oil prices to broader economic conditions, he says.

“You’ve got to be relatively conservative – diversification is probably the most important part of the next three to six months.”

Rate cuts delayed

Markets have performed strongly this year, and it has been difficult to disentangle the impact of Trump’s candidacy from the broader strength as markets adjust to the prospect of rate cuts, says Saunders.

“In the US, interest rates have dropped 75 basis points off the peak and, until recently,  there was the expectation of a lot more to come. But inflation and labour markets have stabilised and now there are question marks around the pace and the timing of rate cuts, not just in the US, but also domestically as well.

“Bond yields and forward interest rate expectations have risen and look like they might stay higher for longer.” Trump policies are likely to be more inflationary.

That has driven a rotation away from interest rate-sensitive sectors. REITS for example have stalled and partly reversed.

“We think that interest rate cuts are still fairly likely to happen within the course of next year, albeit at slower rate and possibly to a slightly higher neutral level than was previously thought.

“But domestically and internationally, more rate cuts in the offing should see some of the interest rate sensitive sectors do reasonably well again – once rate cuts resume.”

Saunders says the slower trajectory for cutting interest rates should change how investors approach the market over the next six months.

“It will likely prolong the downturn for home builders and suppliers – those companies that are reliant on the construction cycle to improve. You also run the risk of a poor consumption season if consumer sentiment takes a dip because of the expectation of higher for longer interest rates.

“So, you have to be very focused about where you’re taking your exposure.”

In times of geopolitical tensions and shifting economic policies, it’s important to adopt a balanced portfolio approach, says Pendal portfolio manager BRENTON SAUNDERS

• Markets facing geopolitical tensions, economic shifts
• Value in focusing on stock opportunities, not taking big macro bets
• Find out about Pendal MidCap Fund

EQUITIES investors are forced to consider a complex interplay of factors when making asset allocation decisions today.

“Escalation of tensions in the Middle East has had a tangible impact on energy markets, raising concerns about inflation and causing bond yields to rise,” notes Brenton Saunders, who manages Pendal MidCap Fund.

In the US, next month’s presidential poll remains too close to call, while strong jobs numbers have contributed to the upward pressure on yields.

In China there have been significant developments, with Beijing outlining stimulus measures.

“This has sparked a notable rotation in the Australian market, with investors shifting away from large-cap financials and growth stocks and towards resources and value-oriented equities,” Saunders says.

“The continuation of this rotation will largely depend on whether China implements more direct stimulus initiatives.”

China’s Politburo and the National People’s Congress both meet in late October – the latter would need to approve any policy requiring higher deficit spending.

A balanced approach

In the face of these competing forces, Saunders emphasises the importance of a balanced portfolio approach.

“We tend not to take big thematic bets in our portfolios,” Saunders says. “While we’re very alive to how these market developments manifest, we typically don’t have much directional exposure to any specific outcome.”

A balanced approach in the current environment mitigates risks during inflection points in the economic cycle.

By avoiding large exposures to any specific economic outcome, a portfolio may be able to generate steady returns regardless of how a situation unfolds, Saunders argues.

“Our base view is that markets will remain strong through the end of the year, as interest rates are expected to come down, albeit slightly slower than previously anticipated.

“Liquidity in the market is also seen as a strong underpinning for equities.”

There are risks, however.

“There’s the potential for higher-than-expected inflation and for a material deterioration in the Middle East conflict. In this environment, the balanced portfolio approach becomes even more crucial,” Saunders says.

“It is important not to have big macro tilts in your portfolio and to be able to produce steady returns through any outcome.”

Investing in companies that will be beneficiaries of an interest rate-easing cycle should provide rewards, says mid-caps portfolio manager BRENTON SAUNDERS

• Real estate trusts, long duration could benefit
• Discretionary retail and commodities “tough to call”
• Find out about Pendal MidCap Fund

FINDING early cycle opportunities and bond-sensitive stocks should pay dividends for investors.

That’s according to Brenton Saunders, who manages the Pendal MidCap Fund.

“Investing in companies that will be beneficiaries of an ongoing interest rate easing cycle – real estate investment trusts being an obvious one – along with long duration, high multiple sectors, especially the growth stocks, should provide rewards,” Saunders says.

But that doesn’t mean investors should buy into all interest rate-sensitive sectors.

“Discretionary retail is still a tough one to call – some parts of it are doing really well and others are quite challenged,” he explains, adding that it depends on the landing scenario and whether we get a soft or hard landing.

