Monthly View – October 2020

Interest Rates continue to fall

Interest rates fell over the month of September and for the first time in New Zealand some market rates went negative. Into the tail end of the month government bonds with maturities out to 5 years were providing negative yields. This implies that a purchaser of these bonds, if they held them to maturity, would receive a negative return on their investment. The negative yields are a direct result of monetary policy in New Zealand and signal the expected direction and level of interest rates under the current policy settings. The RBNZ has advised financial institutions to prepare for the possibility of a negative Official Cash Rate (OCR) in terms of their systems. This is important as the OCR has an influence over the short- term interest rates retail investors receive from banks. The RBNZ has also continued to aggressively buy bonds issued to the market reducing the level of interest rates generally. Messaging from the RBNZ and Minister of Finance has been that interest rates will remain low, and potentially negative in some instances, for as long as required to lift the New Zealand economy back to full employment and a ‘healthy’ inflation rate. This suggests that the time period over which interest rates are at near zero levels will persist potentially for a number of years.

Term deposit rates have followed bond rates down. Bank term deposit rates are now below 2% on all terms out to 5 years. Despite the low current rates there is still some potential for interest rates to decline further given central government objectives and it is conceivable that term deposit and bond yields will follow.

The decline in interest rates has been prolonged and this has impacted on the income available from fixed interest investments. As interest rates continue to fall into 2021 clients who require a regular income from their investment portfolio, and have an allocation to fixed interest, will find the return from this asset class will be near zero. These low interest rates may continue over the next few years, requiring those investors to re-evaluate their objectives and expectations. Allocating more investments to shares can increase the income as well as the return for investors over the long-term, but this will come with additional risk of the capital value of their portfolio rising and falling.

Portfolio Impact of Low Interest Rates on Debt Securities

Interest rates approaching zero, and potentially below, will result in the potential for capital gain but this is not on an open-ended basis. If eventually the current trend reverses and rates begin to rise in the future, then there is potential for capital losses to be incurred and given the low level of rates the magnitude of losses is amplified. An investor is faced with an investment class that after tax may generate an income for investors of close to zero but if interest rates rise, which may be some years away, a potential capital loss. We expect that in 2021 the risk and reward equation of investing and receiving nothing with the potential for a capital loss will test many investors’ patience. As an example of what an investor could expect from fixed interest is the recent new issue by Mercury Energy of a 7-year bond at 1.56% p.a.

Portfolio Impact of Low Interest Rates on Shares

The fundamental driver of share values is cash flow generation into the future, discounted to obtain a present value. Lower interest rates decrease the discount rate and increase

the theoretical value of the shares. Likewise, the relative attractiveness of dividends to investors improves as interest rates fall and provides a further driver to capital growth in share values. In this scenario both growth companies and yield companies are beneficiaries of the underlying monetary conditions.

In the short-term the translation of these market drivers is not always evident as other factors influence the direction and magnitude of price changes in specific securities. In the last month the S&P/NZX Gross index fell 1.6%. In contrast the S&P/NZX All Real Estate Gross index rose by 2.6%. The broader market index weakened as the previous market leaders A2 Milk and Fisher & Paykel Healthcare share prices fell over the month 17.5% and 9.7% respectively.  These two companies are growth businesses with no and minimal distribution yield respectively. With the knowledge that low interest rates may be something we will need to live with for some time, property emerged from a period of underperformance as yields from property companies once again became compelling with an income return to investors of approximately 5% p.a.

Global share markets also lost traction in local and New Zealand dollar terms. The US market as measured by the S&P 500 lost the most ground. High flying stocks such as Amazon slipped (-8.9%) and investment flowed to value companies e.g. building materials (Martin Marietta +9%) and traditional delivery company FedEX (+15%). Initial public offerings of technology companies continued to be well received e.g. Snowflake and Unit Software listing at large premiums to issue prices.


The current interest rate settings are confronting conservative investors with a stark choice. If investors place greater weight on capital preservation, then the status quo in terms of asset allocation continues but this will be at a cost of minimal income. In order to generate some income from portfolios investors will need to consider increasing the risk within fixed income assets or move from fixed interest to other ‘stable’ assets that generate reliable cash flows, such as selected forms of property and infrastructure companies. Investing in these assets is not without hazard and is always subject to the characteristics of quality and price. There is a popular saying ‘TINA’. (There Is No Alternative). It looks like we might be in a low interest environment for some years and the hunt for income will put pressure on assets that offer an investor an income.

