Market update – November 2022

by Miles Flower | Nov 22, 2022 | Investment News

Markets show signs of optimism, but all eyes are on central banks.

Despite a mixed third-quarter earnings season and stubbornly high inflation, October results saw a comeback in most global sharemarkets. All eyes are now on central banks, as price pressures start showing signs of cooling. Read on to learn more.

A good month for most markets

2022 is quickly winding down, and it’s safe to say it has been an intense year for the investment markets. The headline news largely revolved around inflation, but according to economists, October provided some reprieve and sound returns over the month.

In their latest Market Commentary, AMP reported that the US sharemarket gained 8.1% in October, European markets were up 6.2%, and Australia and New Zealand saw increases of 6.0% and 2.5% respectively. But while most markets experienced a good month, emerging markets continued to struggle and the Chinese sharemarket was down 9.6% for the month, with the strict zero-Covid policy dampening consumer confidence and the economy at large.

Is the fight against inflation at a crossroads?

Over the past quarter, central banks across the world continued to try and tackle inflation with aggressive interest rate hikes, including our Reserve Bank. This has left many investors concerned about the extent of the impact on the economy, and the far-from-unlikely possibility that monetary policies may tip the global economy into a recession.

But more recently, there have been signs of economic cooling, supply chain pressures are easing, and the oil price is stabilising. As Kiwi Wealth highlighted in their Market Commentary for October 2022, markets seem to have shifted expectations regarding the trajectory of interest rate hikes. And in this respect, the US Consumer Price Index released in early November was promising.

At 7.7% in the year through October, the US inflation index was rosier than the 7.9% that analysts had forecast and down from 8.2% in the year through September – welcome news for the Federal Reserve, for American consumers, and of course for global markets. However, Federal Reserve officials said that it’s too early to celebrate, noting that more rate increases are likely to come, albeit at a slower pace. “Just like October, inflation will remain the primary investor narrative in November and likely till year-end,” Kiwi Wealth’s report concluded.

A closer look at the New Zealand market

Here in New Zealand, we’ll have to wait until 25 January 2023 for the next inflation index update. The latest data (September 2022) saw yearly inflation at 7.2% – higher than expected and down only slightly from the 7.3% reported in the second quarter.

This prompted the Reserve Bank of New Zealand to increase the official cash rate (OCR) by another 0.5% in October to 3.5%, the fifth consecutive 50 point basis hike since February 2022. And there are some predictions that the RBNZ may now front-foot inflation with an even more aggressive rate hike later this month. It remains to be seen how things will evolve in the coming weeks.

Mixed quarterly corporate earnings

It was a mixed Q3 earnings season. On the one hand, bank shares performed relatively well. On the other, the subdued earnings delivered by large tech firms seem to point to a slowdown in the global economy.

These include the likes of Microsoft, Facebook’s parent company Meta, Amazon and Google’s parent company Alphabet. Interestingly, Alphabet reported its weakest quarterly growth in nearly ten years, and Microsoft saw its slowest quarterly revenue growth in five years.

On the upside, 73% of the reporting companies in the S&P500 (the benchmark index for the US economy) experienced earnings above analysts’ expectations, compared to the long-term average of 66%. This goes to show that many companies are still managing through challenging conditions, though some have downgraded their growth expectations.

What happened in the rest of the world?

It’s been another eventful quarter overseas, marked by growing tensions around the Ukraine war, the UK’s shortest-ever Prime Minister tenure, and the start of a precedent-breaking third term for China’s president Xi Jinping. But let’s proceed with order.

• Europe & Russia: A quiet confidence is emerging amid the gloom of the European energy crisis. A warmer-than-usual autumn has given EU countries extra time to ramp up their winter gas supply, but according to The Economist, it’s premature to declare an end to the crisis. Faced with military setbacks, Putin may increase the pressure further by stopping all gas deliveries or vandalising infrastructure.
• The UK: Following Liz Truss’s resignation after just 45 days on the job, the new UK Prime Minister Rishi Sunak is looking to calm investment markets. Truss had come under pressure when her Government’s announced tax cuts prompted a sell-off in UK bonds and caused the British pound to fall significantly. Meanwhile, driven by rising food costs, UK inflation was recently back up to a 40-year high at 10.1%.
• The US: The mid-term elections were on this month, and things didn’t go as many had predicted. The shift in the balance of power in Congress between Democrats and Republicans – which could have a deep impact on the economy – didn’t happen. For the foreseeable future, market swings will likely be determined by the next interest rate movements.
• China: After the National Party Congress, the Chinese economy remains in a tough spot. There seems to be no end in sight for the country’s strict zero-Covid policy, and investors fear that with the new leadership team, China will isolate itself even further from the rest of the world.