“Some of the deeper cyclicals, whether they be industrials or resources, will probably take longer to improve in a convincing way,” Saunders continues.

“Commodities will depend on the efficacy of ongoing Chinese stimulus which, to date, has been unconvincing.”

The main macroeconomic driver of equity markets is the turning economic – and interest rate – cycle.

Saunders expects two or three rate cuts in the US, adding that so far, Australia is an exception to the rate-cutting trend and likely to remain the case until 2025.

Turns in economic cycles introduces a level of uncertainty in markets, and Saunders says the most recent earnings season demonstrates nervousness about the economic outlook.

“The market disproportionately rewarded companies with either earnings surprises and/or higher guidance, and disproportionately punished companies that had an issue,” he says.

“The re-rating and de-rating during reporting seasons is still about two-and-a-half times what we were seeing pre-COVID.”

What this means is stocks that are doing well are doing even better, and those on the nose remain that way.

“Turn-around stories for earnings, especially among cyclical stocks, remain difficult. Some stocks that investors have been buying in the expectation of an earnings recovery continue to battle,” Saunders says.

Among sectors, banking stocks continue to rally – in some cases ahead of what fundamental analysis suggests.

“During the earnings season, in aggregate there was some margin compression among industrials, though there were some exceptions to that. What it shows is the ability to pass price on is slowly starting to get undermined,” he continues.

“The growth sectors [such as technology] continue to do well both in terms of the numbers they are reporting and their price performance,” Saunders explains.

“The sector that continues to do really badly, based on the global cyclical theme, is resources. Most parts of resources are on the nose, with the exception of gold.

“Iron ore prices fell below $US90 a tonne, lithium is incredibly cheap – highlighting how a lot of future facing commodities are challenged. Oil is normally a good barometer of global economic activity and aggregate demand, and oil prices have been falling.”

For ASX mid-cap investors, three mega-trends remain central to markets, says Pendal portfolio manager Brenton Saunders

• AI accelerates demand for data centres
• Gold an opportunity, up 20 per cent in AUD terms
• Find out about Pendal MidCap Fund

THREE major trends continue to underpin ASX investing in 2024, says portfolio manager Brenton Saunders, who manages Pendal MidCap Fund.

“The first one is international and ubiquitous – data centres and artificial intelligence,” he says.

“Demand for data centres has been a trend for a long time and AI has accelerated that demand.”

“More recently, we’ve seen a very tangible escalation in demand for data centres among big and small corporations.

“There’s a land grab going on and there’s limited availability that meets all the criteria corporates want.”

New supply isn’t meeting demand, making established players like NextDC (ASX: NXT) attractive investments, he says. (Pendal holds NXT).

But investors should keep an eye on data-centre power requirements, which continues to present a growing challenge.

“Data centres are very power intensive and in the brave new world of decarbonising baseload energy, power is becoming harder to access, more volatile and more expensive.

“The advent of AI and its adoption and commercialisation has focused the minds of the bigger corporations on procuring data, storage space, and finding areas where they can train large language models for AI,” Saunders says. “Power is part of that.”

Decarbonisation

The second big trend is around the ongoing decarbonisation of the mainstream electricity supply and the length of time it is taking.

“Renewable generation capacity is continuing with reasonable success, but there have been delays in terms of both timing and capacity.

“That means a range of sectors — from coal and gas producers to electricity producers and even refiners — have benefited, even though some thought demand for their fossil-fuel-generated power would be downscaling by now.

“This is enabling many of these companies to generate good profits for longer.”

Whitehaven Coal (held by Pendal) has benefited, Saunders says.

In regard to coal, because many corporates are no longer investing in the sector, the coal companies are able to buy good assets at cheaper prices. Whitehaven’s purchase of two mines from BHP last year is an example.

The trend has also benefited uranium stocks.

“Uranium has belatedly been recognised and accepted as part of the decarbonisation of the grid.

“Several OECD countries are reversing plans they had to reduce their reliance on uranium and have recommissioned old facilities and are contemplating new ones.”

Electrification

The third trend is around electric vehicles and battery-aided power, as well as the inputs needed for the sector.

“The performance of some stocks in the sector, particularly lithium companies, has been disappointing.

“High prices stimulated new lithium production faster than the growth in market demand. A similar issue has plagued the market for rare earth elements.

“There is also the maturing of the electric vehicle market globally alongside a softer macroeconomic environment. We have seen a notable shift away from battery electric vehicles towards plug-in hybrids.”

