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

• Find out about Pendal Focus Australian Share fund
• Tune in: register to watch Crispin’s Beyond the Numbers webinar

THE market finished November on a high, helped by falling bond yields and a lower US Dollar.

The S&P 500 returned 1.1% for the week and 5.9% for the month, while the S&P/ASX 300 was up 0.6% and 3.7%, respectively.

President-elect Trump’s threat of 25% tariffs on Canada and Mexico as well as 10% on China did not illicit a durable negative reaction in either bonds or equities – probably due to the attached conditionality and a timeframe that is still almost two months away.

The pre-conditions for a continued rally into year-end remain in place, with positive macro data, flows good, confidence high, and the supportive technicals.

There was strong divergence within Australian equities last week; tech and healthcare outperformed while energy and banks lagged.

The market’s favourite high-momentum growth names are melting up, with Life360 (360) up 20.5%, Pro Medicus (PME) up 13.6%, Sigma Healthcare (SIG) up 13.3%, Guzman y Gomez (GYG) up 12.7% and Telix Pharmaceuticals (TLX) up 9.6% week on week, with flows the main driver.

Our broad-cap portfolio positioning is generally skewed to growth, with Technology One (TNE) and Xero (XRO) underpinning performance in November. This was combined with quality industrials such as SGH (SGH) – formerly Seven Group – and James Hardie (JHX), as well as insurers which benefitted from higher bond yields over the month and the rotation to financials.

US tariffs: hard to know where they land, so not factored in by the market for now

Trump posted that he intends to impose 25% tariffs on Mexico and Canada on day one of his administration.

While these are higher than the market expected, he conditioned them on action relating to immigration and drugs.

We have subsequently seen Mexican President Sheinbaum have a call with Trump, while Canadian Prime Minister Trudeau popped in for dinner at Mar-a-Lago.

Trump also spoke to imposing an additional 10% tariff on China.

The impact, if applied, is material.

The percentage of import value collected as tariffs would rise from low single-digits to roughly 10%, before factoring in anything additional for Europe.

So far, the market is sanguine on this on the belief that they will be watered down in both size and scope.

The other issues to consider with tariffs are:

• suppliers absorb part of the impact in their margins
• that the inflationary effect is diluted as trade flows adapt to avoid them

• currencies may adjust to dampen down effects (e.g. USD strength reduces the inflationary effect)

US economic outlook: looks fine, persistent inflation is one area to watch

This week’s monthly payroll data is an important signal for the US Federal Reserve.

The signals are constructive, with claims data coming off post the hurricane-induced spike. While continuing claims are picking up, it is gradual and still low in historical context.

Consumer confidence – reflected in the Conference Board Expectations Index – has seen a post-election increase tied to the election outcome.

History indicates that this may not result in higher spending, but it doesn’t hurt and reduces risks to the downside.

An encouraging component of the Conference Board measure is the confidence in jobs, which has improved and is a positive read on the outlook for employment.

Overall, the growth outlook remains encouraging according to the Atlanta Fed GDPNow indicator, which still has Q4 2024 GDP at above 2.5% growth.

There is a concern among some that inflation is not coming down sufficiently for the Fed to cut rates much below 4%.

In this vein, the latest Personal Consumption Expenditures (PCE) data – the Fed’s favoured inflation indicator – saw Core PCE up 0.27% month-on-month, in line with expectations.

However, the three-month annualised rate increased to 2.8% year-on-year.

Some of the services components are proving sticky; the concern is that the PCE won’t be able to break below 2.5% next year before we begin to get the effects of tariff increases and the potential impacts of lower immigration and tax cuts supporting the economy.

This could leave the Fed in a difficult position in terms of predicting the outlook, which may make them more cautious of further rate cuts.

The market is currently pricing 3.3 cuts by the end of CY25.

Australia: inflation data provides no help for case to cut rates

October’s Consumer Price Index (CPI) was lower than expected at 2.1% year-on-year, but this was all down to government subsidies.

Underlying inflation measures remain stubbornly high and the trimmed mean was 3.5% for the 12 months to October, up from 3.2% in September.

This provides no cover for the RBA to cut rates.

Inflation in areas such as rents and new dwelling purchase costs remain high, driven by structural issues in the economy.

We continue to see limited risk of a material slowdown in Australian GDP, but confidence is muted and growth seems likely to remain below trend for the next few quarters.

Markets: short-term signals remain positive

November was a good for equity markets, triggered by the decisive US election outcome.

The S&P 500 returned +5.9% for the month and the S&P/ASX 300 3.7%, with the bulk of the move from valuation re-rating.

Short-term market signals are positive:

1. The US dollar has not broken above its range and retraced in the last week.
2. Bonds yields have also rolled over and didn’t get back to the April highs.
3. Market technicals like breadth and seasonality are positive. For example, 77% of the S&P 500 is trading above its 200-day moving average.
4. Earnings revisions have been positive. This has been driven by mega-cap tech, where FY25 earnings have been revised up 11% over CY 2024. The rest of the tech sector has been revised down 1.6% and the rest of the S&P 500 down -3.8%. However, this is well within the normal range of zero to -5% earnings downgrades over the course of a year.
5. Flows into US equities remain strong, with a large spike following the election result.

The challenge is US equity valuations are full. There appears little catalyst to change this currently, but if there was a shift in liquidity or in the economy, then valuations could reset.

The S&P 500 is on the top decile in terms historical market valuation going back to 1999.

There is an argument being made that the market structure is now dominated by mega-cap tech companies which have low capital intensity, high rates of return on investment and incremental return, as well as strong revenue growth rates which may suggest that valuations aren’t as extended as simple historical analysis suggests.

We do note that credit spreads are low by historical standards, which suggests that the liquidity environment remains supportive.

Australia

Information technology (+10.2%), banks (+7.1%), consumer discretionary (+6.6%) and industrials (+5.6%) led the S&P/ASX 300 higher in November. Energy (-0.7%) and resources (-3.4%) lost ground.

Growth momentum performed best; results from TNE, XRO and Block (SQ2) were good, while PME won a key contract.

With limited revisions, the banks’ earnings season was neutral, with CBA performing the best.

Insurers outpaced the banks, helped by bond yields.

Resources continue to fall and have given back more than 50% of their China stimulus rally.

Battery materials remain the worst of the sector, despite lithium prices stabilising. BHP continues to be burdened by the fear of it re-bidding for Anglo American now that the six-month lock period is up. Finally, copper and gold have retreated post the US election.

Portfolio positioning

Generally, across our broad-cap portfolios, we have kept our sector skews relatively limited:

• We have been underweight defensives/bond sensitives, though this has been reduced somewhat with the addition of Scentre Group (SCG) in recent months.
• We also have a small underweight to resources.
• The bank underweight has increased in recent weeks. We see reduced risk of valuations breaking higher for the bank sector given the strong run and current rating. This exposure is also partly offset by the overweight in insurers. 
• We are underweight consumer defensive – notably supermarkets – which we see as expensive, low-growth stocks.
• Against this we are overweight growth, mainly through technology companies where we see earnings growth underpinning the higher valuations.
• We have also benefited from an overweight in cyclicals industrials, with stocks in good industries and/or strong market positions such as Aristocrat Leisure (ALL), SGH (SGH), James Hardie (JHX) and Qantas (QAN) all performing well in November.