Where to from here?

With so many different factors at work, it’s nearly impossible to predict the direction of the markets. All the economists and analysts that we have looked at agree that the ongoing challenges we’ve seen all year will likely persist. So, markets are expected to be unsettled for the foreseeable future.

That said, as AMP economists put it, “October has demonstrated that not all volatility is bad, and it goes both ways. Market ups and downs are a natural, and an inevitable part of investing. This is why it’s important to remain with your investment and savings strategy, and to focus on the big picture, so you don’t miss out on the market rebounds like we saw in October.”

In the meantime, here are some key local factors to watch, according to ANZ:

• Wage growth momentum – If the wage-price spiral keeps surprising, the RBNZ may need to increase the OCR beyond 5%.
• Net visitor arrivals – Migration flows are expected to recover, but they have a long way to go before returning to normal.
• Labour market – To overcome the ‘sticky’ domestic inflation, it’s crucial that the unemployment rate increases from the current 3.3%.
• House prices – To date, national house prices have fallen between 12% and 8%, depending on the analysis. How low they might go is anyone’s guess.   

Sources and further reading:

• ANZ Research – Quarterly Economic Outlook – November 2022
• AMP New Zealand – Market Commentary – October 2022
• Kiwi Wealth – Market Commentary for October 2022
• ANZ – The Month Ahead – November 2022
• ANZ – Adviser Wrap – October 2022
• NZIER – QSBO shows businesses are feeling less downbeat
• Stats NZ – Consumer Price Index (CPI)
• CNBC.com – Fed officials welcome inflation news but still see tighter policy ahead
• RBNZ – Monetary policy/OCR decisions
• The Economist –Europe’s energy crisis is very far from over
• Forbes – What Midterm Election Results Could Mean For The Stock Market

Disclaimer: Please note that the content provided in this article is intended as an overview and as general information only. While care is taken to ensure accuracy and reliability, the information provided is subject to continuous change and may not reflect current developments or address your situation. Before making any decisions based on the information provided in this article, please use your discretion and seek independent guidance.

Investment Update – November 2019

by Miles Flower | Dec 4, 2019 | Investment News

Heightened Sensitivity

Investors continue to face two contrasting scenarios:

A) Global economies remain subdued and markets decline from elevated levels;or

B)Central bank stimulus continues to prime the pump and markets continue to climb in value.

As a result, investors are fine-tuned to market signals as to whether to retreat to safety or continue to pursue returns from more risky positioning. Investor returns in October were driven by sentiment relating to the immediate impact of interest rate policy decisions and trade negotiations. Consensus outlook improved over the month as the new calendar year approaches. The International Monetary Fund (IMF) published its projections for 2020 and expects 2020 to be a better year than 2019 in terms of economic growth. However the IMF, as usual, makes its projections with significant caveats.

United States Key to Global Trends

The United States share market is being buffeted by the trade dispute with China but has remained remarkably resilient. The S&P500 rose over the month, recovering early losses. Third quarter earnings reporting occurred over the month with 74% of companies delivering earnings in excess of admittedly muted market expectations. This is despite most of the S&P 500 earning substantial revenues offshore and the US industrial sector showing definite signs of deceleration. Supporting the equity market is resilient US consumer demand which comprises 70% of US GDP and the effect of the Federal Reserve’s prior interest rate reductions. Where the central bank makes a change to the benchmark interest rate it typically takes several months for the effect to translate to the real economy. US GDP’s latest print was 1.9% per annum. This exceeded market expectations of 1.6%. The better result was driven by higher consumer and government expenditure. In contrast investment and trade segments of the US economy were weaker.

The US Federal Reserve has continued to cut short-term interest rates as ‘insurance’ against a slowing economy. The Federal Reserve reduced the Federal Funds rate to a range of 1.5% to 1.75% at the end of the month, down 0.25%. It appears that the Federal Reserve will not increase the Federal Funds rate while inflation remains dull.

