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Higher US interest rates test the world Magellan Asset Management August 2022 |
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New York's Plaza Hotel, in financial circles, is best known for when the finance ministers of France, Japan, the UK, the US and West Germany gathered in 1985 to suspend the free-float of the US dollar. The problem the ministers sought to solve was the US dollar had soared 44% since 1980 because US interest rates had jumped over that time. The world was worried that the subsequent widening of the US trade deficit could prompt Washington to restrict imports. Under the Plaza Accord, the G-5 agreed to lower the US dollar over the following two years. The intervention, which drove down the US currency by 40%, is still the biggest manipulation of the US currency since it was floated in 1973.[1] Another Plaza Accord might be needed in coming times.[2] Once again, rising US interest rates are boosting the US dollar to heights that trouble the world. Against the 'real broad dollar index', the US currency has surged 10% over the past year to its highest since this index was compiled in 2006.[3] The US dollar is likely to stay strong because the Federal Reserve needs to smother inflation that reached a 41-year high of 9.1% in the 12 months to June. The Fed raised its benchmark rate from about 0% in March to between 2.25% and 2.5% in July and more rate increases are almost certain. Higher interest rates in the world's largest economy always present challenges for the world. Today's trials wrought by higher US rates, however, could be more troubling than usual because the pandemic and Russia's invasion of Ukraine are magnifying the standard threats posed by higher US interest rates while minimising the usual benefits. Three difficulties stand out, starting with the higher greenback. A stronger US dollar comes with advantages and disadvantages. Among pluses, a rising US currency eases US inflationary pressures via cheaper imports. The flip side, however, is the rest of the world confronts an inflationary shock in three ways. First, US exports cost more in other currencies. Second, trade priced in US dollars between non-US parties becomes more expensive in other currencies. An IMF paper in 2020 estimated about 40% of global invoices are priced in US currency and that countries doing so "tend to experience greater US dollar exchange pass through to their import prices".[4] The third inflation threat is that today's strong US dollar is unusually coinciding with higher oil prices due to the Ukraine war, which magnifies the increase in oil prices in other currencies. In the past, high oil prices have usually coincided with a feeble US dollar.[5] To counterattack the inflationary threat of a high US dollar, central banks from Canada to Singapore to Saudi Arabia to Switzerland are unexpectedly boosting key rates in bigger steps[6] to support their currencies in what has been dubbed a 'reverse currency war'. The term 'currency war' was coined in 2010 to describe how central banks were lowering currencies to help exports. The futility is that all countries can't push their currencies in the same direction at the same time.[7] The eurozone is especially vulnerable to US-dollar-imported inflation, even allowing for an export boost to the US. The euro in July fell to a 20-year low (below parity) against the US dollar, to mark a 14% drop since January 1. Higher import prices, pandemic disruptions to supply and higher food, energy and commodity prices stemming from the Ukraine war propelled eurozone inflation to a record 8.6% in the year to June. In response, the European Central Bank in July raised its key rate by 50 basis points to 0%, to end eight years of negative rates. While the ECB's delay in raising rates has undermined the euro, the lag and tumbling currency are more because the eurozone's economic fundamentals are so weak.[8] The ECB is worried that inflation will drive yields on the sovereign debt of indebted euro members to levels that trigger another financial crisis and possible exits from the common currency. A second challenge of higher US rates is they hamper the US economy. US GDP, which is about 70% consumer spending, contracted over the first six months of 2022.[9] The immediate outlook seems problematic because the fiscal stimulus tied to the pandemic and supply disruptions have boosted inflation to levels that trouble consumers. US consumer confidence in June fell to a record low as surveyed by the University of Michigan, which has tracked US consumer sentiment since 1952.[10] A weak US economy means the high US dollar is not offering its usual boost to world exports - as it did in the first half of the 1980s. The third challenge of higher US interest rates is they bludgeon emerging countries, especially those that have borrowed in US currency or have currencies linked to the greenback. As at May 31, the IMF said eight poorer nations were in "debt distress" and another 30 countries were at "high risk".[11] Since then, Bangladesh, Ghana,[12] Pakistan and defaulting Sri Lanka have asked the IMF for aid. Many are concerned another 1997-style Asia crisis is festering in South Asia.[13] Indebted economies have been weakened by the pandemic and face a cost-of-living crisis resulting from the Ukraine war. The fact that emerging countries are overwhelmingly borrowing in local currencies is failing to insulate them from higher US interest rates and a stronger US dollar. A Bank of International Settlements paper in July warns how the currency risk has only shifted to creditors who invest on a US-dollar basis.[14] Thus, capital is still fleeing emerging countries. The Institute of International Finance estimates international investors yanked US$38 billion from emerging markets in the five months to July. Outflows each month from February to July mark the longest periods of consecutive monthly net outflows since records began in 2005.