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About Crispin Murray and the Pendal Focus Australian Share Fund

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

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

Find out more about Pendal Focus Australian Share Fund  

Contact a Pendal key account manager

At the end of a year in which almost half the world’s population were eligible to vote, investors can finally look forward to more certainty, says Pendal’s ADA CHAN

• End of a huge election year improves certainty for investors
• Potential opportunity emerges in China
• Find out more about Pendal Global Emerging Markets Opportunities Fund
• Watch a Pendal webinar covering the outlook for global equities and emerging markets

IF IT feels like a hectic year for emerging markets investors, you’d be right.

So far 66 national elections have taken place around the world in 2024, according to the International Institute for Democracy and Electoral Assistance, an intergovernmental organisation that supports democracy worldwide.

And another eight or so are still scheduled before the new year.

Just after the US election, Pendal Global Emerging Markets Opportunities fund manager Ada Chan joined Pendal Global Select fund manager Chris Lees in a live webinar to discuss major trends emerging from these polls, along with other issues.

You can watch the full webinar here. 

Below are Ada Chan’s key points. Click here for insights from Chris Lees.

A big year for elections

Investors in emerging markets (EM) can expect more certainty after a huge year in national elections, says Pendal emerging markets fund manager Ada Chan.

“We will have to wait and see the details on many Trump Administration policies … and implementation is key from the US.”

But there are already actionable lessons to be drawn from elections in Indonesia, Mexico and India — which all had “very different elections this year”, Chan says.

“In Indonesia, there is continuity and stability and that is viewed positively. It is a market where reforms are [working] and driving the economy. That’s a differentiator among ASEAN markets.”

James Syme, Paul Wimborne and Ada Chan (right) are co-managers of Pendal Global Emerging Market Opportunities Fund

“In Mexico investors expected Claudia Sheinbaum to win, but the surprise was her super majority. There was also an overlap with her predecessor … and that created uncertainty and investors don’t like uncertainty.

“Mexico is a difficult market – which part of a valuation is driven by a carry trade unwinding, which part is driven by local politics and which part is driven by anticipation of what Donald Trump is going to do. We think a lot of the bad news is already in valuations,” she says.

“In India, people expected Narendra Modi to win, and he did. But markets in India are pricing in perfection. In India it isn’t so much about the election as high valuations.”

China

Investors in China should focus on domestic industries, rather than manufacturing exporters, Chan says, ahead of any Trump Administration decision on tariffs.

“The Chinese government wants to stimulate its economy. But I think there is a little bit of wait and see, to make sure they know what Trump is proposing,” Chan says.

“It is a timing issue for China. They want a bit more clarity [on the Trump Administration] before they come up with their stimulus. We do expect there will be more stimulus, but it is a step-by-step process.”

Chinese consumers are changing as well. Previously foreign brands sold better than local products but that is no longer the case.

“Chinese consumers are embracing domestic brands. They can buy better products, with higher average prices, that are a lot cheaper than foreign brands,” Chan says.

Country-first analysis

Chan’s investment process starts with identifying a promising country, based on an outlook and valuation perspective.

“There are opportunities emerging  in China. We think people had become too pessimistic and gone too extreme when looking at China.

“We saw Chinese companies report better numbers, raise forward earnings [guidance] and then get sold off.

“There is the opportunity to [invest] in companies that are becoming stronger because management are focusing on what makes the business more efficient, in an environment which is very difficult.”

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About Pendal Global Emerging Markets Opportunities Fund

James Syme, Paul Wimborne and Ada Chan are co-managers of Pendal’s Global Emerging Markets Opportunities Fund.

The fund’s top-down allocation process is based on analysis of a country’s economic growth, monetary policy, market liquidity, currency, governance/politics and equity market valuation.

James, Paul and Ada are senior fund managers at UK-based J O Hambro, which is part of Perpetual Group.
 
Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management.

Contact a Pendal key account manager here

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

• Find out about Pendal Focus Australian Share fund
• Find out about Pendal Property Securities Fund

EQUITIES continue to grind higher, with the S&P 500 up 1.7% last week and the S&P/ASX 300 up 1.3%.

Safe havens like gold, oil and the Swiss franc caught a bid on the back of rising geopolitical tensions, with outgoing US president Joe Biden giving a final push to resolve the Russia-Ukraine conflict before Donald Trump takes office.

Treasury yields were relatively stable as markets attempt to discern the likely policy mix under a Trump administration, made even more difficult by some interesting cabinet nominees. 

US Fed-speak was mixed but on balance more dovish.

Nvidia, the world’s largest company, reported Q3 results with guidance for Q4 sales only beating by $400 million versus the normal $1 billion. Management highlighted some delays and cost pressures around the next-generation AI chip. 

In Australia, Reserve Bank minutes noted that easing in the labour market might have begun to stall or modestly reverse. The RBA wants to see two quarters of declining inflation before cutting the cash rate.

US macro and policy

Howard Lutnick, CEO of bond broker Cantor Fitzgerald, was appointed US commerce secretary and hedge fund manager Scott Bessent was announced as Treasury secretary.

Lutnick advocated for higher tariffs at a recent rally in New York, citing the prosperity of the early 1900s when there was no income tax and all the government had was tariffs. Though he did acknowledge they would raise prices, at least temporarily.

In an interview with the Financial Times, Richmond Fed president Tom Barkin noted the US was more vulnerable to inflationary shocks than in the past, with businesses more readily passing on costs to consumers.

The inflationary effects of potential tariffs and immigration plans under president-elect Donald Trump were a “concern” for businesses, but the Fed shouldn’t adjust monetary policy before possible changes in economic policy, he said.

Elsewhere, US home builder sentiment rose to a seven-month high. The results suggest optimism that high-income households will move forward with home-buying plans, given US personal tax cuts will persist.

While sentiment has been strong actual starts have been softer, with starts and permits declining 4% and 7.7% year-on-year. Mortgage rates have risen 80bp to 6.86% over the past two months.

Walmart reported sales +5.3% with the retailer benefiting from trading down.

Recent surveys suggest US consumers are set to spend 4% more on holiday shopping this year. While consumers may feel fearful of inflation, their balance sheets look good.

Initial jobless claims came in at 213k, better than consensus expectations (220k) with the data showing that the labour market is trending sideways at a healthy level.

The narrative that the US labour market is cooling appears inconsistent with the continued strength in data for above-trend GDP growth, strong retail sales, low jobless claims, and rising average hourly earnings.

In addition, credit spreads continue to be tight, corporate profits and forward profit margins are at all-time highs and US household balance sheets are in very good shape.

In short, the US economy remains very strong.

The market continues to pare back expectations of large Fed Fund rate cuts. Expectations for a December rate cut from the U.S. Federal Reserve have diminished, with the likelihood now at 53%, a sharp drop from 82.5% just a week earlier. 

Unsurprisingly the US dollar continues to be very strong.

US inflation and bond rates

The US 10-year bond yield has increased from 3.6% to 4.4% despite the Fed signalling significant rate cuts.

This has not been the case in previous rate cutting cycles where yields have either fallen or gone sideways.

The soft employment print in September prompted a 50 bp cut but was then met by a couple of sticky inflation prints.

Fed funds futures have shifted over the past two months, with the expectation for the end 2025 moving from 2.8% up to 3.8%.

While inflation has been trending down with the core measure at 3.3% year-on-year, it will remain a key concern for financial markets, as well as in the political sphere.

This was the 42nd consecutive month with Core CPI above 3%, the longest period of elevated inflation in the US since the early 1990s.

