Stock Story: Medibank

Airlie Funds Management

October 2024

Playing a pivotal role in Australia's health transition.

The Medibank and ahm private health insurance brands serve over 4.2m customers and play a vital role in funding medical care in Australia. In the most recent financial year, Medibank paid out $6.3bn in health insurance claims, taking a significant burden off the public healthcare system. 

Yet recently, the sector has come under fire from both the government and hospitals accused of making too much profit. In this article, we explore this regulatory tension and why we think Medibank looks an attractive investment opportunity.  

Private hospital profits affected by new models of care 

There is no doubt the past few years have been challenging for hospitals - labour shortages have affected service levels and inflation has been rampant. Private hospital operators have responded by launching a campaign against the health insurers and pressuring the government for a bailout. While additional payments or a tax may provide short-term relief to hospitals, they do not solve the structural issues facing the sector and ultimately would drive up the cost of healthcare and premiums for millions of Australians. To build a sustainable private healthcare system, all participants must work together to find efficiencies and drive down the overall cost of care.  

Medibank is doing its part to lower costs by investing in new models of care away from overnight stays in expensive acute care hospitals to virtual, short-stay hospitals and home care. Without this transition, Medibank estimates the government will need to spend 50% more on healthcare as a percentage of GDP in forty years. While this transition does come at the expense of hospitals that typically earn more for longer in-hospital stays, it is beneficial for the wider healthcare system. Higher hospital costs would simply translate to higher premiums, which are likely to push more members out of private health insurance and place further strain on an already stretched public healthcare system.  

It is for this reason the Federal Health Minister following a review has conceded, "There's no silver bullet from Canberra or funding solution from taxpayers to deal with what are essentially private pressures in the system". Ultimately, it is not the government's job to prop up unprofitable business models and in some cases it is healthy for some private hospitals to shut where there is overcapacity in the system.  

Has Medibank profited at the expense of hospitals? 

Medibank has stuck to its promise not to profit from the pandemic and returned a total of $1.46bn in givebacks to customers for permanent claims savings due to COVID-19. This is evident in the chart below which shows Medibank's health insurance gross profit margin is still below FY19 levels.   

Figure 1 - Medibank Health Insurance Gross Margin 

Source: Company filings

Fear of regulation creates opportunity to invest 

While there remains uncertainty as to how the regulatory situation will unfold with a federal election coming up, we think it's unlikely the government will step in and prop up private hospitals where there is a clear shift to lower-cost care outside the hospital. In the meantime, we believe this creates an opportunity to invest in Australia's largest health insurer, which has grown its earnings per share at 8% p.a. over the past decade. 

Medibank screens as a high-quality business under our investment process for the following reasons: 

1. Financial strength: Medibank has a strong capital position with a capital ratio of 14.1%, well above its 10-12% target range, and has zero debt on its balance sheet. 

2. Business quality: Medibank is Australia's largest health insurer with 4.2m members (27% market share). This scale enables Medibank to negotiate better terms with hospitals keeping a lid on claims inflation while sharing these savings with members to lower premiums and improve retention.  

3. Management quality: David Koczkar has been the CEO since 2021 and prior to this was the COO since 2014. Over this period, the company has seen a return to policyholder growth, expanded its health offering and tightly managed its costs.  

Finally, from a valuation perspective, Medibank is trading on less than 17x P/E (below its long-term average of 19x) and offers investors an attractive dividend yield of 4.6%. 

Figure 2 - Medibank NTM Rolling PE 

Source: FactSet

Author: Emma Fisher and Vinay Ranjan

Funds operated by this manager:

Airlie Australian Share Fund, Airlie Small Companies Fund

Important Information: 

This material has been delivered to you by Magellan Asset Management Limited ABN 31 120 593 946 AFS Licence No. 304 301 trading as Airlie Funds Management ('Airlie') 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 obtain and consider the relevant Product Disclosure Statement ('PDS') and Target Market Determination ('TMD') and consider obtaining professional investment advice tailored to your specific circumstances before making a decision about whether to acquire, or continue to hold, the relevant financial product. A copy of the relevant PDS and TMD relating to an Airlie financial product or service may be obtained by calling +61 2 9235 4760 or by visiting www.airliefundsmanagement.com.au.

Past performance is not necessarily indicative of future results and no person guarantees the future performance of any financial product or service, the amount or timing of any return from it, that asset allocations will be met, that it will be able to implement its investment strategy or that its investment objectives will be achieved. This material may contain 'forward-looking statements'. Actual events or results or the actual performance of an Airlie financial product or service may differ materially from those reflected or contemplated in such forward-looking statements.