[15] Emerging-country currencies tumbled accordingly - many by more than 20%. The linked inflation threat has forced central banks to raise rates to support currencies at a time when the IMF is warning that the pandemic and Ukraine war have widened current-account balances enough to trigger populist protectionist measures.[16] Concerns are rising that economic turmoil could lead to political instability. "Food and fuel inflation threatens to rip poor societies apart," warns Murtaza Syed, acting governor of the Central Bank of Pakistan.[17] Central banks are far from winning their battles against inflation.[18] The accelerated loop triggered by a pandemic-and-war-distorted world whereby higher US rates force other countries to raise rates could run for a while yet. The best hope for the world is that something - ideally, a decline in US inflation, but even a US recession - dampens US interest rates and averts financial upheavals in the eurozone and emerging countries. To be sure, US interest rates are still historically low and the US dollar is well below its 1985 peak. But that matters less when government, corporate and personal debt are so high. US inflation might have already peaked - US inflation eased to 8.5% in the year to July - and the Fed might slow rate increases. But the crest of inflation could matter less than the stubbornness of inflation. If US inflation only slows gradually, US interest rates will stay elevated. The pity is that in a world of floating exchange rates central banks outside the US, for all their domestic political independence, are tied to a Fed that misjudged inflation.[19] There's no solution, let alone an international accord, shaping to alleviate the dangers. The unsolvable handicap Economists Barry Eichengreen of the US, Ricardo Hausmann of Venezuela and Ugo Panizza of Italy chose 'The pain of original sin' as the title of their 2003 study of emerging countries. They presumably judged this Christian concept best describes an insurmountable inherent flaw.[20] The study was a landmark because it was the first to focus on the importance of the currency denomination of foreign debt for emerging countries. The trio found the health of emerging economies depended much more on the currency breakdown of foreign debt than other aspects of macroeconomic stability such as the soundness of monetary and fiscal policies and human and physical capital accumulation. They found the foreign-currency makeup of foreign debt governed "the stability of output, the volatility of capital flows, the management of exchange rates and the level of country credit ratings".[21] The trouble is emerging countries need to borrow to develop. But they are generally unable to borrow in their local currency, the inherent weakness they can't overcome.[22] The trio's paper was written when only 2.7% of emerging debt was sold in local currency.[23] It's widely acknowledged that emerging countries that borrow in foreign currency are vulnerable if their currencies plunge. To reduce this weakness, bodies such as the IMF and the World Bank have long encouraged emerging countries to borrow in local currency. And they have. Over the past decade, more than 80% of the increase in emerging-country debt was in local currency - the ratio topped 95% from the end of 2019 to 30 September 2021.[24] This is why the BIS paper on the failure of local borrowings to insulate emerging countries from currency risk is so sobering. The BIS finding means the tendency of troubles in one emerging market to infect others is as primed to detonate as always. Average gross government debt in emerging markets stood at an estimated 64% of GDP at the end of 2021, according to the IMF. The pandemic drove a 10-percentage-point jump in that ratio.[25] Companies in emerging countries are estimated to have borrowed about 14% of global GDP.[26] Emerging countries are the hardest hit by the blows to living standards from the Ukraine war. They are vulnerable to a Fed boosting US interest rates and a rising US dollar. Calls for a new Plaza Accord are bound to intensify. Nominal broad US dollar index since 2006 Author: Michael Collins, Investment Specialist |
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Funds operated by this manager: Magellan Global Fund (Hedged), Magellan Global Fund (Open Class Units) ASX:MGOC, Magellan High Conviction Fund, Magellan Infrastructure Fund, Magellan Infrastructure Fund (Unhedged), MFG Core Infrastructure Fund [1] Jeffrey Frankel. National Bureau of Economic Research. 'The Plaza Accord, 30 years later.' NBER working paper series. Working paper 21813. December 2015. nber.org/system/files/working_papers/w21813/w21813.pdf [2] See 'Surging dollar stirs markets buzz of a 1980s-style Plaza Accord.' 18 May 2022. bloomberg.com/news/articles/2022-05-18/surging-dollar-stirs-markets-buzz-of-a-1980s-style-plaza-accord [3] Federal Reserve. Foreign exchange rates - H.10. 'Real broad dollar index - monthly index.' federalreserve.gov/releases/h10/summary/jrxwtfbc_nm.htm. Currencies such as India's rupee are at record lows against the greenback while others such as the euro are close to record lows. [4] IMF. 'Patterns in invoicing currency in global trade.' Emine Boz et al. IMF working paper WP/20/126. July 2020. Page 2 and 13. imf.org/en/Publications/WP/Issues/2020/07/17/Patterns-in-Invoicing-Currency-in-Global-Trade-49574 [5] See Javier Blas. 'In the oil market, the strong dollar is the world's problem.' Bloomberg News. 8 June 2022. bloomberg.com/opinion/articles/2022-06-08/record-oil-prices-in-europe-asia-strong-dollar-is-becoming-the-world-s-problem [6] See 'Central banks embrace big rises to bolster currencies and fight inflation.' Financial Times. 17 July 2022. [7] See Jeffrey Frankel. 'Get ready for reverse currency wars.' Project Syndicate. 