Two trends are setting the agenda for asset prices. One is the ongoing global economic expansion: Recent data suggest the outlook has improved a bit further, and equities are likely to continue to benefit. The other, however, is the prospect of less supportive monetary policy: Major central banks (ex Japan) will not be providing the same degree of stimulus as previously, and this will continue to weigh on bonds and bondlike assets such as property and put a spotlight on equity valuations. The central banks will have the biggest effect on the assets most in favour during the previous "hunt for yield" period. In New Zealand, the strong business cycle rolls on, helping growth-sensitive assets, but investors may soon start thinking about the outlook beyond the next 18 months.
New Zealand Cash & Fixed Interest
Short-term interest rates have shown little change, reflecting the unchanged stance of monetary policy: The Reserve Bank of New Zealand left the official cash rate at 1.75% at their latest meeting, and the 90-day bill yield continues to trade at around 2% (currently 1.95%). Long-term yields have followed overseas rates upwards, particularly since late June when many markets started to take a more serious view of the potential for world monetary policies gradually becoming less supportive. The 10-year government bond yield, at just under 3.0%, is still 0.4% below where it started the year, but a better indication of the trend is the nearly 0.3% rise since the cyclical low point of 2.7% on June 27. The just-announced inflation data for the June quarter showed that inflation was zero for the quarter and 1.7% during the past year. This was a little lower than forecasters had expected (they were looking for a 0.2% quarterly increase) and lower than the RBNZ itself had expected (0.3%).
The recent history of the S&P/NZX All Real Estate Index is a mirror image of global bond yields. The index dropped sharply, for example, at the height of the global "Trump trade," when bond yields were rising (and expected to rise even further) but then made back all the lost ground in subsequent months. For the year to date the S&P/NZX All Real Estate Index is now showing a small capital gain of 2.0% and a total return of 4.5% (5.1% including the value of imputation credits). The outcome was well behind the 12.6% with-imputation return from the wider share market. For the A-REITs, the reassessment of relative value was particularly brutal in late June and the first half of July, when investors finally decided that central banks were starting to change course: The S&P/ASX A-REITs Index dropped by 12.6% between June 19 and July 12. As a result, the index is now showing a year-to-date capital loss of 7.2% and an overall loss (including the value of dividend income) of 4.9%.
New Zealand shares have continued to do well. The local market was relatively resilient when global markets temporarily weakened in the second half of June and early July and has risen further more recently. The S&P/NZX 50 Index is up 9.6% for the year to date in capital value and up 11.9% in terms of total return (12.6% including the value of imputation credits).
Gains for Australian shares, on the other hand, have been remarkably modest in a year that has been friendly to most equity markets. The S&P/ASX 200 Index is up only 1.6% in capital value and up 3.8% in total return. The poor performance of the A-REITs (covered in more detail earlier) has been part of the answer, as has the drag on performance from the large weight of the financial sector, which for the year to date is down 0.5% in capital value.
International Fixed Interest
Bond yields overseas have risen recently in the US, the eurozone, and the UK but have shown little change in Japan. For the year to date, global bonds are still showing a positive return: the Bloomberg Barclays Global Aggregate Index in US dollars is up 4.5% for the year to date. The recent rises in rates (and corresponding capital losses) have been outweighed by capital gains earlier in the year, when bond yields had fallen as the Trump trade (expectations of a large and early fiscal stimulus to the US economy) had evaporated. The period of ultralow bond yields and ultrahigh bond prices looks to be coming to an end. It may be a slow and protracted process, but it is already under way in the US and Canada (the Bank of Canada raised rates by 0.25% on July 12), is on the near horizon in the UK, and visible but still a way off in the Eurozone.
After a period in June and early July when equity markets had weakened on fears of less-supportive monetary policy from a number of central banks, more recently global shares have picked up again as investors have taken a more sanguine view of the likely speed and scale of the central bank moves. It has also helped that the Chinese economy logged faster than expected economic growth in the June quarter. The end result is that world shares have done well, with the MSCI World Index up 8.6% for the year to date in the currencies of its component markets and by 11.3% in USD terms (12.6% on a net-return basis, including taxed dividends). NZD investors unfortunately have seen rather smaller returns in hand, owing to the 5.2% appreciation of the NZD against the USD since the start of the year. Among developed markets, the US (S&P 500 up 9.8%) and the eurozone (Germany’s DAX up 9.6% and France’s CAC up 7.6%) have led the way, through Japan (Nikkei up 5.3%) and the UK (FTSE 100 up 3.7%) have also made gains. These good returns were left trailing by the even stronger performance of the emerging markets: The MSCI Emerging Markets index was up 21.9% in USD terms. Asia (up 22.1%) has been the star region, with eastern Europe ex Russia also doing well (up 17.4%). Among the key BRIC economies, India did best, up 20.5%, and Brazil has recovered somewhat from the impact of corruption scandals and is now up 8.3%. There was a small gain of 2.4% for China’s Shanghai Composite Index, while Russia has continued to be held back by the effect of lower world oil prices: The FTSE Russia Index was down 9.1% for the year to date. World equity markets have been on a sustained bull run, and investors have come to expect that risks will be steamrolled by the momentum of the global cycle. But as the July 11 "Weekly Letter" from Merrill Lynch said, “a fearless market is one usually feared by seasoned investors. Slower-than-expected growth in the US, an overzealous Federal Reserve, an unexpected geopolitical event—all of these factors could trigger a spike in volatility in the months ahead.”
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