While these ripples have arisen in recent times, the electrification trend remains intact.

Gold

Gold is an investable thematic in 2024, though possibly not as long-lived as the other three trends, Saunders says.

“We’re now seeing a number of developed markets cut interest rates and gold has reacted.

“It is up more than 20 per cent year-to-date in AUD, allowing the gold producers to more than offset the high cost inflation of the past two years,” Brenton says.

“Margins have expanded, and companies have been able to generate more cash. They are paying down debt and there’s been more M&A activity, making the sector more buoyant.

“It’s a thematic we think will play into next year.”

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

• RBA board “not ruling anything out” on interest rates
• Market-implied pricing suggests a rate cut before 2025 looks unlikely
• Find out about Pendal MidCap Fund

THE artificial intelligence revolution marches on, with Nvidia touching a US$3.2 trillion market cap last week – second only to Microsoft – and the broader S&P 500 gaining another 0.63%.

Markets look technically extended on momentum indicators, but corporates continue to trade reasonably well – with economies remaining resilient in the face of high interest rates.

Labour markets have weakened at the margin, but slower than anticipated, and remain in good shape.

Strong interest income and asset price strength has supported the top end of the consumption cohort. 

The fixed interest market continues to contemplate the potential for rate cuts in the US, while many emerging markets and some developed markets have already started easing.

The Swiss National Bank cut interest rates by 25 basis points (bps), while the Bank of England said it was close to cuts, with inflation having reached the target range in May.

The RBA, on the other hand, delivered what was seen by some as a hawkish pivot in its comments around the decision to hold rates steady.

It implied that the potential for one or possibly two rates hikes before year’s end was firmly back on the table, much to the dismay of the Federal Government.

The S&P/ASX 300 gained 0.93% for the week.

Elsewhere, US bond markets were largely unchanged, with ten-year treasury yields rising 5bps to 4.25%.

Brent crude oil rose 3.2%, base metals and gold were down between 0.5% and 1.5%, and iron ore was flat.

Lithium marched lower on weak auto sales and continued share gains from plug-in hybrids – which require less lithium – at the expense of battery electric and internal combustion engine vehicles.

US economy and policy

Data points last week tended to underpin the view of an economy softening at the margin, but holding up reasonably well:

• Industrial production beat expectations, with manufacturing output up 0.9 per cent in May – recouping all the declines of the previous two months.
• The March quarter current account deficit widened by $15.9 billion (7.2%), largely reflecting an expansion in the goods deficit. The deficit represents 3.4 % of nominal GDP, up from 3.2% in the previous quarter.
• Advance retail sales for May came in at 0.1% versus the 0.3% forecast. April was revised 0.2% lower to -0.2%. Sales excluding auto and gas rose 0.1% versus the 0.4% expected. April was also revised down on this measure, from -0.1% to -0.3%. 
• Initial Jobless claims declined 5,000 to 238,000. Continuing claims decreased 10,000 to 1.81 million.
• Housing starts fell 5.5% in May (the lowest level since June 2020) and permits fell by 3.8%, the third consecutive monthly decline. The weather is having some impact, but new home construction is now at a four-year low.
• The NAHB Housing market indicator slipped to 43, with weakness across the sub-indices and against the expectation for some improvement.
• The Composite Purchasing Managers Index (PMI) was 54.6, moderately ahead of the 53.5 forecast. The Manufacturing PMI was 51.7 (51 forecast) and Service PMI was 55.1 (54 forecast).

Several comments from US Federal Reserve policymakers noted recent encouraging trends on inflation.

New York Fed President John Williams noted that the labour market is slowing to more sustainable levels and that he expects rates to come down over the course of the year.

Thomas Barkin and Susan Collins, Presidents of the Richmond and Boston Feds respectively, both noted the encouraging inflation figures and said that, while patience was required, there were scenarios where rates were cut once or twice this year.

Dallas Fed President Lorie Logan also saw recent indicators of colling inflation as “welcome news”, but said that several more months of data is required to confirm the trend.

The net effect was very little change over the week in market-implied expectations around rate cuts.

China

May’s retail sales surprised to the upside, rising 3.7% year-on-year – the first monthly reading to beat expectations after six misses.

That said, sales – in part – reflected strength in spending on electronic and communications devices as several new products were launched in the month.

Despite this, the dynamics in China remain weak.

Infrastructure investment is slowing, the housing sector is yet to bottom, and the consumer is losing some tailwinds.

