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Caution warranted after strong market rally

The market’s turnaround from last year’s pessimism is a short-term reaction to a “perfect storm” of positive events – and investors should take a cautious approach, says Pendal’s ALAN POLLEY

THE monetary policy outlook and the effect of higher rates on households and business earnings will dictate how markets trade over the rest of the year, after a strong start to 2023 that leaves more room for downside than upside, says Pendal’s Alan Polley.

Polley believes recent rising markets are the result of a “perfect storm” of positive news, with softening rhetoric from central banks, China’s reopening, mild weather in Europe and better-than-expected corporate earnings.

But he cautions that much of the 15 per cent-plus gains in equities so far this year can be explained by near-term events like investors closing out last year’s short positions — and there is less clarity about the medium-term prospects for shares.

“We’ve been fading some risk exposure here and there into the strong rally and the reason for that is we think the cumulative effect of higher interest rates is still out there on the horizon,” says Polley, a portfolio manager with Pendal’s multi-asset team.

“We’re still concerned. Markets have pretty much priced out a deep recession but while conditions are better than what you may have thought a few months ago, there is still the risk of recession. Yes, less than before — but it is still a material risk.

“We think the market went too far and has been too optimistic.”

Markets have staged a remarkable turnaround from last year’s pessimism.

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“Last year, we had a massive bear market — top to bottom was about a 25 per cent drawdown.

“So going into the end of last year, there were a lot of people short — if there’s all these fundamentally positive events in quick succession, they have to cover their shorts.

“That’s a big reason why equity markets have rallied — 15% is a big rally.”

But short-term gains mean markets no longer offer the value they did a few months ago, meaning the risk is tilting to the downside.

“This is a short term, exuberant rally. Yes, some fundamentals were better than expected which gave it some credence, but positive short-term sentiment has compounded the rally beyond a point that is consistent with the fundamental outlook.

“There is a significant accumulated increase in interest rates that will affect the real economy at some point in the near to medium term.”

Polley says the effect of accumulated rate rises could take a year or more to be fully reflected in the real economy.

“That’s why we think there’s more downside than upside.”

He says investors should pay close attention to corporate earnings, which is where the effect of higher rates on household spending and business activity will start to show up.

So far results are mixed in the current ASX half-year reporting season.

“There’s downside risk on earnings. If earnings are further adjusted down, then equities have more downside risk than upside so there’s not much rationale for material gains at this point, especially after we’ve had markets rally 15%.

“We don’t see reason to have a lot of risk. Our signals are suggesting being reasonably neutral.”

About Alan Polley and Pendal’s Multi-Asset capabilities

Alan is a portfolio manager with Pendal’s multi-asset team.

He has extensive investment management and consulting experience. Prior to joining Pendal in 2017, Alan was a senior manager at TCorp with responsibility for developing TCorp’s strategic and dynamic asset allocation processes covering $80 billion in assets.

Alan holds a Masters of Quantitative Finance, Bachelor of Business (Finance) and Bachelor of Science (Applied Physics) from the University of Technology, Sydney and is a CFA Charterholder.

Pendal’s diversified funds provide investors with a variety of traditional and alternative asset classes and strategies.

Find out more about Pendal’s multi asset funds:

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This information has been prepared by Pendal Fund Services Limited (PFSL) ABN 13 161 249 332, AFSL No 431426 and is current at February 23, 2023. PFSL is the responsible entity and issuer of units in the Pendal Multi-Asset Target Return Fund (Fund) ARSN: 623 987 968. A product disclosure statement (PDS) is available for the Fund and can be obtained by calling 1300 346 821 or visiting www.pendalgroup.com. The Target Market Determination (TMD) for the Fund is available at www.pendalgroup.com/ddo. You should obtain and consider the PDS and the TMD before deciding whether to acquire, continue to hold or dispose of units in the Fund. An investment in the Fund or any of the funds referred to in this web page is subject to investment risk, including possible delays in repayment of withdrawal proceeds and loss of income and principal invested. This information is for general purposes only, should not be considered as a comprehensive statement on any matter and should not be relied upon as such. It has been prepared without taking into account any recipient’s personal objectives, financial situation or needs. Because of this, recipients should, before acting on this information, consider its appropriateness having regard to their individual objectives, financial situation and needs. This information is not to be regarded as a securities recommendation. The information may contain material provided by third parties, is given in good faith and has been derived from sources believed to be accurate as at its issue date. While such material is published with necessary permission, and while all reasonable care has been taken to ensure that the information is complete and correct, to the maximum extent permitted by law neither PFSL nor any company in the Pendal group accepts any responsibility or liability for the accuracy or completeness of this information. Performance figures are calculated in accordance with the Financial Services Council (FSC) standards. Performance data (post-fee) assumes reinvestment of distributions and is calculated using exit prices, net of management costs. Performance data (pre-fee) is calculated by adding back management costs to the post-fee performance. Past performance is not a reliable indicator of future performance. Any projections are predictive only and should not be relied upon when making an investment decision or recommendation. Whilst we have used every effort to ensure that the assumptions on which the projections are based are reasonable, the projections may be based on incorrect assumptions or may not take into account known or unknown risks and uncertainties. The actual results may differ materially from these projections. For more information, please call Customer Relations on 1300 346 821 8am to 6pm (Sydney time) or visit our website www.pendalgroup.com

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