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.

 

The door may open for the RBA to pass three cuts next year, but that may be “as good as it gets”, writes 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

THE ABS released new inflation data today and – in the spirit of more information – it seems there are now more numbers to watch than before.

The most watched are the quarterly numbers – that is, the September quarter versus the June quarter.

These showed headline inflation at 0.2%, courtesy of electricity subsidies and lower fuel prices. Against the September quarter last year, prices are 2.8% higher.

Also released were the September monthly numbers.

This compares prices for September 2024 versus September 2023. Here, the news was even better, with headline prices only 2.1% higher over the year.

However, the ABS tries to strip out the noise of volatile prices by reporting trimmed mean inflation, Australia’s version of underlying inflation. The highest and lowest 15% of moves (weighted for size in the CPI basket) are excluded.

Here, the news is mixed.

Trimmed mean inflation for the quarter was 0.8% and 3.5% versus the September quarter last year.

This is heading lower, but the RBA would need to see consistent prints 0.7% or lower to feel comfortable about inflation being sustainably in its target band.

Source: CPI rose 0.2% in the September 2024 quarter | Australian Bureau of Statistics

The path ahead

So, where exactly is inflation and what path is it on? And what is the RBA reaction function?

The RBA will keep talking about services inflation being uncomfortably high. The pace of last quarter showed no improvement, stuck at 4.5%.

Services make up around two-thirds of the CPI basket, so clearly that needs to be nearer 4%. If we dig into services, the problem areas (those above 5%) remain housing, health, education and insurance.

As wage growth moderates with inflation, there is some cautious optimism that education inflation should drift back to 4%. For example, NSW teachers just signed a three-year wages agreement of 3% per year plus 1% more super.

Housing is more mixed. State government spending on infrastructure continues to create labour shortages in construction, impacting both rents and the cost of new dwellings. In this area, 5% inflation may be here to stay for a while.

Insurance premium rises should moderate but may also struggle to fall through 5%.

Health prices remain impacted by massive labour shortages and readjustment of wage levels in the care sector. Again, this is driven by government policy.

Putting it all together

When we put this together, the path for inflation looks like hitting 3% (underlying) early next year but remaining stuck around that point.

This means that the RBA will have a door open to cut rates, though it will be driven by employment markets and the size of cuts globally.

We remain optimistic that this will allow for three rate cuts next year.

However, without some external shock hitting the economy, that may be as good as it gets.

Market pricing has not budged with this number. A February rate cut is priced at a 50% chance, with a full cut not priced till May 2025.

This places the odds slightly in favour of a long-duration position, though US election fears are keeping volatility high and risk size modest.

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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

Investment conditions continue to look promising in Brazil and China. Here Pendal’s Global Emerging Markets Opportunities team explains why

• Despite local currency weakness, inflation levels are nearing targets in Brazil
• Shifts in Chinese policies result in attractive equity valuations 
• Find out more about Pendal Global Emerging Markets Opportunities Fund

SEPTEMBER and October are often monumental months in global markets and economics: for example the Asian economic crisis of late 1997 and the GFC in 2008.

This year’s start to Spring may not be quite as pivotal, but we’ve nevertheless seen unexpected and drastic changes in Brazil and China.

Brazil

Brazil’s composite Purchasing Managers Index — a measure of manufacturing industry health — was 56 in July and 52.9 in August.

A PMI above 50 indicates expansion, while below 50 indicates contraction.

Yearly retail sales were broadly up 7.2% in July.

We’ve also seen strong returns from Brazilian equities in local currency terms. The local Bovespa stock index hit a record high at the end of August.

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

This economic strength has not come with much inflationary pressure.

Inflation was 4.2% in the year to August (according to the local IPCA consumer price index). This
compared with 4.6% at the end of 2023 and 3.7% in the year to April 2024.

The Brazilian Central Bank (BCB), has responded by moving into a more hawkish monetary stance, lifting the benchmark interest rate by 25 basis points to 10.75% in September.

This move reflects waning confidence that inflation will decline to its 3% target.

Meanwhile, the US interest rate outlook has shifted in recent months, with a sharp decline in expected future interest rates and a 0.5% cut in the US policy interest rate in September.

This has eased pressure on emerging market economies and their currencies.

Together, these developments have further enhanced our enthusiasm for Brazilian equities.

Brazil is performing better than expected, but the weakness in the currency has offset this zeal for international investors.

