Quick, actionable insights for investors
What the latest sentiment data means; why global equities look good; how to think about China now; an impact investing opportunity
You’ve driven a car designed on a computer — but have you driven one designed by a computer?
The rising sophistication of simulation software means your next car — or at least parts of it — will have its performance simulated and tested by computer software, says Regnan’s Maxime Le Floch.
The technology is dramatically cutting the time to create and test new designs, improving manufacturing efficiency and cutting costs and resources.
“We need to speed up innovation across the global economy. This is called out by UN Sustainable Development Goals 9 and 12 which highlight resource efficiency and enhancing scientific research,” says Maxime, an analyst with Regnan’s Equity Impact Solutions team.
The software is also used in the renewable energy industry to design wind turbines.
Regnan’s Global Equity Impact Solutions fund has a position in US-listed simulation software leader Ansys, which aims to “help innovative companies deliver radically better products”.
It’s time to be fully invested in financial markets, not sitting on the sidelines, says Pendal’s head of global equities Ashley Pittard.
Earnings seasons in the US and Europe have been strong, and there are signs inflation is peaking, which would allow the US Fed to slow its interest rate cycle, says Ashley.
On a sales basis, about half the companies beat consensus forecasts. On an earnings basis that rises to nearly two-thirds.
There have been exceptions, says Ash. “But when you look at this market, it’s one that you want to be fully invested in.
“We are at the point where the Fed might pause for a bit, or only has a couple of rate rises to go and earnings are growing around 5 per cent.
“That’s a good position for equities because the price-to-earnings multiple on Wall Street has come back to more normal levels on a historical basis.”
Consumer and business sentiment are heading in different directions according to the latest data.
What’s going on?
Early last year consumer confidence boomed as we escaped from lockdowns with money in our pockets, says Pendal’s Tim Hext.
“Sentiment hit an all-time high in April 2021. Weighed down by rising prices and rate hikes we’ve since plunged almost to the March 2020 low.
“For business, however, it’s hardly looked better. An NAB survey sees business conditions at 20, not far off the April 2021 high of 30 (it averages around 5).”
So far rate hikes have been manageable for consumers, but the next 1% this year will start to bite — heavily for some, says Tim.
Meanwhile tight supply of goods and services means businesses are able to pass on higher costs, maintaining margins and seeing conditions as strong.
“Of course, consumers and business can only be out of step for so long — and 2023 will see a reckoning.”
Want to understand the outlook for China?
Look to Japan’s 1990s stagnation experience, says Samir Mehta, who manages Pendal Asian Share Fund.
As the rest of the world wrestles with supply constraints, runaway inflation and rising rates, China instead faces lacklustre growth, rising unemployment and the prospect of deflation.
“What we are seeing at the moment in China is reminiscent of what happened in the Japanese economy when their bubble burst in the 1990s,” says Samir.
“For the next three decades Japan’s economy was mostly hobbled. The companies that stood out had high pricing power, an industry structure with few irrational competitors and very strong cash flows.
“In my portfolio in China, I am gravitating towards these kinds of businesses – export-oriented champions or domestic champions with pricing power and cash flow.”
The big debate is whether the market’s rebound is a bear market rally or whether we’ve put in the lows for this cycle.
“At this point the rebound is almost bang on the average bear market rally (in terms of rebound and length) in the S&P 500 since 1950,” says our head of equities Crispin Murray.
“The market breadth of the rally is not yet consistent with a change in trend.
“The rule of thumb is you need to see 90% of stocks above the 50-day moving average to signal a change in market direction. We are at 73%, though this could continue to climb.”
“The challenge to this perspective is the unusual speed and scale of the increases and the market’s current confidence that inflation will be brought back down.”
The bull case for equity markets is:
Stocks have bounced off long-term technical support levels
Oil prices have peaked, with demand weakening
Bond yields have peaked, helped by lower commodity prices
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May 10, 2022See all
What the RBA’s ‘no set path’ line means; The three phases of ESG; Digitalisation trends in small business; Where bonds fit right now; Brazil as an Emerging Markets opportunity
Did the RBA this week signal fewer rate hikes ahead? Probably not, says Pendal’s head of government bond strategies Tim Hext.