Australasia not Isolated

The local economy and share market are affected by offshore developments in terms of externally facing companies’ revenues and capital flows into and out of the New Zealand fixed interest and equity markets. The New Zealand share market slipped in the month with some intra-month volatility. This volatility reflected the circumstances of particular companies and positioning in relation to changes to the MSCI index as it relates to New Zealand’s largest companies. The composition of the MSCI was reviewed with market speculation that Fletcher Building would be removed, and Mercury enter the index. These changes drive passive offshore investment flows into and out of shares.

In addition, both Fletcher Building and the electricity companies which represent a substantial proportion of the market index were impacted by company specific events. Fletcher Building’s convention centre project for Sky City suffered a fire which will delay completion of the project. As the insurance position of the respective companies is unknown the financial impact of the fire remains uncertain. Nevertheless, the issue will likely impact sentiment for a lengthy period of time as the parties’ dispute liability for the actual and consequential costs of the fire.

The electricity companies have been impacted by a reopening of negotiations by Rio Tinto over the price of electricity supplied to their aluminium smelter at Tiwai Point in Bluff. The smelter is a sufficiently large electricity consumer that if the smelter closes it will result in a fall in power prices for several years. All power companies are impacted by a market wide fall in electricity prices. Although closure is thought to be a low probability outcome, ongoing uncertainty will hang over company share prices until resolution.

Long-term interest rates in New Zealand and the United States rose slightly over the month. Longer term interest rates globally are impacted by US rates although the strength of the correlation fluctuates over time. Investors in fixed interest became less pessimistic as to the outlook for growth (trade negotiations between the US and China appeared to make progress) and the supply of bonds continued to expand. New Zealand interest rates reached a six-week high with the government 10-yearbond at 1.27% on 29 October. This is a large move in interest rates in a short time period but is still outweighed by falls earlier in the year. Bond fund returns were adversely impacted as a result. Market pricing in relation to a further cut in the Official Cash Rate moderated over the month but an overall expectation of a further cut remains.

Like New Zealand,the Australian share market was flat over the month. The Australian economy is providing mixed signals. There are a number of positive signs. Residential housing prices in the major Australian cities appear to have bottomed, but building consents declined 23% last month relative to the previous comparable period.

The Australian business outlook per Reuters forecast poll is for GDP to print at 1.9% for 2019 and for the Australian economy to pick up in 2020 to 2.5%. Positively, investors in Australian equities are paying a much lower average price earnings multiple than New Zealand although this is distorted by the preponderance of banking and resources stocks.

Performance of the Australian share market was held back by the major Australian banks taking further substantial customer remediation charges, and a further inquiry into bank’s mortgage pricing. Uncertainty over the Australian bank’s capital positions in response to changing regulatory requirements is also impacting bank share prices. The major mining companies, BHP and Rio, continue to be affected by a weakening iron ore price. Rio also owns aluminium smelters (including Tiwai Point) and clearly weak aluminium profitability is also a drag.

A feature of the month in Australia was the withdrawal of six company listings, including Latitude, a consumer finance business. The current biggest uncertainty in Australia is the Australian consumer who remains subdued, impacting consumer finance demand and discretionary retailers. To combat the absence of strong consumer demand, below target inflation and higher level of unemployment compared to New Zealand, the Reserve Bank of Australia reduced the cash rate to 0.75% at the beginning of the month. The withdrawal of the floats is being interpreted as exhibiting healthy tension between investors and promoters rather than symptomatic of inherently weak demand for new issues.

New Zealand Property

The returns from New Zealand commercial property in the last year have been exceptional, at over 30% including dividends. The domestic property market is not homogeneous, and returns can vary depending on geography and property type. Although high returns have been achieved rental growth has not kept pace and yields have fallen. While there appears to be strong demand for industrial property, extra supply of office property in the major centres may result in higher vacancy and minimal near-term rental growth in this market segment. While property may remain attractive to yield investors relative to fixed interest, continued gains of the past magnitude are unlikely.