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 – November 2019

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.


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.


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

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.


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.


Investment Update – August 2019

Addicted to monetary policy

Markets have been fuelled by a decade of bailouts and dovish monetary policy. It’s hard to ignore the importance of this fact and how it has characterised the current economic expansion. Just recently the Federal Reserve has cut its main interest rate by 25 basis points, the first reduction since the financial crisis, and signalled that it was prepared to ease monetary policy further if necessary. In its policy statement, the US central bank suggested the monetary easing was justified by “uncertainties” stemming from weakness in the global economy and simmering trade tensions. Adjusted for inflation, the Fed’s benchmark rate is now just a quarter of a percent and the cost of borrowing has rarely been closer to free, but the dependency for easy money keeps growing. With trade wars threatening the global economy, Federal Reserve officials say rate cuts are needed to keep the slowdown from spilling into the United States, and to prevent doggedly low inflation.

Wage growth is also preoccupying policymakers. Last year, Mr Powell and other Fed officials assumed that wages would pick up as the US economy barrelled towards full employment, feeding through to higher prices and inflation. This dynamic would be the trigger for rate rises. But it did not turn out that way. Now Mr Powell launched a review of the Fed’s policy framework, and changes to the way officials look at inflation rose quickly up the agenda.

Many Western economies are facing a similar ominous backdrop following the global financial crisis of 2008. Since then central banks have responded aggressively to every hint of a downturn, making money ever cheaper and more plentiful to try to juice growth. Yet, in this expansion, the United States economy has grown at half the pace of the post-war recoveries and inflation has failed to rise to the Fed’s target of a sustained 2 percent. Meanwhile, every new hint of easy money inspires fresh optimism in the financial markets, which have swollen to three times the size of the real economy.

Trade negotiations on twitter

US President Donald Trump said the US would place a 10 per cent tariff on $300bn of additional Chinese goods, escalating the trade war between Washington and Beijing in a new threat to the global economic outlook. The announcement shook financial markets, sending the yield on the 10-year Treasury note to its lowest level since 2016 and pushing down stock prices after they had risen earlier in the day.

In a series of afternoon tweets, Mr Trump shattered a tenuous truce he reached with Xi Jinping, his Chinese counterpart, at the G20 summit in Osaka in late June, which had paved the way for a new round of high-level upcoming talks in Shanghai. The truce with Xi Jinping temporarily suspended his threatened imposition of duties of up to 25% on $325bn-worth of Chinese imports, but leaves in place all previous tariffs imposed during the trade war. Trump also threatened in May to impose tariffs on all imports from Mexico if it did not crack down on immigration but reversed himself in June. He has delayed till November a decision on whether to impose tariffs on automobile imports, which would hit European manufacturers hard.

Global trade growth has fallen from 5.5% in 2017 to 2.1% this year, by the OECD’s reckoning. The immediate threat comes from President Donald Trump’s imposition of tariffs on America’s trading partners and renegotiation of free-trade agreements, which have disrupted long-standing supply chains in North America and Asia.

Slowing, but resilient US GDP

In the US there have been some signs of a slowdown, with second-quarter growth coming in at 2.1 per cent, a big drop compared to 3.1 per cent in the first quarter and a far cry from Trumps 3%.

However, the gross domestic product figures topped Wall Street’s median forecast. Strong consumer spending helped sustain the expansion even as businesses cut back on investment. The GDP showed substantial softness in business investment but other parts of the economy are holding up. Consumption remains strong, as is the labour market which experienced solid employment growth in June.

Brexit uncertain is a certainty

Britain now has its third Tory prime minister since the vote to leave the European Union three years ago. Its deadlocked Parliament is refusing to back the exit deal struck with the EU, even as an October 31st deadline approaches. The uncertainty is quickly reflected in the pound, which is near an all-time low against the US and wilting at the prospect of crashing out with no deal. Steering a course out of this mess requires an extraordinarily deft political touch. Boris Johnson, socially liberal, pro-immigration but more recently turned Eurosceptic, has been chosen for the tall order.