Voter perceptions of inflation were important in the recent US elections. The economy was the top concern for Republican voters, and three quarters of US voters felt inflation created hardship for them this year.

Tariffs generally apply to lower frequency consumer durables, with consumers less aware of price changes unlike the hyper awareness of changes in prices at supermarket or petrol stations.

As such tariffs may end up raising inflation with less impact on the politically important perception of inflation.

Europe macro and policy

The European Central Bank’s index for negotiated wages rose to 5.4% year-on-year in Q3, up from 3.5% in Q2, a record lift since the euro area was formed.

A jump had been anticipated after large, negotiated wage rises in Germany for auto and engineering workers.

The ECB expects wage inflation to fall next year to a rate more consistent with the 2% inflation target.

The market’s reaction was limited, with the data playing to the view that the ECB is likely to cut by only 25bps next month.

China macro and policy

China announced some tax reductions for home buyers. This might indirectly support consumer spending, with new home buyers having more spare cash to spend on furniture, for example.

However it is not the degree of consumer support markets really wish to see.

A wide gap has opened between mortgage interest rates and mortgage borrowing, implying that potential homebuyers are unwilling to buy apartments at any level of mortgage rate.

With an estimated 90 million empty apartments and a population expected to fall by roughly 100 million in the next 20-to-30 years, the cyclical and structural headwinds make stimulating this important part of the economy extremely difficult.

Australia macro and policy

Minutes from the RBA’s November meeting noted that easing in the labour market might have begun to stall or modestly reverse.

A breakdown of Australian unemployment by duration shows that short-term unemployment appears to have stabilised below pre-pandemic levels. 

The board also highlighted that due to govt subsidy ’noise’ from government subsidies in the December 24 quarter, it wants to see two quarters of declining inflation before cutting the cash rate’.

This means that the first rate cut (if any) is likely to occur from May 2025.

Australian housing prices have also hit a historical peak of unaffordability – with the average home now costing eight times the median household income.

The percentage of national median income needed to fund a mortgage on the national median dwelling value has hit 50.6%, according to CoreLogic, versus a 20 year average of 36.6%.

Rental costs are 33%, versus a 20 year average of 29%, by the same measurement.

The Australian Bureau of Statistics considers a household to be in housing stress if it pays more than 30% of income on housing costs.

While first home buyers have benefited from assistance from the Bank of Mum and Dad in recent years. There are warning signs of pressure here.

By one measure, the percentage of households in the 55-64 year age cohort owning a home with no mortgage has fallen from over 70% in 1995 to under 40% today.

Markets

There are some warning signals in US equities, such as historically high valuation levels, insider selling (although there are some seasonal effects here) and Berkshire Hathaway loading up on cash.

However, sentiment remains strong, and earnings growth continues to be supportive.

Market breadth is also improving and favouring small caps which are likely to benefit from US pro-growth policies.

The stock market is the second most expensive for any incoming President (after George W Bush in 2000). 

Given Trump’s pro-market tendencies, it is reasonable to expect that he is likely to double down on market friendly policies in the event of a big sell off.

Locally, the ASX unwound some of the recent weak performance in energy and resources with both sectors up strongly at the expense of IT, consumer discretionary stocks and AREITs.

 

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Shorting bonds may no longer be the best trade, argues Pendal’s head of income strategies AMY XIE PATRICK

• Bonds carry plenty of risk premium for the uncertainty that lies ahead
• Hedge funds piling on short US bond bets “like no other time in recorded history”
• Find out more about the Pendal Monthly Income Plus Fund

IN the final weeks leading up to the US election, political pollsters said it would be a close call.

Bond markets, on the other hand, traded like a Trump victory was in the bag.

While the market continues to show little love for bonds in the aftermath of the “Red Sweep”, this article looks at whether the bond short remains the correct “Trump trade”.

What’s priced in?

Bonds have had a busy time. For most of the year, US bond yields have danced between large and small rate cut expectations, fuelled by recession fears and resilient data, respectively.

Despite the US Federal Reserve (the Fed) kicking off this easing cycle with a 50 basis point (bp) cut to the Fed Funds Rate in September, bond yields have failed to fall any lower.

The fear of a Trump victory and the anticipation of his economic policies have played a large part in the most recent bond sell-off.

This move has been similar to the post-election bond market reaction in 2016.

After some immediate confusion as to whether a Trump presidency would herald the end of civilisation as the world had known it, bond yields started to take off. This made sense, as tax cuts and corporate repatriation tax breaks were lifting US growth expectations across the board.

The Fed was also engaged in a hiking cycle.

Between the 2016 US election and the middle of 2018, most tax cuts and repatriation flows had already happened. In that same window, US 10-year Treasury yields climbed by nearly 1.00%.

This time around, bond yields started to move ahead of the US election.

Since the September Fed rate cut (and there has been another cut since then), US 10-year bond yields have climbed by close to 0.9%.

Source: Bloomberg

This latest rise in US bond yields has effectively erased all the market’s anticipation of how the Fed easing cycle would play out on longer-dated bond yields.

It could even be argued that this similar rise in bond yields compares as more extreme than the 2016 experience, which took place against the backdrop of a Fed tightening cycle.

While it’s impossible to say whether the full impact of Trump’s presidency is already in the price, it is certain that bonds already carry plenty of risk premium for the uncertainty that lies ahead.

The real rise in yields

The rise in US bond yields since September is not just about a fear of Trump’s policies being inflationary. Figure 3 shows that both US 10-year breakeven and real yields have marched higher.

Breakeven yields indicate the market’s view on long-term inflation expectations. Since the September FOMC meeting, 10-year breakeven yields have risen by 0.24% to 2.35%.

In other words, the market is having doubts about the Fed being able to maintain inflation at its 2% target in the long run.

Real yields, however, have risen by twice as much in the same period – from below 1.6% in September to nearly 2.1% today.

The prevailing market explanation is that the incoming Trump administration is very likely to see a worsening of the US deficit situation, leading to an increase in US government bond supply.

However, real yields can move due to both the demand for and supply of capital.

An increase in US government bond issuance represents an increase in demand for capital. But existing academic studies have found that the most significant drivers of real yields in the US are demographics and growth.

Source: Bloomberg

Ageing populations lead to higher savings rates, which increase the supply of capital – pushing down real yields.

This long-term trend is unlikely to be suddenly reversed by Trump’s policies and may, in fact, be exacerbated if the working-age population can no longer grow so easily due to more hawkish immigration policies.

GDP growth is positively linked to real yields, because when an economy grows, its need for capital tends to increase. This is why productivity growth is also tied to real yields. Higher productivity is usually a result of investment in technology and innovation – both of which require capital.

The likely effect of tax cuts and tariffs

An expansion and extension of tax cuts under the Tax Cuts and Jobs Act may indeed lift the growth rate of the US economy. But with a real yield rise of over 0.5% since September, a lot of those higher growth expectations have already been baked in.

Furthermore, tax cuts are unlikely to have the same distributional impact as the post-pandemic fiscal handouts implemented under the Biden Administration.

As illustrated in Figure 4, the poorest half of Americans still have more cash in their pockets than prior to the pandemic. The poorest one-fifth of US households have still experienced significant growth in their ex-real estate wealth since the pandemic.

In addition, trade tariffs tend to have a contractionary effect on demand and global growth.

The US economic slowdown in 2018 was evidence of this during Trump’s tariff wars with China. The deflationary effects were so strong at the time that it forced the Fed into the famous “Powell Pivot”, whereby the hiking cycle was abruptly halted (Figure 5).