Industrial production was weaker than expected and slowed to 5.6% year-on-year in May, from 6.7% the previous month.

Electricity output also slowed from 3.1% to 2.3%.

Australia

The most interesting thing domestically last week was the debate around the RBA following the Tuesday meeting where it left rates on hold at 4.35%, as expected.

There are a lot of “known unknowns” facing the RBA, including the lagged effect of previous hikes, the impact of tax cuts and the wealth effect of higher home prices and lower inflation on consumption, the effect of tighter labour markets and slowing demand on prices, as well as an improving outlook for the US and possibly China, and higher commodity prices.

At the end of its minutes, the RBA noted: “Inflation is easing but has been doing so more slowly than previously expected and it remains high. The Board expects that it will be some time yet before inflation is sustainably in the target range.”

The Board is also not ruling anything in or out in terms of interest rates.

Some economists have a hawkish take on the statement and Governor Bullock’s press conference.

This view is that the RBA and Federal Government’s views are diverging, and that the central bank may be positioning for a potential hike depending on inflation data from Q2 2024.

Key points for this argument are that inflation remains persistent and above target and that the pace of decline has slowed, while data suggests continued excess demand and elevated costs in the economy.

Real disposable incomes have also stabilised and may be bolstered by lower inflation and tax cuts.

This view was reinforced by Governor Bullock’s comments that the case for a hike was discussed at Tuesday’s meeting, while the case for a cut was not considered.

Market-implied pricing suggests that an interest rate cuts before 2025 looks highly unlikely.

All of this suggests the Australian economy is six-to-nine months behind the US in terms of its economic and interest rate trajectory.

Elsewhere, job ads on the Indeed platform declined 2.1% in May and are down 8.2% year-on-year. Demand for labour continues to weaken and, with population growth supporting an expanding workforce, the unemployment rate should continue to trend higher.

Despite weaker consumer sentiment, higher-for-longer interest rates and the threat of more rate rises, consumption data remains resilient in nominal terms, which is supportive for corporate Australia.

Price inflation has materially offset volume weakness in most categories and, so far, corporate margins have been maintained by the ability to pass on price.

The question is whether margins come under pressure the longer interest rates remain high.

We are seeing signs of pressure on margins in the consumer electronics space, which was reinforced by feedback during the week and suggests risk are building for retailers in this space.

Aggregate household spending remains strong and rose in April versus March, but is slowing in a number of discretionary categories.

Aggregate household expenditure is buoyed by high wage increases, resilient employment data and population growth.

The resulting inflation remains resilient at levels above RBA targets, with few inflation categories showing much decline.

How is a post-pandemic Thailand competing with regional rivals such as Indonesia, Taiwan, India and China? Portfolio manager SAMIR MEHTA visited to find out

• Thailand has many advantages, but strong regional competition
• A case of watch and wait
• Find out about Samir Mehta’s Pendal Asian Share Fund

TO ESCAPE the constant hyperbole of all things Gen AI, we recently went to Thailand to meet a few companies.

Bangkok is normally gridlocked, but fortuitously we were there during school holidays. The pace was laid back and refreshingly languid.

Known as an export base for autos – especially trucks – Thailand has suffered from the advent of electric vehicles, which are dimming the future of internal combustion engine vehicles.

Tourism – including medical tourism – is a pillar for economic growth, but Covid upended that for a while.

Chinese tourists, a backbone of visitor numbers till 2020, have not yet returned in force.

Meanwhile, another chapter of political uncertainty hasn’t helped.

Demographically challenged with a comparatively smaller workforce and an ageing population, Thailand faces severe competition from other ASEAN countries such as Vietnam and Indonesia.

Lower disposable income growth, high levels of personal debt and a generally slower global economic recovery are also headwinds.

No wonder stocks in general have been a disappointment.

We do not presently own stocks in Thailand, but cheap valuations prompted us to visit some of those on our watchlist.

A few observations:

The geopolitical realignment around China is manifest in several ways.

Some foreign companies are relocating to Thailand as an alternative to China. They are increasingly supplemented by Chinese companies expanding in Thailand to circumvent tariffs or quotas on goods manufactured in China.

Thailand’s smaller and higher-cost workforce sets it at a disadvantage to its neighbours.

Companies looking for larger unskilled or lower-skilled employees prefer Vietnam.

India and Indonesia attract firms targeting their respective domestic markets rather than just exports.

Thailand’s advantage is that its people tend to be better educated and higher-skilled.