We believe the central bank raising rates will not significantly worsen the outlook for local equities. Instead it should substantially improve the outlook for the currency (as does the US cutting interest rates).

We continue to believe Brazil equities can deliver strong USD returns.

But we now expect a larger share of that to come from the currency relative to the local equity market.

China

China’s Politburo convened in September outside its typical April-July-December timetable.

A resulting policy statement delivered a dramatic surprise for markets.

The Politburo underlined a critical shift in priorities, including “stopping the decline in housing” and “increasing lending to white-listed projects”.

There was also a Quantitative Easing-like target to “ensure necessary fiscal expenditures” through ultra-long special sovereign bonds and local government special bonds.

The People’s Bank of China had previously announced a number of monetary policies including cuts in official interest rate cuts, bank cash reserve requirements and the outstanding mortgage rate.

The bank also announced RMB 800 billion of support for the stock market.

Crucially, alongside these measures, the Politburo provided subtle updates to its monetary policy language, replacing the word “prudent” with “forceful”, indicating the direction of cuts in policy interest rates.

The market reaction was visceral.

Hong Kong-listed Chinese stocks rose 26% in six trading days on the Hang Seng China Enterprises Index. The Shanghai Composite Index rose 21.9% in the same period.

Consumer and property names (including the bulk of Chinese holdings in our portfolio) led the rise, including eight names that rose more than 40% between September 23 and October 2.

During a grinding slowdown in the Chinese economy since 2020, there have been previous policy-driven market spikes (including October 2022 and January 2024).

The magnitude of these recent occurrences aligns with previous episodes, but are moving at a faster clip.

What matters now is whether the new policies reverse current economic trends.

Our process involves paying close attention to emerging economic data, precisely because of turning points such as this.

Even amid these movements, we consider China’s low inflation, large trade and current account surpluses, earnings growth in parts of the equity market, and attractive equity valuations as reasons to maintain holdings in Chinese equities.

We have been overweight China since April 2024, have been rewarded for that stance in recent weeks, and continue to be on the look-out for opportunities in China.

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’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 has been focused on the sell-off in bonds, which is tied to better US economic data as well as the possibility of a Trump win and a “Red Sweep” of Congress in the US election.

US 10-year Treasury yields rose 16 basis points (bps) and are up 45bps month-to-date.

This flowed through to equities, with the S&P 500 selling off 0.96%. Australia followed its lead, with the S&P/ASX 300 down 0.86%.

China also appears to be “on hold” pending the US election outcome.

The October politburo meeting will be held this week, but the National People’s Congress standing committee’s next meeting, from 4-8 November, is likely to provide the next indication on stimulus plans.

A string of updates from Australian companies noted slowing activity in the US (Brambles, Reece), Europe (Reliance Worldwide) and Australia (Super Retail, Metcash).

Offsetting this, we did see upgrades from Qantas and a good ResMed result.

This reinforces our view that we are at a stage in the cycle where stock-specific factors are more important. 

US economy and policy

There was little to change the prevailing view that economic growth remains solid.

Current anecdotes are distorted by the effect of recent hurricanes. Also, the upcoming election may be prompting some deferral of hiring and investment decisions. 

Weekly jobless claims continue to fall back to their prior levels, with no sign that the recent hurricane-related spike is the start of a sustained deterioration. 

The US Federal Reserve (the Fed) came under some criticism from former member Kevin Warsh, who suggested there was no data which would have justified a 50bp first cut.

Some debate has begun as to whether the Fed will pause and hold rates steady in one of the two meetings before year end.

The market is pricing in a 75% probability of a cumulative 50bp move.

We don’t see a reason for the Fed to pause in November and the market seems to agree – currently pricing only a 5% probability of no rate cut.

US election

With only nine days to go, Trump remains in better position today based on the polls, though his upward momentum has stalled in the past week.

The RCP Betting Average has him slightly ahead – but well within the margin of error – in the seven key battleground states.

Overall, he is currently a 60% chance of winning, but there is some debate as to whether betting odds can be relied on – noting that in 2016, Trump’s odds of winning were 16% on the day of the election.

Key “Trump trades” – such as a stronger USD, financials and rising bond yields – are outperforming, so the case can be made that a lot of a potential Trump win has been priced in.

Geopolitics

After waiting 25 days, the Israelis retaliated against Iran.

They appear to have targeted military sites, weapons and drone manufacturing facilities, as well as air defence.