Source: Bloomberg

The extent to which Trump’s policies can lift the US economic growth trajectory is uncertain. That the poorest Americans stand to benefit the most is unlikely.

Place your bets

While the US economy has remained resilient, we remind ourselves that only weeks ago recession was the main concern on the supposed breach of the “Sahm rule”. Whether the US labour market will manage to avoid further deterioration remains the main concern.

As Figure 6 highlights, once the unemployment rate starts to turn higher, recession usually follows.

Source: Bloomberg

In the meantime, global hedge funds have piled on short US bond bets like no other time in recorded history (Figure 7).

 

Source: Bloomberg

Asset managers’ natural positioning on Treasury futures tends to be long, as often futures will be used to ensure their portfolios’ duration do not fall short of their benchmarks. This creates room to put cash to work on higher-yielding assets like credit.

The most recent rise in the net Treasury futures position among global asset managers may be linked to their chase for credit, rather than an outright desire to extend their US government bond exposures.

Hedge fund positioning, on the other hand, tends to be driven by a direct view of how US Treasuries will fare.

In the low-rates era, hedge funds built up short positions on views that lower rates could not possibly last forever. The pandemic brought in a brief period of even lower rates and forced those hedge fund short positions to be unwound.

Since 2022, however, hedge funds have re-engaged with the short-bond trade because of concerns over inflation, the US deficit situation, and likely a multitude of other factors such as momentum.

The most recent driver of short positioning among global hedge funds seems to be the “Trump trade”. With hedge funds’ short bets on US Treasuries at an all-time high and yields having already risen significantly, the risk is that even hawkish Trump policies fail to push this trade on further.

Market positioning is never the primary driver behind our portfolio positioning decisions. However, it does inform our assessment of the risk-reward dynamic affecting any active decision we make.

If the details of Trump’s economic policies surprise to be more benign or if hawkish policies lead to disappointing market reactions, one expects profit-taking or capitulation to occur among the hedge fund community.

In other words, market positioning points to risk-reward that favours bonds. At the very least, shorting bonds may no longer be the best Trump trade.

 

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

• Find out about Pendal Focus Australian Share fund
• Tune in: register to watch Crispin’s Beyond the Numbers webinar

THE post-election rally in equities hit the wall last week, driven by a combination of being overbought, a rise in bond yields, hawkish comments from the Fed, and concerns over some of Trump’s cabinet appointments.

The Fed’s Chairman, Jerome Powell, signalled that a December rate cut was not a certainty. We have now had four cuts taken out of forward expectations in the past two months.

The US economy continues to travel well and is increasingly divergent from the rest of the world.

This is leading to a strong US Dollar, which is also acting as a check on equities. The S&P 500 shed 2.05% for the week.

There were several results for ASX-listed companies which were, on balance, positive. The S&P/ASX 300 finished up 0.07%.

Commonwealth Bank’s quarterly update reinforced the benign credit environment, leading to small upgrades that fuelled further outperformance from the banks.

US interest rates and economy

The outlook for interest rates continued to shift higher on a slightly more cautious tone from the Fed as Chairman Powell signalled that a December rate cut was not locked in.

“The economy is not sending any signals that we need to be in a hurry to lower rates,” he said.

He further noted that current economic strength was giving the Fed “the ability to approach our decisions carefully”.

In a break with recent messaging, there was also no mention of rates being “a long way from neutral”.

The US government two-year bond yield has risen from roughly 3.6% in September to 4.3% now, as a signal of where the market thinks rates are likely to go.

The market is still pricing a 62% probability of a rate cut in December, before a pause in January.

While expectations for the end of 2025 are broad, the market is assigning the highest probability for rates to be 3.75-4.0% – that is, three more cuts from current levels.

All up, four cuts have been removed from expectations in the past two months. This reflects three factors:

1. The economy is holding up well. The latest Atlanta Fed GDPNow indicator for Q4 is 2.5% growth. The latest consensus data has US GDP growing 2% over the next twelve months, with Goldman Sachs – which has called GDP well this year – estimating 2.4%.  Jobless claims data remains benign, falling back down to 217k last week. October’s personal consumption data was solid and indicates consumer growth is around the trend rate of 2.5% to 3.0%.
2. Inflation is holding up above target levels. October’s CPI data was okay and certainly better than September. Headline CPI was up 0.2% month-on-month to 2.6% year-on-year, while core CPI rose 0.28% month-on-month (versus 0.31% in September) to 3.3% year-on-year. As always, CPI data can be cut to support multiple arguments. Core CPI looks to be trending the wrong way, but the super core measures – excluding idiosyncratic categories – are more consistent with the Fed getting towards its target. Ultimately, there is enough uncertainty here to indicate the Fed will be careful with rates.
3. Trump policies. Tariffs are seen as a one-off reset of prices rather than an ongoing issue. However, immigration policy may have more of an impact on rates. If immigration slows from the estimated annual run rate of three million people to 750,000, then labour supply is tighter which can affect wages. The employment growth needed to hold the unemployment rate steady is estimated at 170k per month, and this could be down to 60k-70k in H2 2025.

Elsewhere, the Senior Loan Officer Opinion Survey (SLOOS) still indicates relatively tight credit standards, but these continue to normalise and suggest that credit demand will pick up in the US over the next 12 months.

The Fed watches this carefully as a gauge for how tight monetary policy actually is.

Markets

US equities corrected last week, and a period of consolidation is understandable given the recent move.

Australia, like the US, has seen a significant sector rotation.

Resources have been weak on disappointment over China stimulus. Consumer Staples and Utilities are underperforming due to defensive attributes and rising capital intensity.

Technology and Banks lead the market. 

Currency markets

One issue to watch is currency markets.

The US rate outlook is moving higher at the same time as the market is becoming more pessimistic about European growth. Expectations of sub-1% growth in Europe in the next 12 months would require the European Central Bank to cut more aggressively.

The implied interest rate differential between Europe and the US has widened to 200 basis points (bps) by the end of 2025. There has been a similar issue with Japan and this has led to a significant move higher in the US Dollar.

The roughly 5% increase in the US Dollar trade-weighted index is not good for equity markets. A similar move in July to October 2023 coincided with a 9% correction in the S&P 500.

That said, the 2023 sell-off also coincided with a 130bp increase in US 10-year yields – we have only seen an 80bp move here so far.

Oil also rose $20 in that period to $95, whereas it is sitting at its lows currently.

So while there are some early warning signs, this is not as material a headwind as last year.

Liquidity/risk-on signals such as Bitcoin remain positive. Credit spreads are close to 20-year lows, which suggest this is more a consolidation than a market reversal.

US earnings are also supportive, with earnings per share (EPS) growth expected to pick up in the next 12 months.

Banks

Banks had another big week and have fully recovered from the China stimulus sell-off in late September.

The sector has now outperformed about 25% over the past 12 months, with the market almost uniformly negative and underweight the sector.

The move, relative to Resources, is even more extreme – now about 66% over 12 months.

Given the earnings outlook for banks is flat, the bulk of the move in Banks has been valuation re-rating.

To highlight the relative valuation shift, we need go no further than the example of Commonwealth Bank which, at 25.88x next-12-month price-to-earnings, has just overtaken CSL (25.14x) for the first time.

Bear in mind that CSL is expected to grow EPS by more than 10% per annuum for the next five years, whereas CBA is likely to be low single digit.