Mr Johnson may be making similar mistakes as his predecessor Mrs May. Her undoing was through making unrealistic promises about the deal Britain would get, pledges she spent two dejected years retreating from. Boris promises he will bin the “backstop” designed to avoid a hard border in Ireland, which the EU insists is non-negotiable. He claims Britain need not pay the exit bill it agreed on and he says that if the EU does not roll over, it would be “vanishingly inexpensive” for Britain to leave with no deal. Mrs May found the contact with reality hard enough, for Mr Johnson it could be brutal.

Getting the support of parliament is an additional complication for Mr Johnson. The Conservatives’ hold a narrow majority, with plenty of rebels on both the Brexit and Remain wings. So, doing a deal would probably mean working with Labour, whose price is a second referendum and unlikely to be acceptable to hard-line conservatives. In the Brexit saga uncertain is a certainty.

Australia regionally positive

Since the Federal election saw the unexpected return of the centre-right Liberal/National coalition government there has been a period of stabilisation in Sydney and Melbourne property markets. The election result removed the prospect of significant changes to taxation arrangements for property investors which could partly explain the modest recovery that the recent house sales volumes and numbers suggest.


Familiar triggers for recession are still absent which suggests that the (moderately) good times can roll on. The trouble with this logic is that, just as the economy has changed, so have the risks and it is inevitably hard to identify exactly what might go wrong. Dependency of growth on monetary policy cannot be sustained indefinitely and political risks such as Brexit and US China trade tensions remain on the horizon with potentially disastrous consequence.

The good news: households and firms in developed markets can borrow at exceptionally low rates, unemployment is low, labour income continues to grow, and business cost pressures are visible but modest.

A balanced and diversified approach to investment remains appropriate.

Market Update – May 2019

Last month we wrote about the significance of the dovish positioning from the central banks around the world led by the Fed backing off interest rate increases earlier in the year. This response from central banks worked to support markets and was essential to offset investors’ concerns around slowing global growth. The relationship between slower growth and low interest rates remains a central theme to the global economy and is a key consideration for investors.

There were some positives in April to restore some confidence that a slowdown in global growth was previously overstated by some commentators. Trade flows are picking up in Asia, America’s retail sales have been strong and even Europe’s beleaguered manufacturing industry has shown flickers of life. Also positive, albeit retrospective, was the news that the US delivered beyond market expectations for first quarter 2019 GDP growth, while defying claims of a possible earnings recession.

However, it would not take much bad news to reinstate caution. The global economy has slowed and further downwards momentum, or a new negative shock, could further weaken economic prospects. Policy risks in the form of deteriorating US-China trade relations and a No-Deal Brexit remain key threats too.

US – Economy boasts +3.2%… but still no inflation

The US economy defied fears of a first-quarter slowdown, overcoming a prolonged government shutdown, trade tensions and global economic uncertainty to deliver growth that trounced analysts’ expectations. Gross domestic product rose at an annualised pace of 3.2 per cent during the first three months of the year, handily topping Wall Street predictions for 2.3 per cent growth. It is also an improvement from the 2.2 per cent pace of expansion recorded during the fourth quarter of 2018. The robust reading is a boost for economies around the world after a growth scare earlier this year triggered a fall in bond yield.

The data quelled previous fears that the US is running into an imminent recession and leaves the economy on track to hit its longest-ever expansion later this year. But beneath the impressive headline growth figure, some of the underlying detail in the report was less buoyant. Consumer spending slowed from the fourth quarter and growth relied heavily on a build-up in inventories, which could reverse later this year. The report will further complicate the policy deliberations at the Federal Reserve, which is weighing firm headline growth and a resilient labour market against perplexingly soft inflation as it considers whether the next move in rates should be down rather than up.

The US central bank, led by chairman Jay Powell, is likely to keep policy unchanged at 2.25 to 2.5 per cent for the more immediate future. With US activity improving after a shaky start to the year and overseas risks diminishing, many commentators suggest the Fed will likely keep rates at their current level for the remainder of the year.

