“The sun is shining, the weather is sweet, yeah|Bob Marley
Make you wanna move your dancing feet”
A LONG overdue spell of warm and sunny weather has lifted spirits here in Sydney.
For the first time in three years everyone is out and about and looking forward to celebrating Christmas. Party invitations are issued and fingers are crossed on the health front.
However, the tone in markets is more sombre.
Cumulative central bank tightenings are starting to hit hip pockets and liquidity is worsening.
In simple terms a decade of low rates — and the associated investment structures built up around them — are starting to unravel. It’s increasingly looking partly structural not just cyclical.
This is what central banks intend to happen.
For years one of our major themes was the chase for yield. Now it is the chase for inflation protection — though too many remain stuck in the mindset of the last decade.
The ultimate aim of the superannuation industry should be to protect the spending power of their members —who defer consumption today for their retirement.
If the economy is productive, hopefully that money can grow a little faster than inflation to increase the standard of living.
A decade of low inflation and falling interest rates made that look easy.
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In 2022 with super funds down on average 5% and inflation close to 8%, the spending power of members has gone backwards by 13%. Not so easy now.
We expect US inflation will fall soon and Australia will follow by mid-2023.
“Risk markets may take some encouragement from this, but inflation is likely to remain around 3-4%.
“Goods prices may fall — or even go negative — but inflation on services will remain stubbornly high.
The markets may look for rate cuts, but inflation could prevent that. At least rates will stop rising. “
In this environment investors need the defensiveness of bonds, which have now restored their insurance credentials after this year’s hits, says Hext.
“My recommendation would be to buy inflation-linked bonds.
Returns from inflation-linked bonds are adjusted for inflation, allowing investors to protect real returns.
They’re not popular in Australia, which is something of a mystery to Hext.
“The mainstream investment community seems to prefer standard, nominal bonds — as evidenced by the nominal-only benchmark proposed for bonds in the Your Future Your Super guidelines.
“In my view this is poor policy, overlooking the benefit that inflation-linked bonds provide for retirees or those near retirement.”
While we enjoy summer in Australia, the wintertime blues of an energy-constrained northern hemisphere will mean summertime blues for markets in Australia.
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.
Pendal is an independent, global investment management business focused on delivering superior investment returns for our clients through active management.
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