25 May 2022. project-syndicate.org/commentary/strong-dollar-high-inflation-reverse-currency-wars-by-jeffrey-frankel-2022-05 [8] See Paul Krugman. 'Wonking out: The meaning of the plunging euro.' 15 July 2022. Krugman here explains how the eurozone's weak fundamentals correspond to the analysis of exchanges rates in German economist Rudiger Dornbush's classic paper of 1976, 'Expectations and exchange rate dynamics'. nytimes.com/2022/07/15/opinion/euro-dollar-fed-ecb.html [9] The US economy shrank at an annualised rate of 1.6% in the first quarter and 0.9% in the second. [10] University of Michigan. 'Surveys of consumers.' June final results. 24 June 2022. The index fell to a record low of 50.0 in June 2022 compared with 85.5 a year earlier. In July, the index rose to 51.1, a result described as "relatively unchanged, remaining near all-time lows". data.sca.isr.umich.edu/ [11] IMF. 'List of LIC DSAs for PRGT-eligible countries.' 31 May 2022. LIC stands for low-income countries. DSA stands for debt sustainable analysis. PRGT stands for poverty reduction and growth trust. imf.org/external/Pubs/ft/dsa/DSAlist.pdf [12] See 'How Ghana makes a success out of failure.' The Economist. 5 August 2022. economist.com/middle-east-and-africa/2022/08/05/how-ghana-makes-a-success-out-of-failure [13] See 'South Asia debt woes evoke fears of another 1997-style crisis.' 4 August 2022. bloomberg.com/news/articles/2022-08-03/india-sri-lanka-pakistan-debt-woes-evoke-memories-of-1997 [14] "Exchange-rate fluctuations induce shifts in portfolio holdings of global investors, even in the absence of currency mismatches on the part of the borrowers," the paper says. Boris Hofmann et al. 'Risk capacity, portfolio choice and exchange rates.' BIS working papers. No. 1031. Bank of International Settlements. 15 July 2022. bis.org/publ/work1031.htm [15] Financial Times. 'Emerging markets hit by record streak of withdrawals by foreign investors.' 31 July 2022. ft.com/content/35969b19-86db-4197-a419-b4a761094e9a [16] IMFBlog. 'Global current account balances widen amid war and pandemic.' 4 August 2022. blogs.imf.org/2022/08/04/global-current-account-balances-widen-amid-war-and-pandemic/ [17] Murtaza Syed, acting governor of the Central Bank of Pakistan. 'Now is not the time to neglect developing economies.' 3 August 2022. https://www.ft.com/content/f0e2df4c-f64b-4820-b3b3-27389b256ecf [18]IMFBlog. 'Soaring inflation puts central banks on a difficult journey.' 1 August 2022. blogs.imf.org/2022/08/01/soaring-inflation-puts-central-banks-on-a-difficult-journey/ [19] Financial Times. 'The Fed's rate increases are a matter of high interest for everyone.' 28 July 2022. ft.com/content/db77664b-084a-462e-8dc1-1b127fac1b35 [20] Barry Eichengreen, Ricardo Hausmann and Ugo Panizza. 'The pain of original sin.' August 2003. Berkeley. eml.berkeley.edu/~eichengr/research/ospainaug21-03.pdf [21] "That the external debts of emerging markets are disproportionately denominated in foreign currency goes a long way towards explaining why their economies are more volatile and crisis prone than those of their advanced-country counterparts," the trio conclude. Barry Eichengreen, Ricardo Hausmann and Ugo Panizza. Op cit. [22] Stephen Mihm, professor of history at the University of Georgia. 'Strong dollar always clobbers developing nations.' Bloomberg News. 27 July 2022. bloomberg.com/opinion/articles/2022-07-27/strong-dollar-always-clobbers-developing-nations [23] BIS. Op cit. Table 1. Page 28. [24] Reuters. 'Emerging markets drive global debt to record $303 trillion - IIF'. 24 February 2022. reuters.com/markets/europe/emerging-markets-drive-global-debt-record-303-trillion-iif-2022-02-23/. 'Total global debt dips, but emerging market debt hits record high.' 18 November 2021. reuters.com/business/total-global-debt-dips-emerging-market-debt-hits-record-high-2021-11-17/. The article quotes data from the Institute of International Finance. [25] IMFBlog. 'Emerging economies must prepare for Fed policy tightening.' 10 January 2022. blogs.imf.org/2022/01/10/emerging-economies-must-prepare-for-fed-policy-tightening/ [26] Lorenzo Forni and Philip Turner. 'Global liquidity and dollar debts of emerging market corporates.' Vox EU. 15 January 2021. voxeu.org/article/global-liquidity-and-dollar-debts-emerging-market-corporates Important Information: This material has been delivered to you by Magellan Asset Management Limited ABN 31 120 593 946 AFS Licence No. 304 301 ('Magellan') and has been prepared for general information purposes only and must not be construed as investment advice or as an investment recommendation. This material does not take into account your investment objectives, financial situation or particular needs. This material does not constitute an offer or inducement to engage in an investment activity nor does it form part of any offer documentation, offer or invitation to purchase, sell or subscribe for interests in any type of investment product or service. You should read and consider any relevant offer documentation applicable to any investment product or service and consider obtaining professional investment advice tailored to your specific circumstances before making any investment decision. A copy of the relevant PDS relating to a Magellan financial product or service may be obtained by calling +61 2 9235 4888 or by visiting www.magellangroup.com.au. 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ESG: Why inclusion matters - even for astronauts Pendal August 2022 |
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Investors should look for evidence of inclusion right across a business - even in product design, says Regnan's head of engagement ALISON EWINGS