US-China trade negotiations – high hurdles remain

As U.S. and Chinese officials try to close a trade deal, the punitive tariffs the governments slapped on each country’s goods in the conflict stand as a major obstacle. High-level talks between the U.S. and China recently resumed in Beijing. As they work through final issues, including planned Chinese purchases of U.S. goods, how and whether to remove the tariffs the two governments imposed in the earliest phases of the dispute are now at the forefront of the talks. At issue is how much of the tariffs the U.S. levied on $250 billion of Chinese goods will be removed. The U.S. wants to leave some in place as a tool to enforce the agreement while Chinese negotiators see those tariffs as an affront, and negotiators have batted the issue back and forth for at least a month.

One can be confident Beijing won’t want to accept a deal where the U.S. continues to insist on imposing tariffs, and prohibits China from retaliating, as a way to make sure Beijing fulfils commitments in a trade deal. The tariffs would be embarrassing for the leadership and politically difficult to sell to Chinese businesses and other domestic constituencies. The current tariffs also created uncertainty for investors, compounding last year’s slowdown in the Chinese economy.

Europe – Some green shoots

In March this year, the narrative surrounding the euro region was driven by fears of ‘Japanification’ (describing the environment of deflation and expansionary monetary policy such as experienced in Japan). The manufacturing Purchasing Managers’ Index (PMI) for the region had declined, despite a rise in PMIs around the world. At the same time, the European Central Bank extended their forward guidance for the period in which rates will remain negative to the end of the year, raising the prospect of a negative rate trap (where target interest rates are set below zero) for the region and its banks. Just one month later the macro view of Europe is turning more positive. Business confidence is still low but has recently posted its first increase in six months and retail spending has improved, supporting the case that strong labour markets will continue to support household spending. However more generally, across Europe confidence continues to wane across all sectors, which suggests activity indicators will continue to print on the soft side and interest rates will remain low for the foreseeable future.

UK – Kick Brexit down the road

In our April economic report, we wrote about the chaos created by Brexit and apparent lack of a clear and viable way through. Since then not much has changed except to provide for more time (31 October is the third ‘final’ deadline). Mrs May asked the EU for more time because MPs voted down her exit deal three times. Getting the House of Commons’ bipartisan approval for the draft treaty is still a big challenge, unless the talks between the Conservatives and Labour produce a breakthrough. But the Prime Minister is wishful that the deal can be approved and ratified before May 23, so Britain can avoid holding elections to the European Parliament that day.

In a blow to the chances of a second referendum, Jeremy Corbyn has seen off a challenge from Labour’s Europhile wing, defeating a bid to commit the party to holding a second EU referendum in all circumstances. The Labour leader announced afterwards that the party would maintain its existing policy of backing a soft Brexit with a customs union. He added that Labour would support the “option” of a public vote only if it was unable to secure the changes to the government’s existing withdrawal deal and could not force a general election.

Australia – Location, Location, Location

Across the Tasman, Australian economic growth remains constrained as the housing market in Sydney and Melbourne continues to negatively impact consumer spending and housing construction. The labour market is holding up well, but the softening in the housing market is expected to hit jobs related to construction, housing services and retail, and cause a rise in the unemployment rate. Business investment growth is improving as mining investment is no longer acting as a large drag on the economy, but non-mining business investment remain underwhelming.

Sydney’s median house price will fall below $1 million within the next two months even if the property downturn eases slightly from its current pace. Sydney house prices have now fallen 14.3 per cent from their mid-2017 peak, including a drop of 3.1 per cent over the March quarter. Melbourne house prices fell 10.4 per cent over the year and 2.4 per cent over the quarter.

An election later this month is likely to see a new Labour-led coalition. This has the potential to bring some policies which are business unfriendly.

New Zealand – following the herd

New Zealand GDP growth, emblematic of the global economy, shifted down a gear as the data for second half of 2018 was disappointing, and rising capacity constraints will continue to have a moderating influence on growth in activity. There are tailwinds, largely on the back of fiscal stimulus and growth in labour income.

