The Point

What does Xi Jinping’s consolidation of power mean for investors?

Confirmation of Xi Jinping’s third term as China’s leader wasn’t surprising, but his apparent control is greater than most expected.

It appears Xi’s main aim is to turn the “successfully achieved moderately prosperous society” into a “modern socialist society”.

“This is seen as part of China’s ambitions to be an independent technology powerhouse and to project power and influence,” says Pendal’s Brenton Saunders.

“This may suggest the economy remains on a relatively austere pathway by historical standards. 

“The potential for China’s property market remains muted. Material stimulus is unlikely beyond the short term.”

That’s a headwind for economic growth and demand for steel-making materials, Brenton says. “Iron ore and coking coal stocks are most exposed to the trend long term.

“But China’s strategic pivot to technology, grid investment and electric vehicles should benefit base metal and lithium-producing companies in the long term.”

Turning point for shares: what to watch

Waiting for a market inflection point?

We asked Aussie equities portfolio manager Brenton Saunders which signs he’s watching.

“One is the Chinese macro-economic outlook,” says Brenton, who manages Pendal MidCap Fund. “It’s unclear, despite some attempts at stimulus, that they are addressing the right areas to reverse that market in any kind of meaningful way.

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

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

On rates, we may see more rises than the market’s expecting, “and likely higher for longer”.

“We still think we need an earnings downgrade cycle to put a bottom in this market – especially in discretionary retail and possibly commodity cyclicals.”

ASX earnings season: the big talking points

ASX-listed companies posted better-than-expected full-year earnings, though the averages hid a wide variation in individual results, says Pendal’s Brenton Saunders.

Revenue and dividend “beats” outpaced the misses by around 1.3x. But forward earnings guidance was negative on average.

Inflation, interest rates, labour availability and trade working capital increases were the big talking points in a reporting season that was complicated by a shifting global macroeconomic environment.

“Look for stocks that are either beneficiaries of the move higher in interest rates or those whose business are not overly geared to higher rates and have been heavily sold off year to date,” says Brenton, who manages Pendal MidCap Fund.

The mid-June rally benefitted oversold discretionary retail and long-duration, profitable tech companies, he says.

“It’s very much an alpha kind of environment, where staying across stock specifics is not only useful — it’s an absolute necessity.”

Why mid-caps look good right now

Aussie mid-caps are in the sweet spot for equity investors right now, argues Pendal portfolio manager Brenton Saunders.

Midcaps are stocks ranked from 50 to 150 in the S&P/ASX200.

Historically, the mid-cap universe outperforms small caps and large caps in absolute terms and on a risk adjusted basis, says Brenton, who manages Pendal MidCap Fund.

“Mid-caps provide managers with the ability to better hedge portfolios because they can more get equal representation across a broad range of different sectors.

“If one sector is doing poorly, you can offset it from other sectors. You can’t always do that in the large cap space, especially if large sectors like the banks and miners are both doing poorly.”

Mid-caps offer a better better balance of exposure across sectors, says Brenton. That helps manage risk while allowing investors to get focused exposure. And they’re more often M&A targets.

Conservative, pragmatic and style-agnostic: how to think about equities right now

“There really is no obvious default for investors in this kind of market,” says Brenton Saunders, who manages Pendal Midcap Fund.

“With macro factors lurching around so quickly, it pays to have a very balanced portfolio.

“Things that once took a year to play out are happening inside a quarter. If you have big macro tilts in your portfolio, you run a big risk of getting it wrong at some stage if you’re not nimble enough.

“We’ve seen an extension of the de-rating of high-multiple, high-growth sectors. We’re now seeing cyclical stocks like commodities getting impacted as well.”

A sensible positioning is to stay conservative, pragmatic and style-agnostic, says Brenton.

“It’s very much a stock-picker’s market. It is really now about understanding a company’s specifics and spending time with a company.

“Even subtle differences in terms of exposures in cost and revenue bases can create quite different outcomes in similar-looking companies.

“It is an environment where research and stock picking are making a difference.”

Markets are underestimating structural change in commodities

Russia’s invasion of Ukraine has caused structural change to commodity markets which will be with us for a generation, says Pendal’s Brenton Saunders.

The market is underestimating the depth and longevity of those changes says Brenton, who manages Pendal Midcap Fund.

The war will lead to long-term rises in commodity prices, and buyers are likely to turn to Australia for commodities they once bought from Russia.

“When you speak to the BHP marketing and logistics team who are managing these cargoes for customers all over the world, you can see the impact and implications are wide-ranging and immediate.

“You’ve got ships that won’t go to certain parts of the world anymore to transport commodities. Ships that can’t get insurance to go to certain parts of the world. Traders that can’t get collateral to deal with parts of the world they have been dealing with for decades.

“This is the biggest dislocation I’ve ever seen in commodity markets.

“The war will end — and we pray it does quickly — but the implications will be with us for a generation.”

Good times for stock-pickers as rate-hike cycle arrives

“For the first time in a while, it’s our sense that 2022 will be less about beta and more about alpha,” says Pendal’s Brenton Saunders.

Wholesale sell-off is creating opportunities for equity investors willing to take a stock-picking approach, says Brenton, who co-manages Pendal MidCap Fund.

“Previous rate hike cycles have been short and sharp — this one will be different.”

This has important implications for asset allocation and sector allocation within equities, he says.

“A lot of the stocks and sectors that were beneficiaries of the huge stimulus we’ve seen through Covid are now starting to battle the impact of higher bond yields and the prospect of higher interest rates down the line.

“We think asset performances will be quite moderate this year and stock selection will be more important than it has been in recent years.”