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Has China turned a corner? | The case for stable inflation | Why volatility could continue | An emerging markets hotspot | How value investors can get AI exposure
US inflation numbers were higher than expected in August, prompting more headlines about a second wave of inflation and further interest rate rises.
Can investors really expect a 1970s inflation re-run?
“There’s a lot of commentary on a possible ’70s-style, second wave of inflation,” says Oliver Ge, a portfolio manager with Pendal’s income and fixed interest team.
“But I don’t believe we’re going down that path. We’re not even close to a rerun of the 70s.”
Higher US inflation in August is just one uptick after 13 consecutive months of disinflation – and inflammatory news headlines are unwarranted, Oliver argues.
“The difference is that back then, the US was highly oil-dependent, and it also was experiencing a massive devaluation of its currency. Put the two together and it triggered a big wave of inflation.
“The US is no longer energy-dependent – in fact it is an exporter of oil. Unionisation is no longer widespread. There’s none of the original catalysts that prompted the blowout.”
You’ve probably flown through Dubai – but have you thought about investing there?
“It’s one of our overweights that’s been doing well and which we think is perhaps flying below the radar,” says James Syme, a senior portfolio manager with our Emerging Markets team.
Since Covid, the UAE has staged a powerful comeback, says James.
“We’ve seen a big recovery in overnight visitor numbers. We’ve also seen a full recovery in oil production which took a big hit during Covid.
“But perhaps more importantly, we’ve seen a number of structural changes that are helping support the recovery.”
Among the reforms is the creation of a new visa category for non-nationals that allows residency for up to 10 years.
“That’s really helped support the movement of foreign nationals into the country.”
Here are the main factors driving the ASX this week according to Pendal investment analyst ANTHONY MORAN. Reported by portfolio specialist Chris Adams
THE dominant narrative of resilient global economic momentum and higher-for-longer rates continues.
US 10-year government bond yields rose 7bps last week, driven by higher oil prices, a slightly higher-than-expected inflation print and resilient economic and corporate data.
At the margins there was data suggesting China’s economy is turning a corner.
Commodities were strong overall and US dollar took a breather after its strong rally over the quarter-to-date.
The European Central Bank took a dovish turn after increasing rates last week. President Christine Lagarde indicated the tightening cycle was most likely done. The problem for Europe is they are heading into a recession.
The S&P 500 fell 0.12% and the S&P/ASX 300 gained 1.82% last week.
Monthly industrial output sped up and retail sales grew faster than expected. Is this a turning point in the economic cycle?
That remains to be seen, cautions Pendal’s head of income strategies Amy Xie Patrick, who has taken a close look at the latest signals.
“It’s been only a few months since hopes for a re-opening led boom in economic activity were dashed,” says Amy.
“We think activity is now stabilising on a cyclical basis, and China’s economy can continue to gradually recover into the end of the year.
“But structural drags on the economy are heavy and deep-rooted.”
Amy has just published an article covering the strength of the recovery, structural issues and implications for global growth and investing.
Most people would be aware from last week’s per-capita recession headlines that Australia’s population growth is outstripping economic growth.
But population growth – especially immigration and temporary visas – is also supporting corporate earnings, says Pendal’s head of equities Crispin Murray.
“All up, we’re probably looking at about a 3 per cent rise in the population today versus a year ago.
“People are coming to Australia with money in their pockets, setting themselves up and getting accommodation – which is driving up rents.
“Part of the reason we’re seeing resilience in the top line of companies is because they’re basically driven by nominal GDP, not per capita GDP.”
Population growth is also offsetting the effects of the ‘mortgage cliff’ which forces households into higher, variable mortgage payments as low-rate fixed loans expire, Crispin says.
“With each company we met over reporting season, we talked about the issues facing them and if they were seeing consequences from this mortgage cliff. So far, the consequences are very limited.”
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Population growth is supporting ASX earnings | Floating rate credit as an inflation hedge | Shopping malls a bright spot for A-REITs | Value in small caps
A surprising rebound for shopping malls was the standout feature of this year’s real estate investment trust reporting season, says Pendal’s Julia Forrest.
Rising interest rates and the expiration of interest hedges meant earnings declined for many Australian REITs, surprising investors in a sector where performance is typically well-flagged.
“But the positive surprise was in shopping malls where operating metrics improved,” says Julia who co-manages Pendal’s property trust portfolios.