“We know we’re going to hit neutral this year. Another 1% can be expected, moving the cash rate to 2.85%.
“Whether it’s four lots of 25bp or 50bp at fewer meetings is only of interest to short-end traders. Hence the RBA’s line that it is ‘not on a pre-set path’.
“Sounds like an opportunity for everyone to interpret this with their own confirmation bias — which on Tuesday seemed to be fewer hikes, not more.
“I think that’s reading too much into it.
“As asset owners we must remember the ‘central bank put’ is now also a ‘central bank call’.
“If bonds, equities and credit spreads rally too much without a significant easing in inflation pressures, the RBA will lean against the easing of conditions.
“The rally of the past month suggests this is in danger of happening — so expect more hawkish speeches from officials, especially in the US.”
The development of a decarbonised economy will take a long time.
But that doesn’t mean it’s not a critical factor right now, says Pendal portfolio manager Brenton Saunders.
The ESG transition can be divided into three periods, says Brenton:
“Once you understand that, it’s really about characterising companies in terms of where they sit in these transitions,” says Brenton, who manages Pendal MidCap Fund.
“Are they making their way across those phases to an environment where they can contend with the decarbonised, ESG world? Or are their business models fairly constrained to one of those thematics?
“We are very careful about how and if we invest in those latter sectors because this transition will take place over the course of the next 10 years. That’s definitely within the context of an investible timeframe.”
Small businesses are under pressure to shift their accounting systems online as a global regulatory push to e-invoicing and real-time tax gathers speed, says Pendal Aussie equities analyst Elise McKay.
E-invoicing — pushed by the ATO and other regulatory bodies globally — aims to reduce security issues and fraud and speed up payments.
Elise has just returned from digital accounting platform Xero’s annual conference in the UK, where the big topic was the push to digital tax.
From 2024 British businesses and landlords with £10,000 turnover will have to report digitally, impacting some 4.2 million taxpayers.
“Regulatory tailwinds are very supportive for cloud accounting adoption,” says Elise.
“I spoke to one UK accounting firm with more than 3000 clients who are going to have to adopt cloud accounting solutions.”
A re-assessment of fixed income securities and yields — and their defensive qualities — have recently made bonds attractive again, says Dale Pereira, who heads up client solutions at Pendal.
“Bond returns don’t predict the future — they reflect what’s happened,” says Dale.
“That’s where the opportunity lies: they may be showing negative returns now, but the future looks a lot brighter.”
Bonds typically lead equities in terms of market reaction, says Dale.
“From the end of 2021 and into the first half of 2022, bond yields moved in line with expectations of future rate rises — which in turn reflected inflation expectations.
“But markets often over-react when extrapolating good and bad news. And that’s probably the case now.
“The market has likely priced in too many rate rises. It’s priced in a good chance that central banks won’t be able to control inflation. (Though recently that pricing has started to dissipate, making yields less volatile.)
“This means the bond market is at a much better entry point for investors.”
Brazil’s powerful agriculture, energy and mining sectors have been among the world’s big economic winners from the supply squeeze in 2022.
But with an election due in October markets are starting to get nervous about a change of government.
Left-wing Luiz Inácio Lula da Silva is leading in the polls. When he was last elected in 2002, markets sold off sharply, fearing a big-spending, left-wing agenda.
“But he moved centre-left when actually took office,” says Paul, who co-manages Pendal Global Emerging Markets Opportunities fund.
That was largely because his presidency coincided with a commodity super-cycle that boosted export conditions for Brazil and allowed increased spending.
Ironically, a similar story may play out again in 2022. High prices for energy, agricultural commodities and iron ore are boosting Brazil’s export earnings and lifting tax revenue.
“It’s too early to say, but it may well be that if Lula is elected he could once again be very fortunate in the timing of the commodity cycle.”
What the latest CPI data means; Why we’re probably not facing long-term global inflation; What ESG investors should look for in banks; why investors should consider Mexico
It’s been a volatile year for bonds on the back of higher inflation and the unwinding of the Reserve Bank’s yield curve control policy. As a result, fixed income investors are…
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