Crispin Murray: What's driving ASX stocks this week

Crispin Murray, Pendal

20 September 2021

Here are the main factors driving Australian equities this week according to our head of equities Crispin Murray. Reported by quantitative analyst Lee Ma

GLOBAL EQUITY markets remained soft last week. The S&P500 fell 0.5%, bringing month-to-date performance to -1.9%.

In Australia the S&P/ASX 300 was flat, though there was some meaningful sector divergence. Metals and Mining came off 4.4% while Energy was up 3.5%.

There were two key drivers of this performance:

1. Concerns about Chinese growth in the wake of a potential default of Chinese property giant Evergrande, which led to a slump in bulk commodities
2. Concerns that central bank policy tightening may come through sooner than expected due to building inflation pressures

Covid and vaccines

Domestic news has been generally positive.

NSW Covid cases peaked at a lower level than feared and vaccine penetration has continued to grow solidly.

Take-up rate for the first dose has risen to 82.2% — up 3.7% compared to last week. This rate has been holding up well. That's important since a higher rate will help relieve potential strain on hospital systems in future outbreaks and reduce the likelihood of future lockdowns.

The seven-day moving average for second-dose vaccinations is close to 61,000 this week — up from about 50,000 last week.

If this trend continues we might get to 80% full vaccinated — and further relief from lockdowns — before October 18.

Globally case numbers continue to improve, albeit marginally in the UK and the US. 

Return-to-school impact can be seen in the higher ratio of kids in case numbers. Though this is tending to sustain case numbers rather than increase them.

Hospitalisation numbers have been slowly improving in both counties. This is leading to some evidence of improved sentiment in the US.

Economics and policy

Tension has been building for weeks around Evergrande, China's (and the world's) most indebted property developer.

Evergrande's bond interest payments are due on September 23. The question is whether the market will see a bankruptcy or some form of debt restructure.

More importantly, people are contemplating whether this will have a cascading effect on China's other property developers and the economy more broadly.

Weakened sentiment contributed to the precipitous drop in iron ore over the week.

We see great uncertainties around how this will eventually play out. There is a good chance a default is possible with the Chinese government choosing to send a strong message on property speculation.

But we think the outcome will be something the government can manage, since Evergrande is not a state-owned enterprise and is not as systemically important.

That said, we will reach a crescendo of concern over the next couple of weeks.

Outside China, the focus has been on renewed concerns that inflation is set to be persist for longer, leading to faster tapering and potentially an earlier move in rates.

Inflation fears in the US have come mainly from a combination of labour shortages and unemployment insurance (UI) payments coming to an end. The next few weeks will be an important test of the durability of labour tightness.

Recent pricing power surveys clearly indicate that US companies are pushing through pricing increases in a number of sectors. This reflects input price pressures, constrained availability of product and higher labour costs.

Also, gas prices continue to remain far higher than we have seen for years in the US and Europe.

Inventories are low heading into winter. There is a 70% probability of a La Nina weather event, which may lead to a colder winter. There are concerns elevated gas prices will persist, which has already led to higher electricity prices in the US and UK.

All eyes are on the Fed's September meeting this week.

The market will closely watch how they signal the pacing of tapering and their quarterly update on the dot plots. The dots are expected to have shifted forward again towards the median rate rise around the turn of 2023. The other focus will be on the number of rate rises through to the end of 2024.

Similarly, there was media attention on unpublished forecasts by the ECB, which could see inflation rising 2% by 2025. This may lead to rates rising in 2023.

All this has added to the market's wariness on the inflation impact on central bank policies.

Markets

The market saw a continued drop in iron ore price. The seaborne benchmark fell 22% last week and is now down 37% for the calendar year-to-date. In contrast the oil price was up by 3% and 45% in the same periods.

The main reason for this disconnect was iron ore's reliance on Chinse demand, compared to oil's link to global demand.

The fall in iron ore has been driven by a number of factors.

It had an over-extended starting point, driven by surging steel production in China in 1H21.

The production surge was then met by a dramatic slowdown starting from 2H21: steel production was down 18% in July and a further 10% in August.

The Chinese government has an aggressive rhetoric around holding down steel production through 2H21 for environmental reasons and trying to keep production growth flat for the full year.

These restrictions are expected to continue limiting steel production through to the end of the winter Olympics in late February next year.

At the same time the Chinese government has introduced policies to maintain controls of the property sector, which is a key driver of steel demand.

Fears for the overall sector have been exacerbated by the Evergrande situation.

Also weighing on demand, the Chinese economy has been generally softer recently due to rolling COVID lockdowns. More stimulatory policies on local government bond issuance that funds infrastructure spend are unlikely to kick in until 2022.

Lastly, the deteriorating relationship between China and Australia may have led to other measures impacting on the commodity price.

Where to from here? The debate is not so much whether iron ore bounces much, but rather whether it can hold in the US$100s or if it continues to move towards a longer term price of US$70.