This material may include data, research and other information from third party sources. Airlie makes no guarantee that such information is accurate, complete or timely and does not provide any warranties regarding results obtained from its use. This information is subject to change at any time and no person has any responsibility to update any of the information provided in this material. Statements contained in this material that are not historical facts are based on current expectations, estimates, projections, opinions and beliefs of Airlie. Such statements involve known and unknown risks, uncertainties and other factors, and undue reliance should not be placed thereon. No representation or warranty is made with respect to the accuracy or completeness of any of the information contained in this material. Airlie will not be responsible or liable for any losses arising from your use or reliance upon any part of the information contained in this material.

Any third party trademarks contained herein are the property of their respective owners and Airlie claims no ownership in, nor any affiliation with, such trademarks.   Any third party trademarks that appear in this material are used for information purposes and only to identify the company names or brands of their respective owners. No affiliation, sponsorship or endorsement should be inferred from the use of these trademarks.  This material and the information contained within it may not be reproduced, or disclosed, in whole or in part, without the prior written consent of Airlie.

Magellan Global Quarterly Update

Magellan Asset Management

October 2024

Arvid Streimann, Nikki Thomas and Alan Pullen discuss key market themes and how the global strategy is positioned to capitalise on emerging opportunities, whilst monitoring the risks. Arvid also discusses the potential market impacts of the upcoming US election based on various possible outcomes.

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, Magellan Core ESG Fund

Important Information: 

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 obtain and consider the relevant Product Disclosure Statement ('PDS') and Target Market Determination ('TMD') and consider obtaining professional investment advice tailored to your specific circumstances before making a decision about whether to acquire, or continue to hold, the relevant financial product. A copy of the relevant PDS and TMD relating to a Magellan financial product may be obtained by calling +61 2 9235 4888 or by visiting www.magellangroup.com.au.

Past performance is not necessarily indicative of future results and no person guarantees the future performance of any financial product or service, the amount or timing of any return from it, that asset allocations will be met, that it will be able to implement its investment strategy or that its investment objectives will be achieved. This material may contain 'forward-looking statements'. Actual events or results or the actual performance of a Magellan financial product or service may differ materially from those reflected or contemplated in such forward-looking statements.

This material may include data, research and other information from third party sources. Magellan makes no guarantee that such information is accurate, complete or timely and does not provide any warranties regarding results obtained from its use. This information is subject to change at any time and no person has any responsibility to update any of the information provided in this material.  Statements contained in this material that are not historical facts are based on current expectations, estimates, projections, opinions and beliefs of Magellan. Such statements involve known and unknown risks, uncertainties and other factors, and undue reliance should not be placed thereon. No representation or warranty is made with respect to the accuracy or completeness of any of the information contained in this material. Magellan will not be responsible or liable for any losses arising from your use or reliance upon any part of the information contained in this material.

Any third party trademarks contained herein are the property of their respective owners and Magellan claims no ownership in, nor any affiliation with, such trademarks.   Any third party trademarks that appear in this material are used for information purposes and only to identify the company names or brands of their respective owners. No affiliation, sponsorship or endorsement should be inferred from the use of these trademarks. This material and the information contained within it may not be reproduced, or disclosed, in whole or in part, without the prior written consent of Magellan.

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Why Australians Are Embracing ETFs

Janus Henderson Investors

September 2024

Funds operated by this manager:

Janus Henderson Australian Fixed Interest Fund, Janus Henderson Australian Fixed Interest Fund - Institutional, Janus Henderson Cash Fund - Institutional, Janus Henderson Conservative Fixed Interest Fund, Janus Henderson Conservative Fixed Interest Fund - Institutional, Janus Henderson Diversified Credit Fund, Janus Henderson Global Equity Income Fund, Janus Henderson Global Multi-Strategy Fund, Janus Henderson Global Natural Resources Fund, Janus Henderson Tactical Income Fund

All opinions and estimates in this information are subject to change without notice and are the views of the author at the time of publication. Janus Henderson is not under any obligation to update this information to the extent that it is or becomes out of date or incorrect. The information herein shall not in any way constitute advice or an invitation to invest. It is solely for information purposes and subject to change without notice. This information does not purport to be a comprehensive statement or description of any markets or securities referred to within. Any references to individual securities do not constitute a securities recommendation. Past performance is not indicative of future performance. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.

Whilst Janus Henderson believe that the information is correct at the date of publication, no warranty or representation is given to this effect and no responsibility can be accepted by Janus Henderson to any end users for any action taken on the basis of this information.

Resources Rally: Boom or Bust?

Marcus Today

October 2024

The resources sector is up 17.96% in 17 days and is now well overbought on a daily chart with an RSI of 74. This is the moment we have been waiting for, the moment to make a lot of money in a short period of time trading the bottom of the resources sector as it comes out of an oversold sentiment hole. We have taken a few trades, as you know, but have 'kept it in our pants' from a Strategy (Portfolio) point of view. The resources sector has rocketed.