The initial interpretation is that this was constrained enough so Iran will not be compelled to respond in an escalating way.

It may be perceived as a sign that tensions will ease for now – and may see oil prices fall.

Markets

Rising bond yields are beginning to hit technical resistance levels, and are likely to pause ahead of Friday’s payroll data and then the US election result.

The negative view on bonds is tied to the fear of inflationary effects from potential Trump policies such as tariffs and lower immigration, which may lead to a tighter labour market.

As mentioned above, much of this concern seems priced in for now.

There weren’t many relevant signals from US quarterly earnings last week. Of the Mag 7, only Tesla reported, with better-than-expected margins driving that stock higher.

Thirty per cent of the S&P 500 has reported to date. The proportion of earnings beats is in line with the historical average of 50%, while 15% have missed expectations.

Another 45% of the market reports this week, including a further five of the Mag 7.

Australia saw a rotation to defensives, such as consumer staples and telecom. Consumer discretionary underperformed on negative stock-specific news, tech was down due to the fall in Wisetech Global, and higher bond yields weighed on REITs. 

A series of trading updates suggested a slightly softer environment for a number of companies. This was often sector and region-specific, though it is clear that anyone with Europe exposure is seeing more generalised softness.

The Metcash downgrade highlighted the effects of weakening home construction, which goes to the structural challenges for building in Australia.

An upgrade from Qantas and a good result from ResMed did provide some balance.

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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 has been recognised – and awarded – at the 2024 Zenith Fund Awards

HELD annually, the Zenith Fund Awards aims to recognise the best in funds management across 24 categories and help raise the standard of funds management for the benefit of investors.

Pendal was recognised in the Multi Asset – Diversified and the Sustainable and Responsible Investments (Income) categories – the latter of which it won.

“As has been our focus in previous years, [the] awards recognise and honour excellence in funds management across all asset classes and disciplines,” said Zenith managing director Jason Huddy.

“We believe that this is fundamental to continuing to raise the standards of funds management in our industry for the ultimate benefit of investors.”

To view the full list of 2024 winners, visit the events page

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

• Find out about Pendal Focus Australian Share fund
• Crispin Murray: Five key questions for 2024 (and how we’re going so far)

WITH global monetary policy (ex-Australia) easing and more fiscal stimulus from China, it appears as if the economic and market cycle will hold or possibly even re-accelerate.

Equity markets are optimistic as we approach year-end, rebounding from the August correction which was driven by some weaker US data points and the Yen carry-trade unwind.

This increased level of confidence saw the S&P 500 rise 0.87% and the S&P/ASX 300 rise 0.81% last week. The latter is up more than 8% since the start of July on a total return basis.

This optimism has been partly fuelled by positive economic surprises, especially since early September. Most prominent are the latest employment reports in the US and Australia, which suggest labour market concerns were overdone.

Betting odds are pointing to a Trump victory and the market seems more comfortable with this outcome.

This looks set to be the closest election in US history.

Harris is picking up the college-educated and female vote, while Trump is gaining amongst non-college educated males and minorities. Gold may spike if there is post-election uncertainty.

High valuations and already bullish sentiment pose risks to the market. However, there is no clear catalyst for a downside move and the global rate cycle (ex-Australia) is helping.

US macro and policy

On the whole, stronger US data is pointing to a soft or even no-landing scenario. 

Retail sales data suggests the US consumer is still looking good, the Fed is now cutting, and the fact that monetary policy is becoming less restrictive is helpful.

Interestingly, the savings rate has been revised up to 4.8%, which supports a stronger consumer.

That said, bank credit is tight and most data doesn’t reflect what is happening in the small business economy, where there are anecdotes of pressure.

The housing market is also soft.

The US labour market is interesting. Businesses have been pulling back from hiring activity over the past year to cut costs, despite GPD growth. This has also been reflected in falling aggregate hours worked.

With fewer people quitting their jobs, it is plausible that a slowdown in the labour market will be seen in the form of layoffs this cycle, which does feed into the risk of recession.  

China macro and policy

China appears to be shifting gear with a set of new policies from late September to support its economy and property market.

The measures include bank reserve requirement ratio cuts, capital injections to banks, as well as moves to support local government debt restructuring and boost the capital market.

There have been additional policies focused on supporting and stabilising the property market, including funding to reduce the inventory of unfinished and unsold housing stocks.

These measures appear targeted at easing specific pressure points, such as local government balance sheets and unsold housing.