The Evergrande final resolution may mark a sentiment low in China and its property sector.

Consequently, some measures to support the economy may be introduced such as the RRR cut.

We should still expect relatively subdued demand from China, but the real-time indicators on the economy look to be near their lows.

Global demand for steel remains strong, as evident from the very high global steel spreads, suggesting there are still cyclical tail winds.

Supply disruption also continues to emerge, with Vale announcing this week its iron ore production next year will be lower than expected.

Overall, this week could be the crescendo in negative sentiment before investors start to rebuilding confidence slowly.

Against this backdrop, equity markets overall are re-testing support levels.

There could be support in early evidence that the US economy is experiencing a re-acceleration as Covid cases start to stabilise and fall. And liquidity from Central Banks remains abundant.

Lastly, we note the rotation of value to growth has been mirrored by fund flows. Inflows to tech and outflows from cyclicals look to be at extremes.

As such, we continue to see cyclicals holding better from here.

Funds operated by this manager:

This article has been prepared by Pendal Fund Services Limited (PFSL) ABN 13 161 249 332, AFSL No 431426 and the information contained within is current as at August 11, 2021. It is not to be published, or otherwise made available to any person other than the party to whom it is provided. This article is for general information purposes only, should not be considered as a comprehensive statement on any matter and should not be relied upon as such. It has been prepared without taking into account any recipient's personal objectives, financial situation or needs. Because of this, recipients should, before acting on this information, consider its appropriateness having regard to their individual objectives, financial situation and needs. This information is not to be regarded as a securities recommendation.

The information in this article may contain material provided by third parties, is given in good faith and has been derived from sources believed to be accurate as at its issue date. While such material is published with necessary permission, and while all reasonable care has been taken to ensure that the information in this article is complete and correct, to the maximum extent permitted by law neither PFSL nor any company in the Pendal group accepts any responsibility or liability for the accuracy or completeness of this information.

Performance figures are calculated in accordance with the Financial Services Council (FSC) standards. Performance data (post-fee) assumes reinvestment of distributions and is calculated using exit prices, net of management costs. Performance data (pre-fee) is calculated by adding back management costs to the post-fee performance. Past performance is not a reliable indicator of future performance.

Any projections contained in this article are predictive and should not be relied upon when making an investment decision or recommendation. While we have used every effort to ensure that the assumptions on which the projections are based are reasonable, the projections may be based on incorrect assumptions or may not take into account known or unknown risks and uncertainties. The actual results may differ materially from these projections.

Jamieson Coote Bonds - August 2021 Market and Performance Review 

Channel Capital

August 2021

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Opportunities and risks for investors in the latest UN climate change report

Edwina Matthew, Pendal

11 August 2021

The latest UN climate change report offers important clues for investors seeking to understand portfolio risks and investment opportunities. Pendal's Edwina Matthew explains

Key points

• The latest IPCC report increases risk of climate activism or litigation against companies. A number of climate cases have referenced earlier versions of the report. Watch also for litigation against governments which could affect regulatory approvals

• There is heightened focus on methane. The EU wants curbs and the US is planning tighter emission rules. This could bring risks and opportunities.

• Carbon removal is a vital -- and potentially investable -- net zero tool from afforestation to wetland restoration to carbon capture and storage and ocean fertilisation.

THE UN's latest Climate Change report made headlines this week with predictions of irreversible global warming, rising sea levels and climate change affecting every corner of the planet.

But it also provides evidence-based information to help investors better understand portfolio risks and identify investment opportunities such as carbon capture and methane-reduction technologies.

The 3900-page report from the UN's Intergovernmental Panel on Climate Change (IPCC) -- the United Nations body for assessing the science related to climate change -- is the gold standard for research on the science of climate change and options for adaption and mitigation.

Government and corporate decision-makers worldwide rely on the IPCC's findings to inform their climate risk assessments and emissions reduction strategies

The report -- which was unanimously endorsed by the governments of all 195 country members including Australia -- is based on a three-year analysis of 14,000 peer-reviewed scientific studies.

It will be the central terms of reference later this year at COP26 -- the upcoming United Nations climate conference in Glasgow.

The report shows unequivocally that human activities are responsible for the warming world. This warming is increasing the frequency and severity of extreme weather events such as heatwaves, droughts, cyclones and heavy rain.

Global temperature rises of between 1.5 and 2 degrees Celsius are expected unless deep reductions in greenhouse gas emissions occur in the next few decades. Regardless of action, changes already occurring due to past emissions are now likely to be irreversible for thousands of years.

Low likelihood, high-impact events such as ice sheet collapses, ocean current changes or Amazon dieback cannot be ruled out.

"It's a sobering read," says Edwina Matthew, Head of Responsible Investments at Pendal.