IN 2019, NASA planned one small step for women: the first all-female space walk from the International Space Station. But it did not go as planned. The problem? There weren't enough medium-sized space suits to go around. "Truly inclusive decision-making goes beyond the workplace," says Regnan's head of engagement, Alison Ewings. "By broadening the approach to consider customers and society at large, you're more likely to have products and services that meet the needs of a wider range of people." Ewings says it is not uncommon for products and services to be designed without proper consideration of inclusion. "We're seeing companies talk about their experience of employing more women only to come across things like no availability of uniforms suitable to be worn when you're pregnant. "We've seen personal protective equipment the wrong size for women. We've seen machinery that cannot be operated by people under a certain height. "These are product and service decisions made well before a company discusses how to implement a diversity and inclusion program." Beyond employee experience Taking inclusion beyond the day-to-day employee experience is an important insight for investors. "Can the impact you have be improved by thinking about how you deliver that more inclusively?" says Ewings. "So, if you're a health company, who are you including in your trials? "For an education provider - if you can reach a broader audience in a developing country, the impact of what you can do about changing those people's lives is far more significant if you approach the delivery of your product and service with an inclusion lens. All companies can benefit from taking an inclusion approach to product and service design, says Ewings. "It can be simple things like supermarkets offering quiet hours for people with autism or older people who find loud noises and bright lights an overwhelming experience." And while diversity has been the watchword for businesses seeking to bring broader talent into an organisation, research shows equity and inclusion are the critical factors in realising the performance potential of a diverse workforce. Regnan's award-shortlisted research report Beyond diversity: Equity and inclusion as an overlooked opportunity for investors (PDF) found that a focus on diversity without equity and inclusion can undermine the very benefits offered by diversity. Three inclusion factors Regnan's research outlines three inclusion factors that investors should take account of when assessing companies:
The benefits of focusing on equity and inclusion within the workplace is equally relevant to the experience of customers and the broader community and is therefore of interest to impact investors, says Ewings. "A true focus on inclusion thinks about what it means for decisions that these organisations make and the products and services that they offer." Organisations that embrace equity and inclusion can apply these skills to their core operations unlocking opportunities to positively impact a wider constituency, and potentially with greater potency. A more intentionally inclusive approach to problem solving also enhances the pool of ideas for how to tackle major societal challenges, she says. Author: Alison Ewings, Head of Engagement, Regnan. Regnan is a Pendal Group business. |
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Funds operated by this manager: Pendal Focus Australian Share Fund, Pendal Global Select Fund - Class R, Pendal Horizon Sustainable Australian Share Fund, Pendal MicroCap Opportunities Fund, Pendal Sustainable Australian Fixed Interest Fund - Class R, Regnan Global Equity Impact Solutions Fund - Class R, Regnan Credit Impact Trust Fund |
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This information has been prepared by Pendal Fund Services Limited (PFSL) ABN 13 161 249 332, AFSL No 431426 and is current as at December 8, 2021. PFSL is the responsible entity and issuer of units in the Pendal Multi-Asset Target Return Fund (Fund) ARSN: 623 987 968. A product disclosure statement (PDS) is available for the Fund and can be obtained by calling 1300 346 821 or visiting www.pendalgroup.com. The Target Market Determination (TMD) for the Fund is available at www.pendalgroup.com/ddo. You should obtain and consider the PDS and the TMD before deciding whether to acquire, continue to hold or dispose of units in the Fund. An investment in the Fund or any of the funds referred to in this web page is subject to investment risk, including possible delays in repayment of withdrawal proceeds and loss of income and principal invested. This information is for general 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 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 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 are predictive only and should not be relied upon when making an investment decision or recommendation. Whilst 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. For more information, please call Customer Relations on 1300 346 821 8am to 6pm (Sydney time) or visit our website www.pendalgroup.com |
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Portfolio Builder FundMonitors.com September 2022 |
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In this short 3 minute video we build a portfolio from scratch including adding annual re balancing and adding and allocating to new funds. It will show just how easy it is to get the most out of your managed fund portfolio. |
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Around the world in 200 Meetings, Jeff Thomson: Financial and Consumer Staples Alphinity Investment Management August 2022 Within the tech sector, the delineation in terms of performance between the winners and the losers in the current environment is becoming clear. What are the key elements that depict the winners and losers? Trent discusses the fundamental themes from his two recent trips to the US which were structured around two technology conferences - the Morgan Stanley conference and the JP Morgan Conference.