Officials at Thailand’s Board of Investments are engaging and willing to go to almost any lengths to smooth inward investments.

Thailand’s small number of free trade agreements is an impediment which the government is fervently working to address.

They have streamlined visa applications (renewal now takes two minutes) and further simplified new investment licensing processes.

One company that owns, develops and sells land in industrial estates narrated a sea change in demand over the past 18-24 months.

Chinese EV producer BYD bought a piece of land from the government, which was four times larger than the previous largest parcel ever sold by them.

Another Chinese EV company is on the verge of signing for almost a similar size plot.

Besides EVs, companies are pursuing data centres as we witness a rush to set up server farms to meet the needs of AI and its attendant infrastructure.

Skilled, English-speaking workers in demand

Availability of a skilled workforce fluent in English and educated with an international curriculum will increasingly be in demand.

We met the founder of an international school whose 20-years-plus struggle is finally paying dividends.

Initially with fewer than 200 students, founded by a set of parents, he has grown to 4200 students with potential to expand into the next decade.

Close to 30% of his students are Chinese nationals. Mostly children of employees from Chinese companies but partly from a certain class of Chinese society with the means to migrate away from China and more comfortable residing in an Asian country. 

Medical tourism is booming

Medical tourism was always a forte of Thailand – most leading hospitals have multilingual staff, significantly lower total costs for top-notch medical expertise.

Keeping with the times of social media-driven transformations, aesthetic clinics (a euphemism for plastic surgery) offer a one-stop shop service to “rectify” any part of the anatomy.

Billboards are emblazoned with doctors portrayed as celebrities, social media influencers extolling the virtues of clinics and clinics appealing to the vanity of the insecure (even in neighboring countries like Indonesia).

Business is booming.

Retail quiet

What was missing was the vibrancy of retail traffic in malls. The absence of tourists has been compounded by a big expansion of retail space.

Ironically, the supermarket and convenience store space has consolidated dramatically.

With an absence of any form of anti-trust action, one family almost dominates the scene – though they have relied on copious amounts of debt which in my view burdens an otherwise good business.

Wait and watch

Overall, the “China plus one” de-risking strategy is real.

The consequences of capacity creation outside China – whether in ASEAN, Latin America or Europe – might become more pressing in a year or so if the global economy slows.

Thailand has many competitive advantages, but competition from rival countries with large domestic markets or bigger workforces is a challenge.

We return with no real compelling cases for investing in Thailand when Indonesia, Taiwan, India and even China present alternatives.

It’s a case of wait and watch – and back to the stream of next new things in GenAI.

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About Samir Mehta and Pendal Asian Share Fund

Samir manages Pendal Asian Share Fund, an actively managed portfolio of Asian shares excluding Japan and Australia. Samir is a senior fund manager at UK-based J O Hambro, which is part of Pendal Group.

Pendal Asian Share Fund aims to provide a return (before fees, costs and taxes) that exceeds the MSCI AC Asia ex Japan (Standard) Index (Net Dividends) in AUD over the medium-to-long term.

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

Contact a Pendal key account manager here

There are no Asian equivalents of the AI-driven ‘Magnificent Seven’ US tech stocks. But there are AI opportunities in Taiwan if you know what to look for. J O Hambro’s SAMIR MEHTA explains

• AI hardware makers have big technical challenges to overcome
• Taiwanese companies such as Jentech have the knowhow
• Find out about Samir Mehta’s Pendal Asian Share Fund

I WAS amused recently to read about the viral resurgence of the iconic Stanley Thermos from a dusty attic relic to an Instagram darling.

Similarly, an ordinary home cleaning product became a coveted possession almost overnight in the UK thanks to a Tik Tok “cleanfluencer”.

Scalability or virality is one of the most desired attributes for a business, especially when accompanied by minimal asset intensity.

The powerful “network effect” of social media propels this concept in ways that boggle the mind.

These are not software products or video games, which have an innate quality of achieving scale if conditions are right.

Making physical stuff is hard to do at scale while ensuring quality and consistency, managing supply chains and such.

Yet we can see a similar effect today among some Asian companies benefiting from the AI story.

Asia does not have a ‘Magnificent Seven’ tech stock equivalent.

But a select group of Taiwanese hardware manufacturers can stake claims as the unsung heroes of an AI-driven shift.

Semiconductor maker TSMC is well known as a critical supplier in this rapidly growing market.

Today I want to outline another example – Taiwanese component maker Jentech Precision Industrial. 

But first, an update on how the rapidly changing AI landscape is impacting the manufacturing of chips and servers.