Big Moves in Key Stocks

BHP is up 20.3% since the low on September 6, fulfilling the first half of Henry's mantra--"Buy at $40, sell at $50". It is now at $45.96. FMG is up 36.7% since bottoming on September 10 at $15.88, now at $20.68. MIN has surged 76.3% in 15 days and is up 48.3% in six days. PLS is up 41.5% in 15 days and 19% in six days. And that's just some of them.

A Time for Caution

I am never one to stand back and wag a finger at people making money, and I hope, like everyone else, that this is a "big" pivot point, not just a short-term rally. The good news is that this rally shows up on the long-term charts and has some of the anatomical signs of being a major low (a short sharp start). However, I am sceptical. These Chinese announcements are, in my humble opinion, more desperate than effective, more hopeful than guaranteed, and the timing, just ahead of the Golden Week holiday, leaves everybody a bit vulnerable as the Chinese markets, PBoC activity, economic indicators, and commodity markets, including the iron ore price, go dead for a week.

Watching the Herd

This is one of those moments when you have to watch the herd. The herd has lost its head. It is justified in the short term. Sentiment has changed, and sentiment is important to share prices, but believing these measures will meaningfully change China's economic trajectory is a gamble. These measures are a bit like throwing rocks at an oil tanker.

The Bubble is Here

We have seen the "Rocket", but I think we have a "Bang" coming. This short-term rally will deflate at some point. Possibly rapidly. If making money in the stock market is about spotting stocks that have dropped into a sentiment hole, then it is also about spotting stocks that have found themselves in a sentiment bubble.Short-term, we are now in a sentiment bubble. And for the superstitious, you might also like to know that I am going on holiday next week, and you know what that means!

What's Ahead for Resources?

The jury is still out on the medium term. Keep watching the herd. Traders, take your profits when the herd stumbles.

Author: Marcus Padley

Funds operated by this manager:

Marcus Today Equity Income SMA, Marcus Today Growth SMA

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Chris Gosselin, CEO of Australian Fund Monitors, speaks to Nichols Chaplin, Director and Portfolio Manager at Seed Funds Management. Nicholas shares insights on APRA's plan to phase out additional tier one bonds, which could destabilise the banking sector and impact retail investors.

The Seed Funds Management Hybrid Income Fund has a track record of 9 years and has outperformed the Solactive Australian Hybrid Securities (Net) benchmark since inception in October 2015, providing investors with an annualised return of 6.39% compared with the benchmark's return of 4.86% over the same period.

Funds operated by this manager: Seed Funds Management Hybrid Income Fund

Global Investment Committee's outlook: low risk no longer

Nikko Asset Management

October 2024

As the Global Investment Committee (GIC) convened on 26 September, our Q2 outlook for resilient though somewhat softer US growth had materialised. However, our US EPS growth estimates (consistent with strong but softer GDP growth) remained slightly more conservative than market estimates. Going forward, we perceive heightened risk to both growth (two-way) and inflation (upside) compared to our Q2 guidance. Nevertheless, our central near-term scenario remains for slowing but positive growth in the US, alongside slowly moderating prices.

Key takeaways are as follows:

• We maintain our main view of benign growth in the US, accompanied by moderating inflation. However, we see heightened tail risks biased toward inflation for global markets and would look to diversify risk portfolios with assets resilient to inflation. We remain constructive on gold as a portfolio diversifier.
• We view Japanese equities favourably given comparatively reasonable valuations (vs. the S&P500 or ACWI) alongside multiple signals of Japan's structural recovery. We would favour an increasing bias toward domestic demand-related stocks as these may be more resilient in the face of any correction in US markets.
• We see limited upside in long-duration US bonds, thanks to front-loaded pricing of Federal Reserve (Fed) stimulus, and insufficient pricing of inflationary or fiscal risks into the longer end of the US yield curve. Due to the positive correlation between US bonds and stocks, bonds no longer provide adequate downside diversification. Moreover, a positive correlation persists among many global bond markets despite diverse interest rate trajectories. We view long-term bonds with caution.

Q3 2024 in review: the "great dispersion" in stocks and bonds

Over the course of Q3, the market experienced a change of course on several factors. Following a surprise rate hike from the Bank of Japan (BOJ) in July (the central bank took overnight rates to 25 bps), a downside surprise in US non-farm payroll data triggered speculation of imminent Fed rate cuts. This, in turn, led to the unwinding of speculative yen-funded "carry trades", triggering both a sudden drop in dollar-yen as well as unexpected volatility in Japanese equities--the target investments of short-term overseas investors utilising borrowed yen. Markets recovered quickly from the volatility, although dollar-yen appears to have corrected decisively lower from highs above 160. Domestic investors went bargain hunting as Japanese indices sold off and Japanese corporates used their large cash balances to buy back their shares at lower prices. Underweight institutional investors accumulated domestic equities to rebalance their portfolios while households, unfazed by speculative selling, continued to exercise the tax advantages that accrued to them under the New NISA. We convened an Extraordinary GIC at the time and shifted our guidance, primarily to allow for greater volatility. Aware that volatility tends to cluster and that markets may be at the threshold of a new volatility regime, we widened our ranges for both US GDP and the FOMC to admit downside risks. We also implemented new ranges for valuation (P/E) alongside existing earnings ranges for Japanese indices.