Speakers: This information is for adviser & wholesale investors only. |
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Funds operated by this manager: Alphinity Australian Share Fund, Alphinity Concentrated Australian Share Fund, Alphinity Global Equity Fund, Alphinity Sustainable Share Fund Disclaimer |
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Is the best value for Australian credit not in Australia? Yarra Capital Management August 2022 While Australian Major Bank T1s are rightly held in high regard, their USD-issued equivalents now trade at a substantial premium and offer much higher risk-adjusted returns. Investors able to access Australian credit in offshore markets remain at a distinct advantage to those constrained to local shores. Our readers may recall a research piece we compiled in May where we highlighted just how expensive major bank BBB- rated Tier 1 (T1) hybrid securities were compared to the lower risk major bank BBB+ rated Tier 2s (T2). At the time, T1 credit margins were trading just ~40bps wider than T2 despite being two notches lower in credit quality. Incredibly, that gap has narrowed further to just ~20bps following the recent T2 issuance from NAB and ANZ which priced at very attractive margins of BBSW+280bps and BBSW+270bps respectively (refer Chart 1). Moreover, based on historical averages, T1s currently look incredibly expensive and should be trading ~200bps wider of current valuations. Interestingly, based on offshore T1 pricing, it seems this disconnect in bank hybrid capital pricing is more of an Australian phenomenon. After diverging in late 2021, there is now a dramatic gap between the two, with US T1s now trading ~200bps wider than their Australian comparatives (refer Chart 2). Looking at T1 curves in Chart 3 - the US (dark blue line) and Australia (light blue line), there are several opportunities for domestic investors to extract a significant premia by choosing the US dollar denominated Australian T1s and hedging out the currency and interest rate risk. We recently purchased a meaningful size of the 2027 Westpac USD T1s. The security swapped back to a credit margin of BBSW+480bps, ~200bps wider than the equivalent ASX-listed security, with all currency and interest rate risk hedged throughout the life of the security. By comparison, given their more attractive pricing domesticly compared to T1, the same pick-ups in credit margins offshore are not currently available in bank senior or T2 segments. However, there are similar opportunities in Australian corporate credit with both the single A and triple B rated curves for Australian issuers significantly wider in USD than in AUD (refer Chart 4 and 5). This approach is enabling us to harvest higher risk adjusted returns across most sectors of Australian credit, while maintaining diversity across the spectrum of household Australian names which are a mainstay of most equity portfolios but typically do not issue debt in AUD. This long list includes major corporates such as BHP, Rio Tinto, Brambles, Bluescope and CSL, to name only a few. Where it makes sense to do so, the Yarra Higher Income Fund is investing in Australian issuers across major currencies; hedging out currency and interest rate risk to optimise risk adjusted returns. With a current yield at ~5% which we expect will increase alongside rising interest rates, the Fund remains well placed to continue delivering consistent monthly income to its investors. |
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Funds operated by this manager: Yarra Australian Equities Fund, Yarra Emerging Leaders Fund, Yarra Enhanced Income Fund, Yarra Income Plus Fund |
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The cost of war 4D Infrastructure August 2022 Russia invaded Ukraine on 24 February 2022, no doubt expecting a quick and easy triumph in achieving its territorial ambitions. Consistent with the old proverb 'those who ignore history are doomed to repeat it, Russia has created a long, drawn-out conflict with no real path to a resolution. What is also now becoming evident is that Russia is paying a significant cost for its actions. To be very clear - there is no doubt that the human and personal costs suffered by Ukraine and Russia far outweigh the economic and financial costs (E&F) caused by the war. Nevertheless, the E&F costs are huge and, left unaddressed, will lead to further human costs. In this article, we identify what we believe are the major E&F costs being incurred by Russia, and consider what they may mean for China and Taiwan. Economic and financial costs of the Ukraine war for Russia Credit rating downgrades All the major rating agencies have withdrawn their Russian credit ratings as summarised below. Prior to war the ratings were: S&P (BBB-), Moody's (Baa3) and Fitch (BBB). Russia's credit ratings Source: World Government Bonds While there are numerous factors limiting Russia's ability to borrow at present, the absence of credit ratings effectively means it is locked-out of the global public debt markets and needs to find funds from other sources. MSCI's ESG rating downgrade Russia has been downgraded from B, with a negative outlook to CCC - the lowest possible MSCI rating. MSCI ESG ratings for Russia
Significantly, this means that Russia is no longer doing its fair share of work in protecting the world's future. The Economist Intelligence Unit's (EIU) sovereign risk rating for Russia went from B to CCCThis reflects that Russia is currently in default after it failed to honour part of its foreign currency denominated external debt. Russia's sovereign risk rating from the EIU
