Turning point for shares: what to watch

Waiting for a market inflection point? Pendal’s BRENTON SAUNDERS outlines a few issues to watch

GLOBAL markets are down in 2022 as the US Fed tightens monetary policy to tackle rising inflation, leaving investors searching for signs of an end to the bear market.

Events in the UK are important reminder of how interwoven financial markets are – and that crisis events can come from the most unlikely of places.

The full fallout from tightening monetary policy has not yet been seen in the global economy, says Brenton Saunders, a portfolio manager in Pendal’s Australian equities team.

“The one thing that’s outstanding from this cycle is that we haven’t had a major crisis,” says Saunders, who manages Pendal MidCap Fund.

“In history, every big down-cycle like this has been caused by, or caused, a financial market crisis of some sort.

“The GFC was full of these kinds of second- and third-derivative market failures.

“The issues in the UK pension market unearthed in late September was ironically in the very conservative asset class of long-dated gilts [UK government bonds], but it could have caused a very significant issue if there wasn’t an intervention.”

Last month’s panic in the UK was triggered by market reaction to a tax cut plan that sent yields on UK government gilts higher.

This had the unexpected effect of forcing pension funds — which are big holders of gilts — to sell other assets to cover their liabilities, ultimately forcing the Bank of England to step in.

Where’s the turning point

Saunders says investors looking for the inflection point in this year’s down trend should look out for a few signs to know if the cycle is finally turning positive.

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“One is the Chinese macro-economic outlook. It’s unclear, despite some attempts at stimulus, that they are addressing the right areas that need to reverse that market in any kind of meaningful way.

“Covodi policies continue to be a big drag on that.

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

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

Saunders says the RBA decision to slow the pace of rate increases was a surprise to markets but did not materially change the outlook for interest rates.

“We still think the Fed remains heavily committed to staying the course on its rate cycle and will continue to do what it needs to get inflation under control, which just means further rate rises and possibly more than the market’s expecting and then likely keeping interest rates high for longer than the market would like.”

“We continue to have this incredibly strong labour market and high savings rates which has so far limited the rate rises from manifesting in anything other than the housing market.

“We still expect that to put a bottom into this market we need to have an earnings downgrade cycle, especially in the discretionary retail and then possibly commodity cyclicals as well.

“From a portfolio perspective, we continue to think that there’s still some outstanding correction that needs to happen and we continue to retain a fairly defensive, conservative exposure.”