"And remember that these are averages - different regions, different countries, even different states will be impacted to a greater or lesser degree than this average.

"For example, the report finds that average global warming is 1.09 degrees Celsius above pre-industrial temperatures. Australian land areas are already 1.4 degrees Celsius above pre-industrial averages.

"This is going to increase the probability of extreme weather events, heatwaves, sea surges and drought."

Risks and opportunities for investors

What should investors take out of the IPCC report? What does it mean for portfolio construction?  And how can investors ensure they understand the risks and opportunities posed by global warming?

Matthew identifies three headline risks and opportunities for investors to consider:

1. The IPCC report increases the risk of climate activism or litigation against companies and governments

The most high-profile litigation so far has been a Dutch court ruling that the multinational oil giant Royal Dutch Shell must reduce its emissions because its contribution to global warming violates human rights.

Previous IPCC reports were referenced in the court case and this latest one will likely be used in the appeal hearing.

A number of Australian cases have also referenced IPCC findings.

Sharma v Minister for the Environment [2021] found the federal environment minister owed a duty of care to children who might suffer potential "catastrophic harm" from the climate change implications of approving a NSW coal mine extension.

Investors also need to watch for governments being the target of litigation which could affect regulatory approvals and business permissions in their investments.

2. The report's heightened focus on methane is of interest for investors

A "strong, rapid and sustained' reduction in methane emissions is required to help reduce greenhouse gas emissions and hopefully avoid the catastrophic impacts of climate change, the report finds.

Methane is not only a vastly more potent greenhouse gas than carbon dioxide, but its concentration in the atmosphere has been increasing rapidly.

Importantly, it is short-lived in the atmosphere meaning controls on methane can rapidly reduce atmospheric concentrations.

Governments are already acting on methane. The EU is proposing curbs on methane emissions while the US is planning tighter emission rules.

But it's a tricky problem to solve. Some gas production emits methane. Raising livestock for meat and nitrogen-based fertilisers are major sources. Rotting waste in landfill also emits methane.

"All of these are important challenges that investors can play a part in," says Matthew.

"Investors can engage with companies to better understand how they're thinking about these issues, what they're doing to mitigate the risks and how they're transitioning to thrive in a low-carbon economy.

"Investors can also direct funds to solutions. For example, CSIRO is working with the private sector to commercialise a livestock feed additive made from seaweed, which has been shown to reduce methane emissions in cattle by up to 80 per cent."

3. Carbon removal solutions can also play a role in investor portfolios

"Carbon removal is a vital net zero tool which has a place alongside absolute emissions reductions," says Matthew. "It covers a range of investable methods, from afforestation to wetland restoration to carbon capture and storage (CCS) and ocean fertilisation."

However carbon removal technologies such as CCS need more development to work at the scale required. We need more co-ordinated efforts to advance these sorts of emissions reduction solutions in sectors with harder-to-abate industrial processes such as cement and steel production.  

Future climate scenarios are becoming clearer

We now know more than ever how possible climate futures could play out.

The report is very clear that without "immediate, rapid and large-scale reductions" in emissions, curbing global warming to below 2 degrees Celsius -- the Paris Agreement goal -- will be "beyond reach".

These findings call on us all to accept and act on the reality of the situation, including policymakers, investors, businesses and consumers.

In the words of the UN Secretary-General Antonio Guterres the report is a "code red for humanity".

Funds operated by this manager:

This article has been prepared by Pendal Fund Services Limited (PFSL) ABN 13 161 249 332, AFSL No 431426 and the information contained within is current as at August 11, 2021. It is not to be published, or otherwise made available to any person other than the party to whom it is provided. This article is for general information purposes only, should not be considered as a comprehensive statement on any matter and should not be relied upon as such. It has been prepared without taking into account any recipient's personal objectives, financial situation or needs. Because of this, recipients should, before acting on this information, consider its appropriateness having regard to their individual objectives, financial situation and needs. This information is not to be regarded as a securities recommendation.

The information in this article may contain material provided by third parties, is given in good faith and has been derived from sources believed to be accurate as at its issue date. While such material is published with necessary permission, and while all reasonable care has been taken to ensure that the information in this article is complete and correct, to the maximum extent permitted by law neither PFSL nor any company in the Pendal group accepts any responsibility or liability for the accuracy or completeness of this information.

Performance figures are calculated in accordance with the Financial Services Council (FSC) standards. Performance data (post-fee) assumes reinvestment of distributions and is calculated using exit prices, net of management costs. Performance data (pre-fee) is calculated by adding back management costs to the post-fee performance. Past performance is not a reliable indicator of future performance.

Any projections contained in this article are predictive and should not be relied upon when making an investment decision or recommendation. While we have used every effort to ensure that the assumptions on which the projections are based are reasonable, the projections may be based on incorrect assumptions or may not take into account known or unknown risks and uncertainties. The actual results may differ materially from these projections.

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