Meanwhile, on the eve of the GIC on 26 September, markets had received news of surprise stimulus from China, on the heels of a larger-than-expected 50 bp rate cut from the FOMC on 19 September which had prompted bond markets to price in a succession of significant US rate cuts. Equity markets subsequently broke to new highs, even as bonds priced in a sombre macroeconomic scenario, though they barely reacted to the Fed's move on 19 September as the market had already priced in multiple 50 bp interest rate cuts.

Meanwhile, toward the end of Q3, both Japanese stock markets and dollar-yen were influenced by speculation that Japan's ruling Liberal Democratic Party (LDP) would elect a new Abenomics-inspired leader (and thus prime minister). However, the LDP leadership vote on 27 September resulted in disappointment for the markets, which had to lower their expectations for the BOJ to end or indefinitely postpone its interest rate hike cycle. The LDP elected Shigeru Ishiba as its new leader and prime minister, who subsequently called a snap election for 27 October. However, as we noted in our insight, "Less may be more in Japan's LDP leadership contest", the situation is very different now than at the start of the Abenomics era when inflation struggled to turn positive. In Q3, we not only saw Japanese Q2 corporate earnings remain consistently strong but we also witnessed incipient signals of stronger consumption demand, backed by the advent of positive year-on-year (YoY) real wage growth.

Global macro: growth risks persist, inflation tamer vs. Q2 on surface

US: From a macroeconomic standpoint, there is not enough clear motivation from underlying economic indicators to price in an imminent US recession, even despite softening data. Although the GIC foresees US GDP growth dipping below the 2% level, our outlook is for YoY growth to remain above 1.5% in the year to September 2025. The US consumer has remained resilient, even despite a softer job market, with consumption among higher-income households assisted by the "wealth effect" of gains in US stocks. While much slower than in early 2024, the US continues to add over two million jobs to non-farm payrolls YoY (see "What the Fed's rate cut tells us about current financial conditions"), which is stronger than job growth typically tends to be immediately prior to a US recession. That said, the unemployment rate has triggered the Sahm rule (typically a forward indicator of recession), due in part due to the widening disparity between the household survey (which shows YoY job growth already in contraction), and based on which the unemployment rate is calculated and the establishment survey, which tabulates non-farm payrolls.

Chart 1: Employment conditions in the US

Source: Nikko AM, BLS

Motivating the divide in part are disperse conditions between higher income households (where both job conditions and investment income are more supportive) and lower-income households, which are a higher proportion of the household survey than the establishment survey. Meanwhile, we see inflation as likely to stay on a gradual downward trajectory, although our median US core PCE outlook is for prices to show above 2% YoY growth over the course of the year to September 2025. Meanwhile, our voter survey shows a less dispersed central tendency for both headline and US inflation compared to Q2 as inflation subsides gradually. Notwithstanding, several members cite heightened inflationary tail risks. Many of the risks cited by voters have the potential to extend beyond the one-year outlook horizon.

Macro vs. forward-looking financial market indicators: We are carefully observing the "great dispersion" of scenarios priced into financial markets, particularly in equities and bonds. We are unconvinced that the circular logic of aggressively lower rates could justify ever-higher equity valuations. This is particularly so given the messaging from the Fed. Although the FOMC did comply with market expectations for a "jumbo" cut in July, Fed Chair Jerome Powell continues to warn against assuming this would be the "new pace" of monetary easing in the absence of clear deterioration of economic conditions. Meanwhile, should economic conditions deteriorate (which is the bond market's signal) we are doubtful that the optimistic scenarios priced into the equity markets would indeed come to pass.

Japan: Despite financial volatility in August, Japanese GDP appears to be on a trajectory to continue growing above-trend (potential GDP has been estimated at around 0.6% by the BOJ). Nonetheless, the median GIC voter offers more conservative estimates of Japanese GDP growth than in Q2 (no longer above 2% YoY) thanks in part to slower--albeit positive--growth in the US and other export markets. Meanwhile although headline CPI is foreseen dipping below 2% as early as the September quarter of 2025 with imported price inflation allayed by a slowly strengthening yen, our median GIC outlook is for ex-food inflation to remain above 2% over the year to September 2025.

Euro area: The median GIC voter meanwhile foresees Eurozone GDP growth as likely to break above 1% YoY and remain at these levels over the year to September 2025, although both headline and core inflation are likely to remain stubbornly in excess of the European Central Bank (ECB)'s 2% medium-term target. However, immediate upside inflationary risks have been somewhat downgraded since the Q2 GIC, when much greater upside dispersion was seen among voters' estimates of future European inflation in both headline and core HICP.

