The Point

How long will the ASX keep going? Here are the factors to watch

It’s been a strong start to the year for the ASX. What will determine how long it keeps going?

Three things are driving a rapid turnaround from last year, says Brenton Saunders, who leads Pendal MidCap Fund:

• The faster-than-expected re-opening of China
• Signs that inflation is reaching a peak
• Increasing evidence that a hard-landing global recession can be avoided

But there are still clouds over the global economy including the prospect of a downturn later this year and the uncertainty of the Russia-Ukraine conflict.

“This year is probably going to be quite choppy, because we have improving longer-term expectations but still with the prospect of some potentially severe short-term implications.

“We still think there’s a fairly high level of binary risk out there that is yet to be quantified.

“Earnings is still the area that we’re most worried about — ratings are starting to improve but there’s still material risk around earnings.”

Brenton Saunders: What you should really be watching as markets rally

The market’s up since the start of October. How should investors interpret this?

Rallies are a sign the market is looking for a slowdown in rate rises. But investors are better off relying on hard economic data than trying to pick a pivot point, says Pendal’s Brenton Saunders.

With labour markets still strong and inflation rising, it is likely too early to suggest central banks are changing their approach, says Brenton, who manages Pendal MidCap Fund.

“Many of the drivers of inflation continue to run hot — and more importantly headline and core inflation remain stronger than expected.

“The Fed has been incredibly clear in terms of their objectives of getting inflation under control.

“We have no reason to doubt them. It just feels like the market is trying to trough a little early.”

Keep an eye on jobs data and earnings downgrades, especially retail, housing and even resources, says Brenton.

It’s time to change how you think about investing in China

The cementing of Xi Jinping’s power in China “completely changed” the environment for investors, says our Asian Share Fund manager Samir Mehta.

“President Xi today exercises complete control over society in a modern state with technology and surveillance unparalleled in history.”

This has important implications for government policy, the economic outlook — and therefore investors, says Samir.

“Economic outcomes like employment and growth will become secondary to satisfy Xi’s idealism of zero Covid.”

The hard-line ideological approach introduces investment risks that most investors have no experience with, he says.

“In the long run, when it comes to investing in China, I’m going to be a lot more cautious.”

What does Xi Jinping’s consolidation of power mean for investors?

Confirmation of Xi Jinping’s third term as China’s leader wasn’t surprising, but his apparent control is greater than most expected.

It appears Xi’s main aim is to turn the “successfully achieved moderately prosperous society” into a “modern socialist society”.

“This is seen as part of China’s ambitions to be an independent technology powerhouse and to project power and influence,” says Pendal’s Brenton Saunders.

“This may suggest the economy remains on a relatively austere pathway by historical standards. 

“The potential for China’s property market remains muted. Material stimulus is unlikely beyond the short term.”

That’s a headwind for economic growth and demand for steel-making materials, Brenton says. “Iron ore and coking coal stocks are most exposed to the trend long term.

“But China’s strategic pivot to technology, grid investment and electric vehicles should benefit base metal and lithium-producing companies in the long term.”

Turning point for shares: what to watch

Waiting for a market inflection point?

We asked Aussie equities portfolio manager Brenton Saunders which signs he’s watching.

“One is the Chinese macro-economic outlook,” says Brenton, who manages Pendal MidCap Fund. “It’s unclear, despite some attempts at stimulus, that they are addressing the right areas to reverse that market in any kind of meaningful way.

“Energy policy has also changed gears. We’ve had rumoured sabotage of Russia’s gas pipelines to Europe. That almost assures Europe will have a tougher winter.

“The OPEC agreement to cut supply is the last thing the US Fed wanted and will come as a headwind to getting inflation under control.”

On rates, we may see more rises than the market’s expecting, “and likely higher for longer”.

“We still think we need an earnings downgrade cycle to put a bottom in this market – especially in discretionary retail and possibly commodity cyclicals.”

ASX earnings season: the big talking points

ASX-listed companies posted better-than-expected full-year earnings, though the averages hid a wide variation in individual results, says Pendal’s Brenton Saunders.

Revenue and dividend “beats” outpaced the misses by around 1.3x. But forward earnings guidance was negative on average.

Inflation, interest rates, labour availability and trade working capital increases were the big talking points in a reporting season that was complicated by a shifting global macroeconomic environment.

“Look for stocks that are either beneficiaries of the move higher in interest rates or those whose business are not overly geared to higher rates and have been heavily sold off year to date,” says Brenton, who manages Pendal MidCap Fund.

The mid-June rally benefitted oversold discretionary retail and long-duration, profitable tech companies, he says.

“It’s very much an alpha kind of environment, where staying across stock specifics is not only useful — it’s an absolute necessity.”

Why mid-caps look good right now

Aussie mid-caps are in the sweet spot for equity investors right now, argues Pendal portfolio manager Brenton Saunders.

Midcaps are stocks ranked from 50 to 150 in the S&P/ASX200.

Historically, the mid-cap universe outperforms small caps and large caps in absolute terms and on a risk adjusted basis, says Brenton, who manages Pendal MidCap Fund.

“Mid-caps provide managers with the ability to better hedge portfolios because they can more get equal representation across a broad range of different sectors.

“If one sector is doing poorly, you can offset it from other sectors. You can’t always do that in the large cap space, especially if large sectors like the banks and miners are both doing poorly.”

Mid-caps offer a better better balance of exposure across sectors, says Brenton. That helps manage risk while allowing investors to get focused exposure. And they’re more often M&A targets.