According to the ANZ Business Outlook Survey, business confidence and firms’ own activity outlook were little changed in April with both remaining at levels well below their long run average (47pts below and 20pts below respectively). Capacity utilization fell to a new post-GFC low.
The RBNZ signalled a material dovish pivot at its April meeting part of which highlighted concerns around a slowdown and ongoing weak business surveys. There is little in the ANZ survey to allay the RBNZ’s concerns on the latter. The RBNZ decided to cut the OCR by 25bp at its May meeting.


We are cautiously positive on equities because economies around the world are still expanding at decent rates and there are no apparent inflation trends. While there are risks that could push the markets periodically downwards, we believe that last year’s bearish moves restored some value to the markets and interest rates now look to be heading lower, not higher.

We believe that maintaining your long-term neutral asset allocation continues to be appropriate in light of the environment.


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 Market Update – Dec 2018

Global Markets Overview

Globally, the Fed and US-China trade relations continue to take centre stage in the economic theatre of 2018 (so far a drama not a tragedy) while Brexit and Italy present challenges to the European outlook.


US / China Trade

In a much-anticipated working dinner in Buenos Aires following the G20 summit, Mr Trump and Mr Xi agreed to a temporary ceasefire, in which the US president suspended his decision to impose higher tariffs, from 10% to 25% on $200bn on Chinese imports until March 1st, 2019 at the earliest. In exchange, China will increase its purchase of American farm produce, energy and some industrial goods. However the truce is fragile and formal talks between the two countries could well fail due to the high hurdles that stand in the way of agreement. First, the Chinese commitment to raise purchases of American goods is by an amount “not yet agreed upon, but very substantial” is unlikely to reduce America’s bilateral trade deficit with China by a significant amount. Second, the challenge that negotiators now have 90 days to agree “structural changes with respect to forced technology transfer, intellectual property protection, non-tariff barriers, cyber intrusions and cyber theft, services and agriculture” is ambitious, particularly when levels of trust between the two sides are so low. It is evident that this theme will continue into 2019.



China’s recent slowdown in gross domestic product growth is unsettling global markets and testing the Communist party leadership. Beijing is determined to keep its economy stable but doing so means tackling the politically sensitive issue of its private sector. Private enterprises are China’s economic mainstay, contributing about two-thirds of output and investment and the lion’s share of jobs. They drive the prosperity upon which the Communist party’s legitimacy rests. Yet Mr Xi has favoured state-owned firms since he took power in 2012 and clipped the wings of several high-flying private entrepreneurs. Now, as Beijing seeks to stiffen its resolve in the US-China trade war, the private sector’s dynamism is flagging, creating economic headwinds. Third-quarter GDP growth slipped to 6.5 per cent, year on year, its slowest since 2009. While this is by no means lacklustre, there are signs momentum could slackenfurther.

We expect flexible policy to come from Beijing as it attempts to manage headwinds associated with trade disputes, slowing demand and negative sentiment toward its equity markets causing investment outflows. China has accounted for 36% of global GDP growth since 2010 and has played a vital role in the economic recovery. This too will be a key focus for the global economic outlook in 2019.



Political uncertainty in the UK is extreme currently and reflected in investor positioning in sterling and UK equities.

Theresa May is battling to save her Brexit deal and her own position as Prime Minister after a series of ministerial resignations and the threat of a Eurosceptic coup left the Conservative party on the brink of civil war. Mrs May insisted she would stick to her plan, which would keep Britain closely tied economically to the EU, and said she was not about to quit in spite of growing criticism from Brexiters in her own party. Mrs May warned that Britain would embark on “a path of deep and grave uncertainty” if it abandoned the withdrawal deal it had agreed with the EU.

It’s unclear whether the refusal of May’s deal by British parliament would turn into a ‘hard’ Brexit (i.e. with no deal). The crucial vote in Parliament is on December 11th. May said there was no plan B, however, some commentators suggest that the transition period may get extended again due to the complexities of reaching a deal. The more it is extended, the closer it gets to the June 2022 election, increasing the likelihood of a potential second referendum.

Britain’s Treasury estimated that GDP will be 3.9% smaller in 15 years’ time than it would otherwise have been if the country leaves the European Union under the deal recently agreed with EU leaders. Under a no-deal Brexit, it would be 9.3% smaller.



The Fed’s tightening path had fuelled fears about a sharp downturn in the US housing sector. Home sales have slowed, inventories are rising, and homebuilder equities have sold off over 30% YTD.