China: were it not for China's recent fiscal and monetary stimulus packages, GIC voters would have likely downgraded their GDP growth outlook, which they expect to still remain in the upper 4% range (but under 5%) over the year to September 2025. According to GIC voters, compared to the beginning of Q3, when stimulus was not priced in, moves by the Fed and the People's Bank of China (PBOC) have shifted the growth outlook. At the beginning of Q3, growth was perceived to come from abroad while now there is much more focus on domestic recovery. Meanwhile, communication between the PBOC and the government, which had previously been much more compartmentalised, now demonstrates greater coordination and a tone of shared urgency among Chinese officials. Their aim extends beyond simply stemming the decline in the housing market, focusing instead on stimulating domestic demand growth.

Voters note that Chinese stimulus has been delivered at a time when markets are particularly sensitive to easing, though the size is half of what was delivered in 2009 (CNY 4 trillion vs. CNY 2 trillion in debt-funded fiscal easing in 2024) when the economy was one-third the size it is now. GDP growth is now less likely to falter near the 4% level (compared to the 5% target), particularly in the near-term--specifically, in the fourth quarter of 2024 and the first quarter of 2025. That the package also includes consumption coupons issued by an administration that once eschewed what it deemed "welfarism" underscores the priority for China to keep social unrest at bay given its sluggish domestic economy. Nonetheless, the outlook for headline CPI remains on the 1% handle, with core CPI still foreseen below 1% YoY over the year to September 2025. This is because voters perceive difficulties for China in lifting prices successfully; rather, attempts to date to allay weakness in the much greater consumer economy with investment in industry and export could potentially mean some degree of exportation of deflationary price pressures on exported Chinese goods. However, the impact of such pressures on trade partners could be limited in comparison to the early 2000s given today's higher relative price levels, reduced global trade openness and rise in trade barriers. That said, exported deflationary pressures are not always persistent. Though many Chinese firms do compete on price to gain market share, once gained, price increases often follow in an attempt to expand margins.

Interest rates: the power of financial markets, a double-edged sword

FOMC: In line with our relatively softer growth and inflation guidance over the year to September 2025, we have also downgraded our FOMC outlook relative to Q2. As mentioned in the "macro" section, softer indicators--particularly pertaining to US jobs--reinforce the need for further rate normalisation, as also apparent in the FOMC's own downgraded "dot plots" for growth, inflation and rates. The median GIC voter took the Fed's own forecast at face value to bring rates another 50 bp lower by the end of 2024. This is less dovish than the outlook currently priced into the bond market, which foresees potential for up to 75 bps in cuts by the end of 2024. Subsequently, the GIC foresees roughly 25 bps of easing per quarter, with a median outlook of 3.7% and an interquartile range between 3.45% and 3.95% by the end of September 2025.

BOJ overnight rates: In Q2, we had priced in a partial but not a full probability of a July rate hike, which we saw as a modest surprise. However, following our August review, we saw little risk of the BOJ following up its surprise July hike with immediate additional tightening prior to gauging the impact of its move in Q3. Moreover, the BOJ called out both financial markets volatility as well as uncertainty abroad (e.g. in US growth) as one reason to remain on hold in September. Much like the influence that the markets appear to have had on the Fed's "pre-emptive" 50 bp cut, we see the BOJ's stance as being much more market-conscious than it was prior to the volatility experienced in early August. We do foresee potential for another rate hike before year-end, but such a move would most likely come after the October inflation data is published. According to the media, consumers will face price hikes on 2,900 food and drink items in the month of October (the broadest price increase in 2024 so far), as firms pass along higher raw material costs to consumers. GIC voters are therefore pricing in prospects of another hike prior to year-end (with the median guidance at 0.3%). There remains the risk that if financial market volatility resurges, the BOJ may remain on hold--all else being equal--at any point over the coming year. Conversely, if inflation surprises to the upside, there is also the risk that the BOJ could deliver a larger hike; our voters attribute a 25% or less chance that rates may rise to 0.45% before the year-end. Subsequently, the median GIC voter foresees rates as likely to rise to 50 bp by June 2025, and to 75 bps by September 2025.

ECB: After the Q2 median guidance of 3.65% for the September-end refinancing rate came in close to the actual outcome, the GIC modestly downgraded its ECB outlook for the coming year. The Fed's larger-than-expected rate cut in September may have opened the door for more aggressive easing by the ECB. The median GIC voter predicts that it is somewhat likely for the ECB to reduce overnight rates before the year-end, with the interquartile range by the end of December 2025 at 3.075% to 3.575%). Nonetheless, given persistent services inflation, especially in Europe, the rate cut outlook is more conservative compared to the FOMC. Our median voter foresees a further 75 bps of cuts as likely in 2025. This compares to the FOMC's 80 bps foreseen for 2025, in addition to the 50 bps of cuts in Q4 2024.