As with the credit rating, country downgrades of Russia by very reputable research organisations, such as the EIU, mean that it will have great difficulty in sourcing funding and generally doing business internationally. Russia's Credit Default Swap (CDS) spreads have explodedRussia's 5-year CDS value is 13,775.17 (last update: 18 Aug 2022). This value reveals a 100% implied probability of default, on a 40% recovery rate supposed. Russia's Credit Default Swap (CDS) spreads Source: World Government Bonds website The CDS pricing suggests that very few, if any, in the market are interested in taking on Russian credit risk at the current time - further obstacles to Russia raising funds and doing business internationally. Russia's GDP shrank by 4% from a year ago in Q2 2022The economy now looks to be heading into a recession. Russia's GDP is shrinking
Source: Trading Economics This means further hardship for the Russian populous as commercial activity declines, businesses likely close and jobs are lost. Banking system under severe pressureThe domestic banking sector is under immense pressure as a result of international sanctions and the exclusion of several Russian banks from the SWIFT international payments system, says the EIU. In addition, major countries are preventing Russia's central bank (CBR) from using its international reserves, and sanctions have been placed on Russian individuals and companies by the US, the EU and other countries. A number of major international companies have left Russia.
A banking system under pressure is clearly a major impediment for Russian citizens - what is happening to their life savings? Clearly, Russia, and the Russian people, are paying a huge E&F cost (as well as personal and human costs) as a result of the invasion of Ukraine. To put this issue into context, imagine if a new, democratically elected Australian government achieved all of the above outcomes in its first 6 months in office. What would be the reaction of Australian voters? Russia's near-term ace Having highlighted the issues Russia now faces, in an effort to be completely neutral we also want to acknowledge the negotiating ace it still holds - its commodity reserves. Europe acknowledges the short-term difficulty in diversifying energy supply, with the major risk being Russia completely shutting off gas ahead of winter. This clearly gives Russia a near-term bargaining chip. However, longer term, the current crisis has highlighted the need for such diversification, and Europe is now fast tracking the shift with growth in renewables, faster permitting and opportunities from Repower EU. As a result, the energy transition is, and will be, the fastest growing infrastructure subsector over coming years, further eroding Russia's commodity strength over the medium term. Would China pay the price for Taiwan? This is the key geo-political question of our time, and the answer will have long-term ramifications for all of us. China's recent sabre rattling following the Nancy Pelosi visit to Taiwan suggests that it may well be willing to pay the price. However, a closer look at recent Chinese history suggests it may be too smart to follow Russia's path, and indeed does understand the lessons of history. During the 'Chinese miracle', as it is known, the Chinese economy experienced astonishing growth, averaging almost 10% a year over the last few decades and catapulting the country to become the world's second largest economy. In 1978, when China started the program of economic reforms, the country ranked ninth in GDP with US$214 billion. Forty-four years later, it has a GDP of US$19.9 trillion and is expected to surpass the US by 2030 in economic size. Source: IMF
Perhaps even more importantly, over this same period more than 850 million people have been lifted out of poverty. This, we believe, is the key factor in this discussion. Delivering economic benefits to the masses has lifted individual wealth in China, but also meant the populous was largely content (getting richer and healthier), and therefore not a threat to the Chinese Communist Party's grip on power. It is very unlikely that this same populous would welcome a return to a life of poverty, isolation and need. We believe this is the largest single voice constraining excessive action by the current regime. Given the lessons in Ukraine, why would they risk all they have achieved by paying too high a price? We believe the domestic political and economic case for China to avoid severe sanctions from the rest of the world is clear. Unfortunately, rational, humane decision-making has not been a feature of historical conflicts, and we continue to monitor the situation closely. |
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Funds operated by this manager: 4D Global Infrastructure Fund, 4D Emerging Markets Infrastructure Fund[1] The US lost over 58,000 military personnel, and Australia over 500, during their involvement in the Vietnam War between 1964 and 1973. It was a very costly war, and one that was ultimately lost. The content contained in this article represents the opinions of the authors. The authors may hold either long or short positions in securities of various companies discussed in the article. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely as an avenue for the authors to express their personal views on investing and for the entertainment of the reader. |