There is no doubt there are significant distortions affecting the market. A lot relates to passive investing, with flows – particularly from offshore – into a small number of mega-cap stocks.

It is hard to predict when these distortions reverse.

But we are reminded of the period where bond yields were around 0% and the market began to justify why this made sense – only to eventually see it unwind.

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About Crispin Murray and the Pendal Focus Australian Share Fund

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

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

Find out more about Pendal Focus Australian Share Fund  

Contact a Pendal key account manager

Pendal’s Global Emerging Markets Opportunities team remains positive about China’s property sector. Here they explain why

• Signs of optimism in China’s property sector
• Caution should be applied when choosing where to invest
• Find out more about Pendal Global Emerging Markets Opportunities Fund

CHINA remains the most interesting emerging market from a top-down standpoint.

Here we focus on its property sector.

The scale of China’s property problem in recent years should need little introduction.

But to summarise it in a statistic: residential property sales were RMB 6 trillion in the first nine months of 2024, down from RMB 12.2 trillion in the first nine months of 2021.

A crackdown on new lending to most private-sector real-estate developers since 2020 has coincided with a broad slowdown in the rest of the economy.

This created a crisis of confidence in real estate, which quickly became a liquidity crisis for developers and a funding crisis for local governments.

Stimulus measures

In September, Chinese policy makers announced fiscal and monetary stimulus which brought about the prospect of change.

This included broad policies aimed at supporting the property sector.

They also specifically allowed the refinancing of a potential USD 5.3 trillion in residential mortgages from November, and a reduction in the banking system’s required reserve ratio.

Signalling from central government fed through to local governments.

Important commercial hub Guangzhou became the first tier-one city to remove all restrictions on buying residential property.

Other top-tier cities Beijing, Shanghai and Shenzhen eased rules on home-purchasing in suburban areas.

James Syme, Paul Wimborne and Ada Chan are co-managers of Pendal Global Emerging Market Opportunities Fund

Property sales rising

Chinese property sales data is normally released in the middle of the month, but there are some data sources that provide an early look.

Most significantly, listed property companies report monthly sales data early the following month.

Data released in early November covers the first full month since stimulus was announced.

For the 22 biggest listed real estate developers, October sales were up 68% month-on-month and 3% year-on-year.

A 3% rise is hardly a return to boom conditions. But as the first ten months for 2024 were down 34% on the equivalent period in 2023, it looks like a significant turning point has been reached.

More positive data

Other anecdotal evidence also supports this view.

New home visits over the October 1 National Day holiday were up 93% year-on-year in Beijing and 200% in Guangzhou.

Prime land in Shenzhen and Chengdu has been sold in recent weeks at high prices, reflecting optimism and financing availability for developers.

October national real estate data (due in mid-November) should give much more clarity on this suggestion of a turning point.

Caution advised

Despite this positive data – and despite strong share price performance among some real-estate developers – some caution must be exercised.

Inventory of unsold homes held by real estate developers is an estimated 28 months of current sales volumes.

Inventory in suburban areas and in tier-two and tier-three cities may be very difficult to sell.

And the Chinese economic slowdown is not driven solely by real estate: policy makers may fail to follow through on their announcements.

Keep an eye on country-level data

Operating a top-down investment process involves continually updating views as economic and company data is released.

A major policy announcement has been followed by a series of data points indicating a turning point in this critically important sector.

We will continue to assess the strength of the recovery and be alert to new investment opportunities.

Until then we remain overweight China in the Pendal Global Emerging Markets Opportunities Fund, with a selective –  and we believe higher quality – set of holdings.

We remain overweight Chinese real estate, with a holding in the more defensive state-owned segment of the industry.

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About Pendal Global Emerging Markets Opportunities Fund

James Syme, Paul Wimborne and Ada Chan are co-managers of Pendal’s Global Emerging Markets Opportunities Fund.

The fund’s top-down allocation process is based on analysis of a country’s economic growth, monetary policy, market liquidity, currency, governance/politics and equity market valuation.

James, Paul and Ada are senior fund managers at UK-based J O Hambro, which is part of Perpetual Group.
 
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

The latest wages data supports the rate cut case, but markets are too focused on Trump, says head of government bond strategies TIM HEXT

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

SEPTEMBER quarter wages data (the Wage Price Index) was released today and, for the third quarter in a row, sat at 0.8%.

This sees a 3.2% annualised pace, though the 1.1% outcome from the 2023 December quarter keeps the annual rate at 3.5% for now.

All sector WPI, quarterly and annual movement (%), seasonally adjusted (a)

Source: Wages grow 3.5 per cent for the year | Australian Bureau of Statistics

Both private and public wages rose 0.8%. A key factor was awards and minimum wage outcomes, which were set at 3.75% in June, down from 5.75% the previous year.

This would be very welcome news for the RBA.

Wage growth and underlying inflation are now heading back towards 3%. Given the two feed into one another, it reflects a more sustainable path for the medium term.

Recent RBA forecasts have underlying inflation at 3% and wages at 3.4% by June next year.

If the RBA has more confidence in reaching these levels sooner, it opens the door for rate cuts in the first half of next year.

Outlook

In another time or place, this data would have seen a decent market rally. But the market has eyes only for the future of Trump’s presidency.

This future is viewed as one of increasing government debt and higher tariff-led inflation in the US, feeding out into the globe.

As a result, markets now have only 30% chance of an RBA February rate cut and less than one cut by mid-year.

On domestic factors alone, this is very cheap, but reconciling it with Trump is proving the problem.

We think the Trump impact will be more mixed outside the US.

Australia’s trade deficit with the US should see us well down the list of targets, but key trading partners are at the top of the list.

Either way, Trump’s policies are unlikely to hit hard data until the back half of 2025 at the earliest, making central banks’ jobs more difficult for now.

We maintain the view that upcoming data leaves a February rate cut wide open.

At only 30% priced in, the risk/reward is becoming attractive, and we will use the sell-off as an opportunity to enter positions.

Further out the curve remains at the mercy of US bonds which, even at 4.5%, don’t seem to be finding widespread support.

Australia should outperform but yields may still move higher.

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About Tim Hext and Pendal’s Income & Fixed Interest boutique

Tim Hext is a Pendal portfolio manager and head of government bond strategies in our Income and Fixed Interest team.

Tim has extensive experience in banking, financial markets and funding including senior positions with NSW Treasury Corporation (TCorp), Westpac Treasury, Commonwealth Bank of Australia, Deutsche Bank, Bain & Co and Swiss Bank Corporation.

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

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

Find out more about Pendal’s fixed interest strategies here

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About Pendal

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

In 2023, Pendal became part of Perpetual Limited (ASX:PPT), bringing together two of Australia’s most respected active asset management brands to create a global leader in multi-boutique asset management with autonomous, world-class investment capabilities and a growing leadership position in ESG.

Contact a Pendal key account manager

Closing gender pay gaps would bring significant benefits to the Australian economy – and to investors, argues Pendal’s ELISE McKAY

• Australian women still earn less than men
• Closing the gender pay gap would pay dividends for investors
• Find out about Pendal Horizon Sustainable Australian Share Fund

CLOSING gender pay gaps could significantly boost Australia’s economy, potentially increasing GDP by 6.2 per cent and creating 461,000 jobs annually — six times more than the current job creation rate.

And for investors, there is substantial evidence that companies with better gender equity tend to perform better financially.

“There’s a strong business case for all stakeholders to work together to close the gender pay gap,” says Pendal equities analyst and portfolio manager Elise McKay.