10-year interest rates: Despite the uncomfortable positive correlation between equities and 10-year bond prices (with long-term bonds affording insufficient diversification from market risk), it is hard for participants in the bond market to "fight the Fed" given the apparently strong influence financial markets have on policy. This may paradoxically dilute the power of financial market indicators, including term structures of interest rates, as forward indicators of economic activity. Moreover, the positive correlation across geographies in longer-term bond markets is also apparent, even despite disparate policy trajectories. For example, in spite of improved prospects for near-term BOJ hikes since Q2 as priced into the short end of the JGB yield curve, the term structure of Japanese yields has flattened modestly since July, possibly influenced by Fed easing. Meanwhile, long-term US Treasury yields have declined even though the inversion between the 2- and 10-year benchmark Treasury yield has corrected. GIC voters foresee limited movement in 10 year Treasury yields from their current levels, even despite additional FOMC cuts, due to many of the cuts already being priced into the bond curve. Likewise, voters' central scenario is for little movement in 10-year Bunds over the coming year. One significant caveat--though not a central scenario among voters that inflation will disrupt the Fed's rate cut trajectory-- inflationary surprises and fiscal risk have registered higher than in Q2 in both probability and impact among voters' tail risks (see "Risks to Our Outlook* below).

Foreign exchange: gradual yen appreciation

Following volatility in August, we adjusted our outlook on the Japanese yen to allow for greater appreciation by the currency, as did the market as a whole. Partly responsible for this outlook adjustment was the prospect for narrowing yield differentials as the Fed eased and the BOJ tightened. Also, after observing one round of carry-trade unwinding and observing that market volatility tends to cluster, we upgraded the potential for volatile moves; volatility tends to come alongside yen appreciation. Meanwhile, the dollar's prospects have been downgraded modestly across currencies. The downgrade is less pronounced against the euro, pound and Australian dollar compared to the yen. Noting that the September 2024 BOJ Tankan survey released on 1 October references a fiscal year-end dollar-yen rate of 144.31, which is reasonably close to the spot rate at the time of writing, additional appreciation may impact exporters' overseas revenues, which we cover in the Japanese equities section.

Mild upside to commodities, dispersed view on gold and oil

In line with the downward adjustment in oil prices thanks to supply and demand factors, the GIC downgraded its Q2 assumptions on Brent crude, foreseeing oil to remain below USD 80 per barrel for the year to September 2025. Any upside surprise, meanwhile, may result in an upgrade to inflation expectations. While this is not our central scenario, we do see rising tail risks connected to geopolitics, including violence in the Middle East. As its central scenario the GIC foresees mild upside to commodity prices over the coming year. Meanwhile, we expect the quest for diversification away from market risk, along with the inconvenient positive correlation between equities and US Treasuries (a traditional risk haven) will prove very supportive for gold in the coming year. Although the market prices a correction to near USD 2,500 per ounce over the next year, the GIC median voter sees potential for gold to rise above USD 2,700, with a 25% chance of the precious metal climbing to USD 2,800 or higher over the year to September 2025.

Earnings growth and equity valuation: making way for higher asset volatility

Over the immediate horizon, the Fed's pre-emptive rate cut has had positive effects. Ongoing stimulus may continue to offer potential for resilient earnings growth from US stocks over the year to September 2025. We foresee double-digit YoY earnings growth still remaining intact over the year to September 2025. However, we also flag risks associated with ongoing market concentration (see "Risks to Our Outlook" below). Although our earnings outlook remains roughly in line with consensus, we foresee the potential for valuations to overshoot near-term due to Fed stimulus, and then gradually moderate over the course of the year to September 2025. We also anticipate potential for rebounds in lower-valued indices, such as the STOXX and Hang Seng. We believe that the latter can capitalise on its recent trough as Chinese stimulus takes effect and earnings growth recovers. But we expect valuations to remain on a downtrend for the STOXX, while we see earnings recovering over the course of the year to September 2025.

Japan equities: low valuation + earnings growth + volatility = opportunity

Although we foresee a rising trend in Japanese earnings and some adjustments in valuation over time, we expect volatility and dips in price creating significant opportunities for new purchases among longer-term investors.

Notwithstanding the volatility, we see potential for broad-based Japanese corporate earnings growth, plus significant ability for the index to regain ground after sharp dips. This is due not only to comparatively reasonable valuation relative to US stocks, whose P/E ratios are well above their historical 20-year range, but also Japan's strong structural growth backdrop. This is evidenced by the gathering momentum of domestic consumption and investment alongside improving governance among corporates. We also note the presence of structural buyers in the form of domestic corporates buying back their own shares, institutions topping up domestic shareholdings to meet allocations and households exercising the tax advantages inherent in the new NISA.

However, we do not discount the potential for interim negative surprises, particularly among large exporters, given the smaller buffer that current yen rates provide to exporters in terms of overseas revenues and investment income windfalls.