International Interest Rates

International interest rates outside of the US look likely to remain at low levels in the year ahead with minimal signs that central banks will pull back from quantitative easing. The outlook appears to be asymmetric in terms of investor risk from a yield and capital appreciation perspective. The ECB kept rates unchanged at Governor Draghi’s last meeting on 25 October. One example of the extremes now occurring are interest rates in Greece. Greek 3-month Treasury Bills were issued at an average negative yield during the month. This contrasts starkly with the situation several years ago when Greek rates surged, and it was feared a Greek default would lead to a widespread collapse.

Outlook

Despite the caution arising from the subdued industrial outlook and lower prevailing business confidence ,share values could be justifiable. The immediate outlook for short-term interest rates is for them to remain anchored at current levels due to central bank actions attempting to lift prevailing inflation rates. There is some scope for longer term interest rates to rise as markets re-assess the growth outlook and conclude that it is not as bleak as pre-supposed. A steepening of the yield curve is not to be discounted but any increase in interest rates is unlikely to be large. Equally, interest rates may continue to remain around present levels. Less likely is a scenario where rates diminish materially from current levels. That being the case it is unlikely that investors will experience the same level of capital return from yield sensitive stocks. In particular given the high rate of capital appreciation from property that is unlikely to be repeated, client portfolios that have been overweight property might bank some of these gains. Given the better potential returns from equities and what appears to be a benign forward outlook a higher allocation to equities appears to provide greater scope for portfolio accretion.

In an environment where GDP growth and general earnings growth is likely to be more subdued, that is all boats will not be lifted to the same extent by the economic tide, selective share positioning will be increasingly important to optimise portfolio returns. We increasingly believe an active rather than a passive approach is desirable.

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Information and Disclaimer:

Source:JMI (previously JMIS), the investment consultant to the Select Wealth Management service.

This report is for information purposes only. It does not take into account your investment needs or personal circumstances and so is not intended to be viewed as investment or financial advice. Should you require financial advice you should contact Miles Flower on 021 645 000.

Investment Update – October 2019

by Miles Flower | Oct 22, 2019 | Investment News

Politics Intrudes on Markets

The risk of President Trump’s impeachment increased in September with Democrats instigating the first stages of the process. The seriousness for US markets will take time to play-out but political focus is likely to drift from the economy and the US budget. In the United Kingdom the Brexit outcome remains chaotic making it difficult for investors to have confidence.

The continuing threat of geopolitical conflict disrupting the smooth functioning of economies was also evident in September. The attack on the Saudi Arabian oil refineries resulted in the oil price spiking short-term. Oil reserves and the ability to repair the damage quickly alleviated the immediate impact.

US Interest Rate Bounce  

Interest rates in the US bond market fell dramatically in August. The US 10-year government bond rate fell half a percent, one of the largest monthly falls since the Global Financial Crisis (GFC). This resulted in a predictable response from borrowers in early September to the low rates with a rash of bonds being sold into the market. The US corporate bond market had record issuance on 8 September with 49 deals in 30 hours totalling US$54 billion. Even cash rich Apple took advantage issuing US$7 billion of bonds including a US$1.5 billion 30-year bond paying 2.99%. The US Government was also encouraged by the low rates to refloat the proposal to issue very long-term bonds of 50 years.The overall trend in interest rates remains “lower for longer” but the trend has not been smooth. United States interest rates bounced back in mid-September. This unsettled the share market and investors switched from high priced revenue growth shares to more traditional profit generating companies.

Over recent years markets have been focused on growth over value. September may represent the first signs of a pivot between these two strategies.

Central Bank Policy

Central banks are concerned with the long-term management of financial conditions focusing on inflation and employment levels. In doing so they look through the short-term fluctuations experienced in the market. A number of central banks delivered policy statements in September. Generally, these statements were consistent with investor expectations. The Federal Reserve delivered a quarter percent cut in line with market pricing. The Bank of Japan kept monetary policy steady but signalled it could ease next month. The Bank of England kept rates steady at 0.75% and the RBNZ similarly held the Official Cash Rate (OCR) at 1%.  Post its decision to reduce the US benchmark rate the Federal Reserve has had to intervene in the overnight cash market on numerous occasions and provide additional cash injections as cash rates rose above the target levels. This is the first time the Federal Reserve has had to intervene in this manner since the GFC. The liquidity problem appears to be more technical rather than a reflection of wider fundamental problem but may require the Federal Reserve to once again expand its balance sheet.