“The financial benefit to the Australian economy of closing the gender pay gap is substantial, and it would benefit all corporates with revenue ties to Australia.”

What is the gender pay gap?

Gender pay gap is not the same as pay inequality, where women and men are paid differently for the same role.

Equal pay for performing the same role has been a legal requirement in Australia since 1969.

Instead, a gender pay gap refers to the overall uneven distribution of salaries within an organisation.

Gender pay gaps can arise even when employers are committed to pay equality, says McKay.

Gender pay gaps can occur when women are under-represented in leadership roles, when women with caring responsibilities have fewer opportunities for career advancement, or when roles typically undertaken by women are undervalued in the workplace.

“The median gender pay gap in Australia is 19 per cent,” says McKay.

The Workplace Gender Equality Agency says that means that over the course of a year, the median of what a woman is paid is $18,461 less than the median of what a man is paid.

All organisations with more than 100 employees must report their gender pay data annually.

Investors should review a company’s gender pay data

McKay says the gender pay gap in many organisations is often a result of women and men being represented differently in high and low-paying jobs.

Carefully understanding these types of representation issues is the first step towards closing the gap.

“It’s a general story across the economy – there are leaders and laggards within each sector,” she says.

“The gender pay gap is a complex issue to resolve and it’s something that stakeholders need to work together to fix.

“We recognise that different companies have different workforces and different segments of their workforce may be traditionally male or female dominant.”

But there are things people can do within organisations to start understanding how to solve the problem.

“The first step is trying to understand the composition of your workforce and what’s driving your gender pay gap,” she says.

“Is it an actual remuneration issue, or is it a representation issue? And what is driving those differences in representation across hiring, promotions, and other factors?”

Proven solutions

McKay says representation issues take time to solve but there are proven paths for organisations to take.

“The company boards I speak to are at different stages in the journey. They range from some that haven’t really thought it through to some that are very evolved in terms of how they’re thinking about it.

“There’s still a bit of trial and error.

“But there’s many steps companies can take that have been trialled and are proven to work – for example, we know that sponsorship of females within organisations is more successful than mentorship.

“We also see companies that have re-thought their rostering to conduct work in ways that are more integrated with women’s lives.”

Case study: Viva Energy

Fuel retailer Viva Energy, which employs more than 1500 people, discovered that overtime payments were a significant driver of its pay gap.

This was partly because a threshold of five years’ experience to be eligible for the operational roles that attract overtime meant fewer women than men qualified.

Men also progressed faster, spending less time at each competency level than women because they were more likely to come to the business with a trade background.

Viva took action to improve the representation of women in operational roles and has reviewed its operator training programs to ensure women progress as quickly as possible – even without a trades background.

Devil in the detail

McKay says it’s important to look beyond the headline data when assessing progress on closing the gender pay gap.

That’s because actions taken to improve gender representation, such as hiring more women at entry-level positions, can sometimes temporarily distort pay gap statistics.

“More women coming in at lower levels can skew the data – so the devil is in the detail and just looking at the headline number does not necessarily show what’s actually going on in an organisation,” she explains.

That means companies need to be prepared to explain their gender pay gap numbers – and investors need to be careful when analysing the reports.

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About Elise McKay and Pendal Australian share funds

Elise is an investment analyst and portfolio manager with Pendal’s Australian equities team. Elise previously worked as an investment analyst for US fund manager Cartica where she covered a variety of emerging market companies.

She has also worked in investment banking and corporate finance at JP Morgan and Ernst & Young.

Pendal Horizon Sustainable Australian Share Fund is a concentrated portfolio aligned with the transition to a more sustainable, future economy.

Pendal Focus Australian Share Fund is a high-conviction equity fund with a 16-year track record of strong performance in a range of market conditions. The Fund is rated at the highest level by Lonsec, Morningstar and Zenith.

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

Contact a Pendal key account manager here

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

• Find out about Pendal Focus Australian Share Fund

THERE was not enough in Australian economic data last week to bring forward expectations of rate cuts.

US economic data remains on the soft-landing trajectory, with a slowing labour market and still-resilient consumption. The market is locked on for a 25bps cut at the Fed meeting this week.

We are seeing the highest dispersion in outcomes in a while from both US quarterly reporting season and the trading updates from Australian annual general meetings (AGMs). There are plenty of anecdotes about consumers “trading down” to cheaper products and services.

There are perhaps a couple of new trends emerging.

– First, weak EU data is prompting speculation about where rates go to – and do they settle below the “neutral” level.

– Second, some are starting to question the return-on-investment expectations around the swathes of corporate investment in AI.

Elsewhere, there is further chatter about a potential stimulus out of China’s NPC meeting this week. If forthcoming, it would see a confluence of China, the EU and the US all on a path of monetary easing and/or stimulus into 2025.

The US Presidential election remains a coin-toss – as does the time frame that it will take to determine a winner.

Increased volatility seems the only sure bet at the moment.

Macro and policy Australia

The headline consumer price index (CPI) for Q3 2024 rose 0.2% quarter-on-quarter, while the year-on-year rate eased 100bps to 2.8%. This is the first time inflation has been within the RBA’s 2-3% inflation target band since the first quarter of 2021.

That said, new subsidies drove electricity prices down 17.3% over the quarter, taking about 40bps off headline CPI.

The trimmed-mean CPI – a seasonally-adjusted measure closely watched by the RBA – rose 0.78% for the quarter and 3.54% for the year.

This has decelerated sequentially over the year; the quarterly growth was +1.01% in Q1 and +0.87% in Q2.

Year-on-year growth for the month of September was 3.2%, only just ahead of the RBAs 2-3% band.

Overall, inflation is tracking in the right direction, but not quickly enough to change expectations around rate cuts.

Breaking CPI into components:

– Goods prices fell 0.6% quarter-on-quarter, driven by the drop in electricity mentioned above as well as -6.7% in fuel prices. This offset a 0.6% gain in food prices.

– Services prices rose 1.1% quarter-on-quarter and the year-on-year figure rose 10bps to 4.6%. The volatile holiday travel and accommodation segment rose 1.4% for the quarter. There was moderating growth in rents (1.6%), other financial services (0.9%) and medical and hospital services (0.1%).

Retail sales

September retail sales rose 0.1%, versus 0.3% expected and 0.7% the previous month.

Weakness in clothing, footwear and accessories (-0.1%) and department stores (-0.5%) offset growth in household goods (+0.5%) and restaurant and takeaway food services (+0.4%).

Retail volumes rose 0.5% for the third quarter, having fallen 0.4% in the previous two quarters. This is only the second time in the past two years that quarterly volumes have increased.

The long-term average trend is 5% annual growth in retail sales. We are currently tracking a little below half this rate.

Macro and policy US

JOLTS

The September Job Openings and Labor Turnover Survey (JOLTS) saw job openings decrease by 418k to 7,443k.

This was lower than a (downwardly revised) 7,816k in August, well under consensus expectations of 8,000k and is the lowest level of job opening since January 2021.

Openings fell furthest in; 1) private education and health services (-175k), 2) trade, transportation and utilities (-132k), and 3) government (-132k). They increased in financial activities (+93k) and professional and business services (+77k).

The job openings rate fell 0.2%, to 4.5%, and the quits rate was down 0.1%, to 1.9%. The hiring rate rose 0.1% to 3.5% and the layoff rate was also up, by 0.2% to 1.2%.

Labour turnover now appears lower than pre-pandemic levels – for example, the quits rate averaged 2.3% in the two years before 2020.