And who else to help us with this question but Google’s AI app Gemini?

I asked Gemini to list the key challenges for manufacturers of AI chips and AI servers as these components become the workhorses of AI.

These are the challenges Gemini highlighted for AI chip manufacturers:

1. Complexity and Cost:

AI chips often employ specialised architectures like “tensor” cores, which are more intricate to design and fabricate compared to standard computer chip cores. This means higher manufacturing costs and lower yields (usable chips per wafer).

Pushing performance boundaries requires ever-smaller transistors, requiring expensive and cutting-edge lithography techniques that aren’t readily available at scale.

Fabrication complexity and cost is also increased by the need to integrate high-bandwidth memory directly onto a chip for improved communication.

2. Heat dissipation:

AI computations demand significant power, leading to intense heat generation. Traditional packaging and cooling solutions often don’t suffice, requiring innovative thermal management methods.

And here are the challenges Gemini nominated for AI server manufacturers:

1. Scalability and efficiency:

Combining different chips (CPUs, GPUs, specialised AI accelerators) within a server demands new designs for efficient communication and data flow.

Power and cooling is again a challenge. Accommodating high-power AI components necessitates robust power delivery and intricate cooling systems, impacting server design and layout.

Server hardware also needs to be tightly coupled with optimised AI software for efficient resource use and minimised bottlenecks.

2. Changes and new designs:

There is a trend away from rigid, fixed setups to modular designs that allow for flexible configurations based on specific AI workloads. This improves efficiency and scalability but requires innovation.

Traditional air cooling might not be enough for high-density AI servers. Liquid cooling systems, while effective, pose challenges in terms of cost, complexity and potential leaks.

New high-bandwidth, low-latency interconnect technologies are needed to facilitate efficient communication between diverse processing elements inside a server.

What this means for Asian tech leaders

I apologise for quoting at length but I think it’s important to understand the complexity of the challenges posed by the fast-growing AI industry.

Gemini’s list above tells us there is a great deal of development still to come if we are to reap the benefits of AI in ways that are meaningful and significant.

I believe Asian economies are likely to benefit from this process in ways that are not yet recognised by international investors.

We own several companies across this spectrum of innovation and change in manufacturing.

One of them is Jentech Precision Industrial.

With poor analyst coverage, Jentech was lumped in with machining and casting businesses.

It was seen as another component manufacturer in a long list of components in a very cyclical industry.

But changes in AI server technology have led to significant added value and potentially an expanded business cycle.

The simplest way to understand this is the likelihood of a PC and device replacement cycle (in companies and consumers) driving volumes.

Also, a monstrous increase in “active server pages” required for AI-related critical components.

It’s difficult to cite averages, but I believe there could be an almost 8-to-10 times increase in realisations for some component makers compared to normal server components.

Jentech crafts intricate “heat spreaders” which keep AI servers cool under pressure.

Its products help dissipate heat from integrated circuits and strengthen thermal modules while avoiding warping.

Companies like Jentech are defined by years of manufacturing know-how.

Another secret to competitiveness is longer durability of their moulds which reduces costs over the long run.

As Jentech’s client AMD moved to larger heat spreaders, Intel had no choice but to approach Jentech too.

Now Jentech’s thermal solutions play an important role in data centres powering AI breakthroughs and even find uses in self-driving cars.

Shovel-makers for Nvidia’s goldmine

Think of it this way: While Nvidia stole the spotlight, Taiwanese companies like Jentech were busy building the props and the stage machinery, ensuring the show went on without a hitch.

Manufacturers like Jentech are the shovel-makers for Nvidia’s goldmine.

From what I understand, most of Nvidia’s clients want to ensure they are not solely dependent on Nvidia – which means the rest of the Magnificent Seven could become potential customers for these Taiwanese companies in time.

Nothing in technology can be taken for granted.

But many of these Taiwanese firms are the go-to partners of choice with very few alternatives when it comes to leading-edge technologies.

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About Samir Mehta and Pendal Asian Share Fund

Samir manages Pendal Asian Share Fund, an actively managed portfolio of Asian shares excluding Japan and Australia. Samir is a senior fund manager at UK-based J O Hambro, which is part of Pendal Group.

Pendal Asian Share Fund aims to provide a return (before fees, costs and taxes) that exceeds the MSCI AC Asia ex Japan (Standard) Index (Net Dividends) in AUD over the medium-to-long term.

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

Contact a Pendal key account manager here