Thus far, there has been no large consumer-related fiscal package. But at least there is some movement at the station.

Markets are anticipating additional stimulus packages for housing and the economy. This can’t hurt the Aussie resources sector.

However, there is the risk that a US tariff package could take as much as 2% off growth.

Beijing is watching the US Presidential Election closely and, if tariffs look likely, may implement more fiscal and monetary in response.

Europe macro and policy

The labour market in Europe (EU) remains tight, despite very low GDP growth.

Consumer spending is tilting towards the labour-intensive services sector.

The German economy remains weak – as does its manufacturing sector, even relative to the rest of the EU. Yet, its unemployment rate is only 0.5% above the cycle low and labour costs continue to rise at a pace inconsistent with sustained 2% inflation.

One factor is the bloc’s severe energy pricing disadvantage, with the European Commission estimating that industrial power prices in the EU are 158% higher than in the US, while industrial gas prices are 345% higher.

Australia macro and policy

Australia’s GDP growth remains positive but muted, not helped by the fact that it is one of the few places in the world where financial conditions (as measured by the Goldman Sachs Financial Condition Index) have increased over the past twelve months – and markedly so.

The labour market remains in decent shape, though growth in government jobs in areas like education and healthcare are a key factor.

The yield curve shows that confidence around rate cuts is waxing and waning – with expectations of cuts ticking down in the past week.

Further rate cuts overseas might assist. Some indicators are pointing to higher unemployment, which might also make the outlook for rate cuts more likely.

Housing finance approvals are rising in Australia, even though the RBA has not yet started to ease policy.

However, the strongest growth is in approvals for either owner-occupiers or investors to buy established dwellings. Finance approvals for the construction of new dwellings remain weak.

Markets

The outlook for FY25 ASX earnings remains muted, due largely to the resources and banking sectors. Industrials are expected to be provide some positive offset.

Meanwhile, investor sentiment is strong – with a benign outlook for inflation and growing confidence in a soft-landing. 

So the market seems quite happy to overlook near-term earnings and is prepared to pay high valuations for banks, if not for resources. 

We are into AGM season; most companies are simply affirming previous guidance.

Some notable improvers on AGM Day were AMP (better flows), Evolution Mining (a beat in production, Red Lake going better) and Bank of Queensland (low impairments).

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About Crispin Murray and Pendal Focus Australian Share Fund

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

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

Find out more about Pendal Focus Australian Share Fund  

Contact a Pendal key account manager

Here’s what the latest jobs data means for markets, according to Pendal’s 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

THE Australian job market continued showing strong resilience in September.

Jobs increased by 64,000, of which 51,000 were full time.

Labour supply also showed strong growth.

A record participation rate of 67.2% and strong population growth drove growth in labour supply, only slightly below jobs growth. As a result, unemployment was steady at 4.1% (though it fell from 4.14% to 4.07% before rounding).

This continues an impressive run for jobs, despite an economy growing at only 1%.

Job growth this year has been averaging almost 40,000 a month – above longer-term averages nearer 25,000.

As population growth moderates, the RBA will be hoping job growth moderates with it to stop labour markets getting tighter rather than looser.

Next week, we get the quarterly break down of jobs by sector.

If the trend of the past few years is to continue, the majority of growth will be in the Construction sector and the Health and Social Assistance sector. This is all driven by state and Federal Government spending, which is independent of interest rates.

Until the governments get their infrastructure and NDIS spending under control, something that will not happen near term, unemployment will stay reasonably low.

Attention will then turn to where full employment is.

As we covered off in our Australian Quarterly, the RBA believes it is nearer 4.5% unemployment. We think this too high. The US Federal Reserve revealed recently that it believes it is nearer 4% for the US economy.

Globally, we see the trend for lower inflation but strong employment being repeated across most developed markets.

The theme underlying this is relief on inflation as supply chains fully normalise, as well as strength in employment driven by big-spending governments.

Bond markets have moderated rate cut expectations this month.

What’s next?

After today’s employment numbers, a February rate cut of 0.25% has gone from 100% chance to only 75%. Anything lower than 50% gets our attention as a good risk-reward trade given our view of a likely cut.

Markets will range trade for now, but the next important data in Australia is Q3 CPI, which is due on 30 October.

This should be market-friendly (our forecast is headline 0.1% and underlying 0.7%) and see the RBA revise down its future inflation expectations in its early November Monetary Policy Statement.

This will leave the door wide open for a rate cut in February.

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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