Inflation

The 0.8% quarter-on-quarter rise in the employment cost index (ECI) was good news for the Fed, as the yearly rate dropped from 4.1% in Q2 to 3.9% in Q3. This is the first reading under 4% in three years.

Recent solid growth in productivity (averaging ~1.7% p.a. for the last 5 years) means that unit labour costs already are rising slowly enough (2.3%) for core personal consumption expenditures (PCE) inflation to fully return to the Fed’s 2% target during 2025.

The PCE price index rose +0.18% month-on-month for September, in line with the median forecast and up from 0.11% in August. It is up 2.09% year-on-year, again in line with the median forecast and down from 2.27% in August.

The Core PCE price index rose 0.25% month-on-month, which was the largest gain since April and is up from 0.16% in August. It is up 2.65% year-on-year, versus +2.72% in August.

The Q3 data appears to have been slightly worse than the Fed expected, as it would now require month-to-month increases to average 0.10% over the next three months for the median participant’s forecast of a 2.6% year-over-year increase in Q4 to be realised.
Nonetheless, the low level of food and energy prices, frictionless supply chains, cooling new rent inflation and the ongoing loosening of the labour market suggest that the outlook for core PCE inflation is fundamentally benign.

GDP

US GDP rose 2.8% in Q3 2024, driven mainly by strong consumption.

Consumer spending rose 3.7% – the largest gains since Q1 2023 – which accounted for 90% of the increase in activity.

This in turn is driven by the top 40% of US households by income, reflecting strong balance sheets and still-favourable wage and employment prospects.
In contrast, the bottom 40% of households are feeling the pinch from higher prices and higher mortgage costs.

Meanwhile, the middle 20% of households are still spending but trading down in the search for value.

Strong consumption offset weakness in other areas such as private investment, which rose just 1.3%, and in inventories, which went backwards.
The Atlanta Fed’s real-time GDP estimate GDPNow is forecasting 2.7% growth in Q4.

Other data

• October US consumer confidence rose 9.5pts to 108.7 which is the largest one month increase since March 2021. Are we drawing a line through the “vibecession” we have been experiencing for a couple of years?

• Pending home sales rose 7.4% in September, the strongest number since June 2020 and well ahead of expectations. Mortgage rates have however spiked since the end of September, so this could be short-lived joy.

• October non-farm payrolls rose 12K, versus 100k consensus expectations. Manufacturing strikes and hurricane impacts rendered the number somewhat meaningless. However there was a significant net revision of -112K across Aug/Sept. The 6-month average in September is ~150k, versus nearly 250k 6-month average in January 2024. The net revisions probably lock in a 25bp cut from the Fed in November.

• The unemployment rate was unchanged at 4.1% in October, matching the consensus.
Average hourly earnings rose by 0.37%, slightly stronger than the consensus, 0.33%. Net revisions were -0.09%.
- The ISM manufacturing index dipped to 46.5 in October, from 47.2, below the consensus, 47.6.

Macro and policy EU

There is some chatter that ECB policymakers have begun debating whether interest rates need to be taken below neutral to stimulate the economy.

While nascent, this is a significant shift in the policy debate.

Europe’s economic backdrop is deteriorating rapidly, while inflation is well below earlier predictions.

This raises the risk that price growth undershoots the ECB’s target, as it did in the decade before Covid.

Germany’s finance ministry flagged that the economy would probably contract in 2024, as it did in 2023, as the country continues to deindustrialise as a result of the EU’s energy policies.

German Chancellor Olaf Scholz noted the need for new a new approach – especially for industry – in the face of high renewable energy costs, weak global demand, and growing competition from China. One key question is how to ensure cheap energy.

Volkswagen asked its workers to take a 10% pay cut, arguing it was the only way it could save jobs and remain competitive.

Whilst only one company at the moment, we are starting to see the wave of deflation that Europe faces.

China

Vice finance minister Liao Min noted that Beijing’s stimulus is focused on lifting domestic demand and reaching the 2024 growth target, while coordinating with monetary policy to target economic restructuring.

There is an expectation that China will unveil fiscal stimulus following the National People’s Congress (NPC) Standing Committee meeting, schedule to conclude on 8th November.

Liao said fiscal policies will be of “quite large scale”, reiterating an earlier message from finance minister Lan Fo’an.

US earnings

The blended Q3 earnings growth rate for S&P 500 EPS currently stands at 5.1%, versus 4.3% expected at the end of the quarter.

The blended revenue growth rate is 5.2%.

70% of S&P 500 companies have reported, with 75% beating consensus EPS expectations. This is below the 78% one-year average and the five-year average of 77%.

60% have surpassed consensus sales expectations, below the 62% one-year average and the five-year average of 69%.

In aggregate, companies are reporting earnings that are 4.6% above expectations, below the 5.5% one-year average positive surprise rate and the five-year average of 8.5%.

In aggregate, companies are reporting sales that are 1.1% above expectations, better than the 0.8% one-year positive surprise rate but below the five-year average of 2.0%.

• Alphabet delivered a well-received set of numbers. Overall Group sales were up 15% versus 14% in Q2. Net income of $26.3bn was up 34% on the same period last year. The Cloud business was the highlight, with revenue up 35% versus 29% in Q2. Advertising growth slowed to 10.4%, versus 11.1% in Q2, with Search advertising of $49.4bn up 12.2% versus 13.8% in Q2. YouTube advertising sales of $8.9bn were up 12.2%, versus 13% in Q2. Investment in AI is “paying off,” according to management
• Microsoft beat consensus expectations for revenue and EPS. Azure, its cloud business, grew revenue 33% versus 29.5% expected, with generative AI contribution 12 percentage points of that. Capex as a percentage of revenue is running at 28%, versus a historical average of 12%.
• Meta grew revenue 19% in Q3, down from 22% in Q2. Q3 profits grew 35% to US$15.7bn. The capex budget for infrastructure is high and going higher. Capex to sales running at 24%, versus 19% historically. Zuckerberg said the company’s AI-driven feed and video recommendations have led to an 8% increase in time spent on Facebook and a 6% increase on Instagram. He added that more than one million advertisers used Meta’s generative AI tools to create more than 15 million ads in the past month, and the company estimates that businesses using image generation are seeing a 7% increase in conversions.
• Amazon expects to spend about US$75 billion capex in 2024 and more than that in 2025, with the majority driven by cloud-based Amazon Web Services (AWS). CEO Andy said “the increased bumps here are really driven by generative AI” which “is a really unusually large, maybe once in a lifetime type of opportunity,” but “customers, the business and our shareholders will feel good about this long term.” He noted that Amazon has “proven over time, that we can drive enough operating income and free cash flow to make this a very successful return on invested capital business…and we expect the same thing will happen here with generative AI.”

 

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About Jim Taylor and Pendal Focus Australian Share Fund

Drawing on more than 25 years of experience investing in top-performing Australian companies and a background in accounting, Jim manages our Long/Short Fund and co-manages our Imputation Fund. He is a Chartered Accountant with membership of the Australian Institute of Chartered Accountants.

Pendal Focus Australian Share Fund is managed by Crispin Murray. The fund has beaten its benchmark in 14 years of its 18-year history (after fees), across a range of market conditions. Find out more about Pendal Focus Australian Share Fund here.