Broader price ranges reflecting reactions to earnings surprises and valuation shifts: In August, we had introduced ranges not only for EPS growth but also for P/E ratios. We calculate price ranges taking into account the combined maximum and minimum impacts of earnings growth and valuation shifts. The highs within the price range represent our anticipated upper end of index fluctuations due both to earnings surprises and valuations, which we believe will experience bouts of interim volatility so long as market trading remains dominated by foreign investors (who on aggregate trade more frequently than domestic investors) even though many classes of domestic investors are likelier to buy and hold.

Chart 2: Percentage of total TSE trading volume by foreigners

Source: Nikko AM, Tokyo Stock Exchange

Risks to our outlook: harbingers of inflation

Despite the generally benign outlook to global growth and inflation, our voters cited the following heightened risks that were biased toward the inflationary upside:

1. Inflationary outcomes from US elections: almost every voter cited risks related to and following US elections, along with risks associated with increased inflation. Voters generally assigned this tail risk a higher probability than in the June GIC, designating subjective probabilities of between 15-30% to inflationary policies such as trade tariffs and draconian limits on immigration. US immigration, incidentally, has been recognised in recent statements by the FOMC to broadly dampen the impact of cost-push wage inflation. Another inflationary risk cited was that of unsustainable fiscal expenditures, which could impact the longer end of the US interest rate curve. One voter pointed out that an outcome where both the Executive and Legislative branches were aligned (though lower in probability than a mixed result) would be more likely to lead to unsustainable fiscal expenditure, which might be received positively by markets on impact and offer an anticipatory boost. At the same time, this outcome might also heighten the risks further along the line of dislocation in bond markets, should overseas investors, who finance the US current account deficit, perceive long-end US yields as an insufficient premium to cover the forward-looking risks inherent in rising debt-to-GDP ratios of above 120%.
2. Political violence and geopolitical risk: Escalating political violence not only between Israel and Palestine but now also involving Lebanon, as well the ongoing Russia-Ukraine war, have prompted GIC voters to upgrade geopolitics as a source of risk, potentially also contributing to inflation. Although our main scenario is for oil prices to remain subdued below USD 80, this could change if political violence spurs fears of supply risks. GIC voters have assigned around a 20% probability to a middle to high impact outcome where political violence escalates and gives rise to disruptive inflationary pressures.
3. Two-sided risks for AI earnings and concentration in technology: Several voters cited the potential for risks surrounding the concentration of US equity returns in technology, and specifically in AI-related stocks. The highest probability tail risks (rated middle impact) were assigned 25% and involved the risk of investors becoming impatient and downgrading technology due to the low current ROI on AI-related capex, and therefore imposing a valuation downgrade despite positive current earnings. The risks surrounding anti-trust cases against large technology firms, as well as potential for re-rating of revenue expectations among tech firms, was also assigned a 15% probability. One voter also cited a high risk of 40% subjective probability that negative operating leverage for companies not exposed to AI, coupled with diminishing pricing power and an inability to compete on price, as well as rising input costs (including labour) has the potential to undermine earnings in sectors other than tech. This would increase the US markets' already high reliance on the sector to generate earnings growth. On the upside, one voter assigned an 18% subjective probability to the potential that already implemented investment in AI, alongside aggressive easing from the Fed, could provide the US with a long-awaited productivity boost. This could lead to an upgrade to non-tech sector valuations, which have been lagging to date.
4. Self-referential US market rally reverses, negatively impacting real growth: The risks associated with any broader unwinding positions in the US tech sector are unlikely to be as benign than those associated with the unwinding of the Japanese "carry trade". In Japan, the base of buyers to date has been narrow (and structural buyers are not yet overweight); Japanese households' exposure to equities is below 15% of their balance sheet, while their cash holdings total over 50%. Conversely, in the US, households' exposure to equities and mutual funds is above 40%. This means that potential for a large market correction to impact real US GDP is greater. To date, the "wealth effect" appears to have supported US consumption above and beyond employment income growth. In the event of a major US market downturn, a 20% subjective probability was assigned to the likelihood of the wealth effect having a negative impact upon US consumption.

Investment strategy conclusion: stay invested, insure against inflation

Our anticipated economic outlook remains benign. Although we anticipate a slowdown in US growth, we do not foresee recession as imminent, with the Fed's pre-emptive rate cut already contributing to accommodative financial conditions due to its anticipatory impact on financial markets. Accommodative financial conditions remain supportive near-term. Meanwhile, though it remains difficult to anticipate the timing of market-related corrections, we also signal heightened tail risks associated with policy uncertainty surrounding elections in the US as well as the potential for even small disappointments in economic data and policy to exercise a greater impact on asset markets and therefore growth in the future. We see the risks as biased toward the inflationary, and also foresee the disparity in outlooks priced in by the US bond and stock markets as ultimately unsustainable. In the event of upside risks to inflation, holding stocks (however volatile) may help protect the future purchasing power of investors, while upside may be limited for bonds, even if central banks do deliver easing as anticipated. For this reason, we continue to see demand for assets that are typically resilient to inflation that may also provide diversification hedges against US market risk. We favour gold and increasing exposure to Japanese domestic demand, which is showing signs of sustainable structural recovery and is less correlated with US growth and stimulus than export-oriented firms.