“Occupancy is pushing towards completely occupied – that’s a long way from where we were two or three years ago.
“There’s genuine demand by tenants for more – and better – space and there’s been no supply for four or five years so you’re seeing competitive tension between tenants.”
A rising population and wages growth has sent retail sales 15 per cent above 2019 levels.
Business managers believe the economy remains on a decent footing and has even slightly picked up from July.
That’s the finding from NAB’s latest monthly business survey.
“The soft landing looks on track, at least for now,” says Pendal’s head of bond strategies, Tim Hext
“Businesses are not confident about the future, but still see conditions as favourable and even improving.”
But investors should separate the nominal economy from the real economy (adjusting for inflation), says Tim.
“Nominally, higher population growth has seen some expansion in the economy and increasing demand for goods and services.
“On the real side, inflation and higher rates has meant individuals are tightening their belts.
“Business knows this, and when the population growth falls back next year the nominal economy will also start feeling this.
“For now, though our models show rate hikes are still more likely than cuts, though the RBA looks happy to sit out the next few months.”
Stocks suited to a high-cost environment | Can commodities be sustainable | Why we’re in a per-capita recession | Assessing company management
For all the focus on macro-economics, the actions of management are a major factor in a company’s success.
There’s a reason why active investment managers spend so much time meeting with company execs.
Understanding a company’s leadership – and how well they are executing an appropriate strategy – is critical to successful long-term investing, says Samir Mehta, a senior Pendal PM who focuses on Asian equities.
When facing similar challenges, company managers often take different approaches – with very different results.
Samir points to Chinese restaurant chain Haidilao and camera lens maker Sunny Opticals. When both faced challenges, Haidilao successfully bunkered down and cut costs, while Sunny persisted in an expensive search for growth.
India’s Asian Paints leveraged an iconic brand, healthy cash flows and strong balance to fend off a potentially irrational new rival, while ASEAN-focused fintech SEA was drawn into a costly fight for market share.
Commodities perform an important role in portfolio diversification.
They tend to be highly correlated with inflation and have a return distribution with a positive skew, meaning returns on the upside can be bigger than returns on the downside.
But commodities – typically metals, energy or agriculture materials – are often excluded by sustainable investors as ESG-unfriendly.
Pendal multi-asset PM Alan Polley argues it needn’t be that way.
A nuanced approach that weighs up the benefits and drawbacks of individual commodities can offer advantages over a simplistic commodity index approach or just negative screening, he says.
“Many buy the broad commodity index which has the fossil fuels and livestock and isn’t consistent with ESG.
“Others think ‘commodities are mining, and mining is bad’.
“But you have to think beyond that because the transition to net zero is materials and resources intensive.”
Xero’s annual Xerocon event is known as ‘Coachella for accountants’ – a reference to a Californian rock concert with a cult-like following.
The ASX-listed cloud-accounting platform has a pretty strong following itself now, with more than 3.7 million subscribers in 180 countries.
That’s led to a pretty good understanding of the state of small-to-medium businesses (SMBs), says Pendal equities analyst Elise McKay.
Xero is seeing SMBs report slower sales growth in Australia, Canada, NZ, the UK and the US, though wage pressures are starting to ease in Australia, NZ and the UK, says Elise.
While SMBs are still unsure about the impact of AI, Xero is adding the technology to speed up repetitive tasks or provide better insights that help humans focus on high-value strategic activities.
“For example, helping to better enable reconciliations or provide better forecasting tools around things like cash flow. And potentially using generative AI to improve customer support.”
This week the ABS released our latest national accounts – quarterly estimates of economic flows such as GDP, consumption, investment, income and saving – for the June quarter.
What did we learn?
“First, the good news,” says Pendal head of bond strategies Tim Hext. “We are avoiding a recession.
“GDP is 2.1% higher than a year ago, though slowing. It’s been 0.4% for two quarters now and will likely end the year near 1.2% – slightly higher than the RBA forecast of 0.9%.”
The bad news?
“We’re clearly in a per-capita recession,” says Tim. That means economic growth is not keeping pace with population growth.
Which means the average person is going backwards in their standard of living.
“Our population grew by 0.7% in Q2, the economy only 0.4%. GDP per capita is now 0.3% lower than a year ago and 0.6% lower than six months ago.”
Why is this happening and what’s next?
History suggests that when the US dollar is falling and China is recovering, there is one place you want to be – emerging markets. But which countries? Which sectors? Probably…
Latest May 2023