However, the recent market reaction to a statement from the Federal Reserve Chairman Jerome Powell that we are approaching neutral shows how critical investors see this current period of tightening. Sharemarkets rallied as Jerome Powell said he sees current interest rates “just below” neutral. That proved to be significant because the language Mr. Powell used 6 weeks earlier indicated a view that the fed funds rate was “a long way from neutral.” Powell added that there is no pre-set policy path, and the Fed will be data-dependent in its decision making, which pleased investors. By highlighting risks, though, that included previous rate increases, trade disputes, and Brexit/EU political uncertainty, the market chose to read between the lines that the Fed chair isn’t wedded to three rate hikes in 2019.

The results for the recent US midterm elections were widely predicted (which is a surprise by itself). Democrats took the House of Representatives which will provide some oversight of the White House when members of the new Congress take their seats in January. Republicans held the Senate—with a bigger majority, which will make presidential appointments easier to confirm. Both sides declared victory. A starkly divided country now has a divided government. Underpinning the results, though, is the deepening of a structural shift in American politics that will make the country harder to govern for the foreseeable future.



The fate of the euro strongly depends on Italy. With annual GDP of more than €1.6trn ($1.9trn), about 15% of euro-area output and debt of nearly €2.3trn, it poses a challenge to the single currency that Europe seems unable to manage but cannot avoid. Matters are now coming to a head, as Italy’s new coalition government instigates a showdown over the European Union’s fiscal rules. The disagreement might well become disastrous. But it is also an opportunity for the euro zone to begin building a better, more durable approach to fiscal policy.

Trouble began earlier this year when the populist Five Star movement, led by Luigi Di Maio, formed a government with the right-wing Northern League, led by Matteo Salvini. Both promised budget goodies: Mr Salvini a hefty tax cut and Mr Di Maio a basic minimum income. Such a bounty may test the deficit limit of 3% of GDP set by the EU’s stability and growth pact and it seems certain to break other fiscal rules set by the bloc: the government’s initial budget plan is forecast to raise borrowing to 2.4% of GDP in 2019, above the 0.8% target to which Italy previously committed itself and enough to reverse recent, modest declines in its debt burden.

The EU did not take the news well. On November 5th other countries’ finance ministers warned that failure to revise the budget would lead to an “excessive deficit procedure” and possible sanctions.



We expect real GDP growth of around 3% by end-2018. Such a pace of growth should see the unemployment rate largely track sideways over 2018. Household incomes and consumption growth remain weak, possibly due to a weaker housing market, particularly in Sydney and Melbourne.


New Zealand

While actual economic output continues to grow a persistent downturn in business sentiment has emerged. The ANZ business outlook survey reported that headline business confidence remained stubbornly low, with a net 37% of respondents reporting they expect general business conditions to deteriorate in the year ahead. The likely explanation for which confidence is being rocked is a combination of policy uncertainty, capacity restrictions and margin pressure.

Labour market conditions have now tightened to a point where we expect wages to (finally) begin to move higher. However the RBNZ took an unexpectedly dovish turn in the August MPS, despite expecting modestly higher inflation in the near-term, and it has reiterated this approach recently.



For New Zealand, our economy has been supported by the tailwinds of record-high Terms of Trade, low interest rates and strong population growth. Nonetheless, business confidence remains weak and points to an upcoming slowdown in growth led by a fall in business investment.

Globally the combination of strong growth and loose financial conditions was highly supportive for equities in 2017. This year we have seen a tightening of financial conditions alongside a divergence of global growth, with the US outperforming. In 2019, we see renewed economic convergence driven mainly by the US economy slowing at a time when inflation pressures and interest rates are increasing. We do not see a recession as likely in 2019. Without a recession, it is unlikely that profits fall. Without profits falling, it is unlikely that we see a sustained equity bear market.

There has been a cyclical increase in global economic activity over the past couple of years, but we believe the longer-term outlook for economic growth remains subdued with risks to the downside because of structural headwinds. The US – China trade talk news will underpin investor sentiment in the short term. In 2019, investors should ensure that their portfolios have a risk exposure consistent with their risk tolerance.



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.