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

Contact a Pendal key account manager here

In a world without bank hybrids, investors should re-consider their income plan, says Pendal’s head of income strategies AMY XIE PATRICK

• Hybrid securities can suffer meaningful shortfalls
• It’s “unwise” to rely solely on hybrid income through all market environments
• Find out more about the Pendal Monthly Income Plus Fund

FOR years, Australian investors have flocked to bank hybrid securities as a cornerstone of income-generating portfolios.

Hybrids — debt instruments issued by banks that can convert to equity in times of trouble — have been popular with everyday investors due to their accessibility.

But investors will soon need to find alternatives, after the Australian Prudential Regulation Authority announced plans to phase them out from 2027 (see more in our recent quarterly update).

ARPA wants to “simplify and improve the effectiveness of bank capital in a crisis” and replace hybrids with “cheaper and more reliable forms of capital that would absorb losses more effectively in times of stress”.

Below we examine whether hybrids truly delivered on their promise to investors — and we discuss an alternative that could help fill the gap.

The myth of defensiveness

Hybrid securities, as their name suggests, sit somewhere between the asset classes of fixed income and equities.

They serve as one of the first lines of defence in a bank’s capital structures in times of turmoil, and outside of those times pay regular coupons, like bonds.

Though the coupon feature means they are often classed as “defensive”, their purpose as a capital instrument makes them inherently ill-suited to serving a defensive role in portfolios.

Through multiple market cycles, bank hybrid securities globally have exhibited a positive correlation with equity markets.

When things are fine, these securities pay their coupons and may even deliver some mark-to-market capital gains should their credit spreads tighten.

In times of severe market stress, hybrids can behave more like equities than bonds. During the collapse of Credit Suisse in April 2023, the bank’s hybrid securities were written down to zero – a worse outcome than Credit Suisse shares.

As the figure 1 graph below highlights, using the example of CBA, the long-term performance of hybrids has lagged even more senior bonds.

These securities tend to behave like high-quality bonds when all is fine, and like equities when all is not.

The capped potential for capital growth in hybrid securities means they are not capable of generating levels of reward commensurate with the likely volatility investors will experience along the way.

Figure 1: All the risk without the reward
Long-term returns of CBA equity, CBA hybrids (“Perls”) and major bank senior bonds

Exchange-traded ≠ liquidity

Another selling point of hybrids has been their exchange-traded status.

Many investors assume this means that hybrids can be easily bought and sold.

In reality, market liquidity for hybrids has always been contingent upon the ability of brokers to match buyers and sellers in the market. In such a retail-dominated asset class, costly buy-sell spreads can also be a feature.

The fallacy that “listed equals liquid” has been exposed in times of crisis, when the exit doors for hybrids can become very narrow.

Repeatable income? Not so fast

Since hybrids come with a higher risk of capital loss than senior bonds, these securities compensate investors with a higher credit spread, translating ultimately into higher coupons than more senior bonds.

Unlike senior bonds, hybrid coupons can be reduced, delayed or completely switched off. This feature of hybrid securities is a benefit to the issuers as it offers a lifeline in times of need.

For investors, it’s a reminder that the higher income potential in hybrids is far from guaranteed.

Figure 2: More risk should command more reward
Risk and reliability of income through the bank capital structure

 

While Australian bank hybrids have not experienced any volatility in coupon payments in recent history, both the events of the Credit Suisse crisis in 2023 and that of many other European banks during the European Sovereign Crisis in 2012 have shown that it has been unwise to rely solely on income from hybrids through all market environments – particularly considering that the majority of income-seeking investors tend to be conservative in their risk tolerance.

A smarter way to use the capital structure

We’ve uncovered that hybrid securities suffer meaningful shortfalls.

Their contractual terms allow issuers to skip coupon payments. Investors’ ability to access their capital is likely to be variable and limited when they most need it. Their potential for capital growth does not compensate for the meaningful volatility that investors can experience along the way.

But what if there has always been a smarter way to use the capital structure?

Figure 3 expands on the bank capital structure to a broader set of asset types. More importantly, the diagram looks at what jobs these assets are good at doing that could be important to any investor.

Figure 3: Asset utility through the eyes of the investor

The key revelations from Figure 3 are as follows:

• Different assets are good at doing different things
• No single asset class can satisfy all investment objectives
• Hybrids satisfy none of the basic requirements

The idea that different asset types need to be employed may seem daunting, but Figure 4 illustrates that the idea is simple.

In the graph below, we compare the long-term return outcomes of holding CBA hybrids, versus holding most of your capital in cash and putting only 10% into CBA shares.

Nothing beats equities for generating capital growth. And a cash-heavy portfolio has significantly diluted adverse volatility events along the way.

Figure 4: A little bit of equities goes a long way
Comparing long-term returns of CBA hybrids versus a portfolio of 90% cash and 10% CBA shares

 

Pendal Monthly Income Plus Fund – a solution for defensive income

As Australian bank hybrids face extinction, our Pendal Monthly Income Plus Fund provides a compelling alternative for investors.

We start from investment objectives and map them to the assets that have a proven track record of delivering against those objectives.

That means we don’t have to accept market narratives about hybrids (or any other asset types) that have not been entirely accurate.

We don’t have to run for narrowing exits when others stampede. And we don’t have to face a mismatch between the liquidity we offer our investors versus the liquidity we are able to access in the market.

The components of the strategy are simple.

We use high-quality investment grade bonds to generate income. We actively allocate to equities to help our investors’ capital grow, with a track record of avoiding market chaos.

And we use government bonds or interest rate exposure more broadly to manage the portfolio through the rates cycle.

Since the portfolio is 100% Australian, investors also get a healthy franking credit benefit through the portfolio’s equities exposure. And since the portfolio is 100% liquid, investors are also able to access daily liquidity.

The fund’s strategy recognises the broad aims of all income-seeking investors: a regular, stable and repeatable income stream, and capital growth to help offset the effects of inflation over the medium term.

These aims help ensure that the Fund’s investment objectives align with its investors. These objectives and how we’ve measured against them are illustrated in Figure 5.

Figure 5: Monthly Income Plus Fund: our three investment objectives

The fund pays distributions monthly and, since inception 15 years ago, has never missed a payment.

While equity and bond markets the world over suffered double-digit losses in 2022, this strategy’s drawdown was limited to 5%.

And alongside regular income with limited drawdowns, the portfolio’s capital has grown every year bar one since inception.

The longer-term track record of the Pendal Monthly Income Plus Fund can be seen in Figure 6.

Here, we’ve illustrated performance against a hurdle of RBA Cash + 2% (consistent with the risk tolerance of conservative income investors), and against an index of Australian bank preference shares as a generous proxy for hybrid instruments (since shares have greater potential for capital growth than bonds).

The Monthly Income Plus portfolio could have been a replacement for hybrids all along.

Figure 6: Long-term track record

Why wait?

In early September, prior to the APRA announcement, the average gap between bank hybrid and subordinated bond credit spreads tracked around 60 basis points.

This gap was at the tighter end of the historical range of this relationship. Today, this gap stands at less than 10 basis points.

Scarcity has been the main factor behind this compression.

Since banks will no longer be issuing these higher-yielding securities, but investors still like higher yields, the demand has far outstripped supply in recent weeks.

Scarcity, however, does not change the nature of hybrid instruments.

They remain on the frontlines to take losses and cease paying coupons in times of stress.

They will still mature at par (100 cents on the dollar), so cannot offer capital growth to hold-to-maturity investors.

And they will likely be hard to sell (at least at the price investors would like) in times of market turmoil.

It is time to look for better opportunities elsewhere.