The GIC's guidance ranges may be found in Appendix 1 of this document.

A note on changes to the Global Investment Committee Process: In June 2024, we made changes to the Global Investment Committee, as to align our quarterly Outlook more closely with the views underlying our portfolio investments. In lieu of forecasts, we have chosen to provide guidance ranges for indicators and indices that we feel most closely relate to the asset classes we manage. In place of forecasts the Global Investment Committee now provide aggregate guidance at the median for our central outlook, and at the 25th and 75th percentiles.

The asset classes represented in our Outlook can change over time, depending on what is most representative of our active investment views.

In the event full ranges are not available, this may be interpreted as to mean that the asset class is not a central focal point for our highest conviction investment views.

Appendix 1: GIC Outlook guidance

Global macro indicators

Central bank rates, forex, fixed income and commodities

Equities

Funds operated by this manager:

Nikko AM ARK Global Disruptive Innovation Fund, Nikko AM Global Share Fund

The China Pivot: This Time Is Different

Ox Capital (Fidante Partners)

October 2024

Ox Capital has always believed  the "perceived" structural problems in China are well discounted by the cheap valuations of Chinese stocks. Furthermore, the underlying issues are less severe than commonly believed for a few reasons.

1. Ageing Demographics and GDP: China's GDP growth has driven productivity growth not population growth. GDP per capita is only USD12,600, far below that of developed economies. GDP per capita growth will continue as the country develops.  
2. Property sector weakness: The bulk of the property market adjustment has already taken place. The authorities are finally putting a line in the sand by aiming to "achieve no further price declines and stabilise property prices".
3. Regulatory crackdowns for private businesses: With the authorities' focus on economic growth, heavy handed regulatory pressure on the private sector has peaked.
4. US-China Competition: This will persist. Unfortunately, the HK market was caught in the middle. With some international capital having departed, the HK market was severely discounted. In response, regulators in HK and China are planning to channel Mainland capital to invest in the HK market. Furthermore, following recent news of economic stimulus, foreign funds have already started to return.

At Ox, we believe this time is different. The authorities are addressing the important issues.

1. Deflation: Weak asset prices have been a main drag for the economy. The ex-Governor of the People's Bank of China (PBOC) publicly urged strong policies to fight deflation.
2. The Stock Market: The authorities showed clear intention to support the stock market. The PBOC is going to allow non-bank financial companies, such as insurers, asset managers and brokers to swap their bonds for cash to invest in the stock market. The initial facility is RMB500bn in size and offered more if needed. From our perspective, this is significant, as it means the PBOC is going to use its balance sheet to support stock prices! Furthermore, there are plans to set up special financing channels for public companies for buybacks, and PBOC is open to setting up a stock stabilization fund.
3. The Property Market: The aim is to stabilise the property market which implies a higher tolerance for property price appreciation. These new stabilisation measures include mortgage rate cuts, down payment requirement cut to 15% for first and second properties, financing for local governments to buy back inventories in the market, and banking support for whitelisted developers.
4. Injection of capital into the banks: This will enable the banks to more readily lend.

In addition, there are more policies being considered.

1. Local Government Financing: The Central Government plans to take over some of the debts from the local governments. More importantly, the Central Government is considering tax reforms e.g.  allowing local taxes to be collected by the local governments. These new measures will improve local government's fiscal positions, which has suffered from weak land sales.
2. Consumption Stimulus: Direct stimulus to provide incentives for consumption and lifting income tax tax-free threshold to boost disposable income.

While China has some structural issues, not unlike most other major economies, we have always believed that the key drag to the HK/China share market was a lack of willingness to sufficiently relax policies to tackle the deflationary impulse resulted from property market adjustment. It appears that the direction and magnitude of these new measures can potentially address these challenges.

The stock market related measures have the potential to re-invigorate the market and so far the impact is encouraging with share market trading volume in both the Mainland and HK surging with rising stock prices. The property market relaxation policies should stabilise prices.

If the authorities follow up by tackling some of the longer-term issues, such as local government finances and income distribution (via taxes and direct transfers), this can improve the fiscal sustainability, defuse risks for the economy and boost end consumption demand.

This pivot from the authorities can ignite the long-awaited Chinese economy reflation. Given the extremely attractive valuations, upside from here can be highly rewarding.

Funds operated by this manager:

Ox Capital Dynamic Emerging Markets Fund

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