Central bank monetary policy implementation reflects actual and anticipated conditions in the real economy. Increasingly, the economic outlook is subdued, and hence central banks are continuing monetary stimulus. However, economists are challenging the effectiveness of such policies in isolation. The effectiveness of monetary policy alone is diminishing, and central banks are calling on governments to undertake more fiscal policy (increased government spending or tax cuts) to support economies.

Trade War Impact

The US economy has been only moderately impacted by the trade war to date, but the signs of increasing effects are becoming apparent. US GDP growth and inflation remain reasonable but below target and below prior levels. US GDP for the second quarter remained at a 2% annual rate. Inflation using the Federal Reserves’ favoured measure was 1.9% annualised just below the 2% target. US job growth in August was lower than expected but unemployment has held at a steady and very low level of 3.7%. The US consumer remains healthy, but consumer confidence slipped in September. Signs in the industrial segment are less positive. The Cass freight index dropped 3% in August the 9th month of consecutive declines. Surveyed manufacturing activity declined in August for the first time since early 2016.

China is also experiencing a slowing of its economy. The Chinese manufacturing index for August showed contraction whereas non-manufacturing in August was expansionary. Exports fell in August by 1% year on year. The Chinese economy perhaps is not being as severely impacted as expected as the Chinese government took early action. Monetary stimulus is now being followed by fiscal stimulus and the authorities have further levers to pull. China appears to be positioning itself for a long-term impasse with the US developing technology internally and diversifying external trade relations so as not to be as reliant on the US.

Australasian Effects

The health of the Chinese economy directly impacts on the export earnings of Australia and New Zealand and the general buoyancy of the Australasian economies. Australia achieved a current account (trade in goods and services) surplus of A$5.9 billion in the June quarter, the first current account surplus in 44 years. This result occurred despite the fall in coal and iron prices which may show up in future quarters. Australian GDP continued to grow at a rate of 1.4% year on year, but this is the slowest rate of growth in 10 years. The jobless rate has remained above 5% in Australia despite the cuts in interest rates by the RBA.

New Zealand similarly has a positive but slowing rate of GDP growth. In the June quarter GDP growth slowed to 2.1% annually, a five-year low. Services sector activity remained buoyant in August, but the manufacturing index contracted.

Similar to the United States New Zealand borrowers were active. There was overall bond issuance of $3.2 billion in September and bond maturities of $314 million.  The New Zealand Government issued $2 billion of bonds in September including $250 million of 2025 bonds. Demand for the 2025 bonds was strong with $810 million bid. However, despite the 3 times cover, the interest rate was not bid lower for the first time in 8 consecutive bond tenders.

Europe Continues to Slow

European markets appear to be more adversely affected by the trade war and their own local economic issues. Germany’s manufacturing sector, the engine of Europe dropped to its lowest level since the GFC. The Bundesbank projected that the German economy has entered a mild technical recession. The European Community reflected global trends with the services sector remaining in mild expansion but the manufacturing sector contracting.

Summary

We continue to be cautious in our outlook. In isolation events such as US Presidential impeachment proceedings are unlikely to be overly disruptive, but the weight of factors combined requires ongoing vigilance. In the fixed interest market sentiment remains for low rates to prevail. Potentially short-term rates in New Zealand will likely continue to decline but some steepening of the yield curve could occur as short-term rates fall further, and longer-term rates do not decline to the same extent. The market currently prices an aggressive reduction in the OCR over the next year of a further 0.40%. That said the possibility of negative rates has diminished over the last month. RBNZ Governor Orr in his most recent speech stated “…in our current view we are unlikely to need unconventional monetary policy tools.” Similarly, global interest rates appear likely to continue to moderately decline/remain with current trading ranges. In an absolute sense interest rates have limited scope to decline further. While the tail winds for the fixed interest rate markets are dissipating there appears minimal risk that rates will lift materially in the near term.

Although economies are slowing, they are not in recession. Within stock markets non-cyclical growth at reasonable price is becoming more difficult to identify. However, earnings yields remain positive and equity values are supported by interest rates. Given the differential in yields between fixed interest and shares is likely to persist, the relative attractiveness of shares is preserved.