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China, Taiwan and Rare Earth Elements Datt Capital August 2022 Following on from the surprise invasion of Russia earlier on in the year, recent events related to the growing tension between China and Taiwan have spurred us, to increase our exposure to Rare Earth Elements ('REE'). Should the Taiwan situation worsen and/or should China use force to attempt to control Taiwan it is likely there will be sanctions enacted against China. However, investors should be prepared for counter-sanctions from the Chinese side and we believe this will entail the restriction of REE supplies. China produces around 80% of the REEs globally and given their critical nature in the production of a wide range of modern technologies, a logical first step would be China restricting this supply to the rest of the world in which it is in disagreement. This group of metals comprises the 15 elements of the lanthanide series and two chemically similar elements in scandium and yttrium. We have increased our exposure to the REE sector in recent months given the market outlook fuelled by the current and prospective geopolitical situation. According to the Australian Government's Geoscience Australia, The growing strategic importance of REE (Rare Earth Elements) and scandium was reflected in their inclusion in the US Government's 2018 list of 35 critical minerals. This list was an initial step toward ensuring reliable and secure supplies of minerals critical to the US economy and military. For those looking for exposure to the space, these five ASX-listed companies listed could be considered for inclusion as part of a diversified portfolio:
Author: Emanuel Datt, Managing Director Funds operated by this manager: |
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Disclaimer: This article does not take into account your investment objectives, particular needs or financial situation; and should not be construed as advice in any way. The author holds no exposure to the stock discussed. |
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Around the world in 200 meetings Alphinity Investment Management August 2022 The first half of 2022 has been extremely busy for Alphinity's five global portfolio managers. Collectively, they have been on 9 overseas investment trips, travelling to 12 cities across 7 countries, visiting existing and prospective portfolio companies. All in, the team have met with over 200 companies face to face over the past 6 months. Travelling again after two years of Zoom calls is an excellent opportunity to reconnect with corporates, gain valuable on-the-ground insights and find interesting new investment opportunities. In this note we share the key highlights of their respective trips. Including interesting anecdotal stories, notable fundamental themes, and some company specific insights. You can also visit our website for videos with our 5 portfolio managers sharing their key highlights. Alphinity is not currently invested in all the stocks mentioned in this note. Alphinity Global Portfolio Management TeamAround the world in 200 meetings across 12 cities and 7 countriesA few anecdotal stories: long queues, missed flights, labour shortages & increased inequalityGlobal airports, trains, hotels, and restaurants are currently overwhelmed. For every meeting, the team had to navigate long airport queues and of course a much higher price tag to get there. Jeff hit the unwelcome record with every one of his flights delayed or cancelled over a two-week period in Europe. Across in the US, Trent almost got trapped in Santa Rosa after visiting Keysight. Uber coverage has become very patchy outside of the big city centres. At Starbucks he also got bumped from second in the in-store coffee line to 60th. The "order ahead app" option is clearly the new and better way to go! Sadly, not all our on-the-ground insights were positive. Mary observed that COVID has exacerbated the income inequality challenge for America as a society. The increased homelessness is now confronting in many major cities such as Seattle. Unionisation movements and worker demonstrations were also a regular occurrence. From smaller companies (Chipotle) to high-profile companies (Amazon and Starbucks) alike. Fundamental themes across sectors: Supply chains, inventory, labour shortages and a clear delineation between the winners and losersThere were several overarching fundamental themes shared across most of the sectors:
Sector specific insightsConsumer - New York, Seattle & EuropeConsumer spending has remained resilient to date despite consumer sentiment plummeting to levels last seen in the 1900's. With pent-up demand focused on travel, leisure, occasion-based spending (weddings), beauty, entertainment, etc. It's likely that this "revenge spending cycle" won't last very long after the end of the summer holiday season. Low-end consumers are already struggling post the COVID stimulus withdrawal. Higher mortgage rates and deteriorating jobs data will also start to weigh. We continue to prefer exposure to the more resilient high-end consumer at this point in the cycle. A few comments on the sub-sectors below:
Financials - Europe, UK, and CanadaFinancials are facing significant macro challenges. Tailwinds from higher interest rates are offset by growing concerns about slower economic growth, difficult capital markets and potentially higher credit risks. We have recently reduced our exposure to banks on falling earnings momentum, such as Bank of America. We prefer financials that are less geared to rates and offer more defensive characteristics. A few comments on the sub-sectors below:
Technology - San Francisco and BostonThere is also a clear delineation between the winners and losers within the technology sector. Or in the current tech market, we should describe it as the big losers and the lesser losers. Companies exposed to Cloud, 5G and Security are holding up better (Microsoft, ASML). The businesses where the model depended on free and almost limitless external capital, are the big losers (Buy-now-pay-later players, such as Affirm for example). A few comments on the sub-sectors:
Industrials - Europe and UKSupply chains and inventory are front and centre for the industrial players. Feedback from the road suggested that the situation overall remains challenging and highly uncertain, although with some incremental improvements in certain areas. For example, truck manufacturers talked about being back at full production. Despite current cyclical headwinds, it was interesting to note that several sub-industries continue to enjoy strong structural trends. These include decarbonization, electrification, factory automation and, more recently, defence. Ironically the big issues causing a lot of the cyclical headwinds appear to be strengthening the longer-term fundamentals for some of the companies exposed to these thematics. For example, Schneider Electric have seen increased demand and shrinking payback periods for their energy efficient products. Their CEO noted that many of the secular tailwinds underpinning growth are stronger than what they were in January. Companies like ABB, Schneider and Siemens are all beneficiaries of electrification and industrial automation (including robotics). On the sub-sectors:
Health Care - Los AngelesAfter attending the Health Care conference in LA, we maintain our view that the fundamentals of the overall sector remain good, especially relative to the rest of the market. The underlying sub sectors within Health Care have very diverse challenges and drivers. Besides the usual ongoing policy risks (new US reconciliation bill for example), there are also significant FX headwinds for the sector. Multiples also still reflect some growth expectations. On the sub-sectors:
We are happy to be on the road again. The world has changed in positive and negative ways since pre-COVID but we are committed to using on-the-ground meetings and travel insights to hone our understanding of the markets and find exciting, good quality stocks in which to invest. This information is for adviser & wholesale investors only. |
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Funds operated by this manager: Alphinity Australian Share Fund, Alphinity Concentrated Australian Share Fund, Alphinity Global Equity Fund, Alphinity Sustainable Share Fund Disclaimer |
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Is the current rally premature? Montgomery Investment Management August 2022 I believe there are good arguments the current rally is premature and might reverse. Keep in mind I am still long and heavily invested in equities. I just think the current rally has got ahead of itself. First, S&P500 forward earnings estimates are declining. Not by much but definitely in the wrong direction. Back in July the S&P500 was expected to earn $250.70 per share in 2023. Today that number is $243.81. As I say it's only a 2.7 per cent decline but it is a negative. Secondly, while many indicators suggest headline inflation has peaked, it's the core inflation number that matters and that is driven primarily by service inflation, which in turn, is driven by wages. The Federal Reserve Bank of New York's Global Supply Chain Pressure index has rolled over, as has U.S. ISM Manufacturing Supplier Deliveries Index and the ISM Manufacturers Backlog of Orders Index. Prices for dynamic random access memory and shipping (as measured by the Baltic Dry Shipping Index) are also falling, as is the price of oil. These declines indicate pressure on the supply chain is easing which in turn gives goods supply a chance to catch up to demand. Moving towards equilibrium should ease goods inflation. Equity markets have understandably become excited. With inflation peaking, the current wave of central bank interest rate rises might lead to rate cuts next year, especially if the current wave of rises causes a recession. One element of inflation however not considered in the above narrative is the extent to which Core inflation is impacted by services. Services generally make up about 73 per cent of Core CPI. 'Services' is responsible for four per cent of the six per cent Core CPI reading in July. And the biggest cost to services businesses are wages. Wage inflation meanwhile is high. Indeed, in the U.S., private sector wages and salaries have jumped 5.7 per cent, even though the U.S. economy is slowing down. To put this in perspective private sector salaries rose by two per cent in the first quarter of 2016 and by about 1.75 per cent in the first quarter of 2012. Meanwhile, the employment cost index, a figure U.S. Fed policymakers follow closely, rose 1.3 per cent in the second quarter. This index climbed 5.1 per cent over 12 months, which is a record for the data series that commenced in 2002. And the U.S .Federal Reserve's preferred inflation measure, the Personal Consumption Expenditure price index set a new 40 year high in June. All that tells me is that inflation could prove to be more persistent than the market currently hopes. Of course, if inflation is truly 'old' news and on its way down, then it is possible the lows for the bear market have already been seen. If, on the other hand, the market's current optimism about an end to rate hikes this year and the beginning of rate cuts next year proves unfounded, or even premature, then the current rally is also premature, and investors may yet see another reversal in prices. Finally, keep an eye on global liquidity. Liquidity matters far more than interest rates when debts need refinancing. Currently, the pace of balance sheet unwinding has slowed. The U.S. Fed paused its liquidity squeeze in July, providing a fillip to equity markets. But all major world central banks are in tightening mode, as are 90 per cent of emerging market central banks. Large balance sheet declines are equivalent to material increases in interest rates. According to some analysts, if the U.S. Fed hits its US$6.5 trillion balance sheet target, it will be equivalent to an effective U.S. Fed Funds rate of nearly eight per cent. If the Fed resumes its stated 30-month QT program, further declines in liquidity can be expected. As a net buyer of stocks, we look forward to the opportunity to add to investors' portfolios at cheaper prices. And being near fully invested now, we also look forward to higher prices. Stay tuned. Author: Roger Montgomery, Chairman and Chief Investment Officer Funds operated by this manager: Montgomery (Private) Fund, Montgomery Small Companies Fund, The Montgomery Fund |
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