Most asset classes have done well. Bond yields have dropped back, despite the Fed tightening US monetary policy, as investors reckon that the strong fiscal stimulus they previously expected from the incoming Trump administration will, at a minimum, be delayed. Equities have benefited from both lower bond yields and from more evidence that the global economy is improving. Looking ahead, bonds will face serious headwinds as the world economy continues to pick up; equities have the potential to make further gains, but on expensive valuations (particularly in the US) they have limited capacity to absorb any unexpected adverse setbacks. At home, the robust economic cycle continues to support local property and equities.
New Zealand Cash & Fixed Interest
Short-term interest rates are unchanged, reflecting the unchanged stance of monetary policy: The Reserve Bank of New Zealand left the official cash rate at 1.75% at its most recent policy announcement on 22 Jun, and the 90-day bill yield continues to trade at a little below 2% (currently 1.94%). The RBNZ’s official line is that it will keep interest rates where they are until late 2019, at which point it envisages a 0.25% increase in the OCR. Perhaps it will be proved right: there is a respectable argument to be made that inflation will take a long time to get back up to the central banks’ typical target of 2% and will require ongoing monetary stimulus to get there at all. Now, however, few other people believe the RBNZ’s argument. Forecasters don’t, with the BNZ, for example, picking a 0.25% increase by March 2018.
The recent decline in bond yields has been good for the listed property sector: It had dropped sharply when bond yields rose in the "Trump trade" era of late 2016 and early 2017 but has been regaining lost ground since mid-March. For the year to date the S&P/NZX All Real Estate Index is now showing a 3.6% capital gain and has delivered a total return of 6.3% (6.9% including the value of imputation credits). It has, however, underperformed relative to the wider share market, which delivered a total return of 9.8% (10.4% with imputation). It was the same story with the Australian A-REITs, which have also benefited from a lessened threat of imminently higher bond yields. There, too, the sector bottomed out in March and has recovered as bond yields have fallen; for the year to date the S&P/ASX200 A-REITs Index has provided a capital gain of 3.0% and a total return including dividends of 3.9%. The total return exactly matched the return from the wider equity market.
New Zealand shares have been doing well. Although overseas equities have been a little weaker in recent weeks after peaking in early June, local equities have had a better month, and for the year to date the S&P/NZX50 Index is showing a capital gain of 7.6% and a total return including dividends of 9.8% (10.4% including the value of imputation credits).
Australian shares have been more in line with overseas developments: Although there has been significant day-to-day volatility, Australian shares are a little lower than where they started at the beginning of June. For the year to date the S&P/ASX200 Index is up 1.9% in capital value and has returned 3.9% including dividend income. The modest scale of gains, especially in comparison with overseas markets, reflects the drag of the miners (down 3.6% for the year to date), who have been affected by recently lower commodity prices, and the financials sector (down 1.8%).
International Fixed Interest
The key event for the asset class has been the Fed’s latest policy move. While recent inflation data in the US has been a little below the Fed’s target 2%–the exact measures vary but are generally around 1.5% to 1.7%–the Fed was nonetheless widely expected to keep to its recent policy of very gradually raising US interest rates. And so, it proved at the Fed’s latest meeting on 14 June, when it raised the target range for the federal-funds rate by 0.25%, from its previous 0.75%-1.0%, to 1.0%-1.25%. It also signalled that another 0.25% is in the cards before the end of the year. The Fed also announced that it would start running down the massive USD 4.5 trillion stockpile of bonds it had accumulated under its quantitative easing programme. Despite the Fed’s move to tightening, bond yields actually fell in the wake of its decision, partly because the bond market has also been focusing on inflation remaining below the 2% target and partly because the Trump agenda of corporate tax cuts seems as far away as ever. Recent events have not given much confidence that significant policy programmes can be developed and successfully shepherded through the US Congress.
World shares have continued to do well. Although prices have drifted down, month to date, from their peak at the start of June, the recent decline has been modest in the context of the earlier strong performance, and for the year to date the MSCI World Index is up 7.8% in the currencies of the overseas markets and by 9.8% in USD terms (11.0% including the taxed value of dividend income). Local investors further benefited from the NZD’s 3.5% year-to-date depreciation against the USD. Outcomes in the main developed markets have been in close alignment with local economic developments. Evidence of a strengthening eurozone, plus positive results from the French presidential and parliamentary elections, mean that eurozone equity markets have performed well, with German shares up 11.1% for the year to date and French shares 8.2%, while the ongoing American expansion has helped the S&P 500 to an 8.7% gain. The unexpected general election result in the UK, which heightened already significant Brexit risks, has held UK shares to a more modest 4.5% gain, while slower-than-expected GDP growth in Japan means that the Nikkei Index has also been a relative laggard, with a 4.3% increase. In the past couple of weeks, we have seen two major reports on the outlook for the world economy, which came to much the same conclusion: The immediate cyclical outlook is reasonably good, though not outright strong.
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