World equity markets have continued to recover from their North Korea related setback in August/September. Income-oriented asset classes (property, infrastructure) have lagged as the prospect of higher bond yields draws nearer. All the data suggest that the outlook for the world economy is improving, providing further support for growth asset performance, but valuations remain expensive across many asset classes and investors appear to be under-appreciating the potential for adverse economic or geopolitical surprises. In New Zealand, the economy went into the election in strong shape, but the new government's likely changes to previous policies, while still not fully clear, have raised the level of uncertainty about future economic performance.
New Zealand Cash & Fixed Interest
Yet again, short-term interest rates have been steady, with the 90-day bill yield continuing to trade at just under 2%. The stability reflects the unchanged stance of monetary policy, with the Reserve Bank of New Zealand (RBNZ) keeping the official cash rate at 1.75% at its most recent OCR review on 28 September and still maintaining that it will keep the OCR on hold all the way out to late 2019. Longer-term interest rates have tracked what has been happening overseas and locally, the 10-year government bond yield, which got down to 2.77% on 8 September, has since risen to 2.95%.
After the election, the outlook is a little less clear. The incoming government is likely to revisit how the RBNZ works and what it should be aiming for and, in particular, may ask the bank to put a greater emphasis on high levels of employment. In the longer run, this suggests that monetary policy could be run on a looser stance for longer, with greater tolerance for higher inflation. This could lead to the OCR staying low for an extended period and bond yields rising a bit more than would have occurred otherwise. It will, however, take some time for the various personnel and policy changes to take place, and in the interim the likeliest outlook is for steady short-term interest rates and slightly higher bond yields if, as seems likely, US yields continue to rise.
The new coalition arrangements also affect the outlook for the currency and it is possible that traders and investors will remain wary of the NZD until they have a clearer view of the details of the new government’s policies, and the immediate risks lie more towards a weaker than a stronger NZD.
Although there have been a number of small cycles during the year, the net result is that local listed property has made little overall progress. The S&P/NZX All Real Estate Index has made a small capital gain (2.3%) for the year and has provided an overall return including dividends of 5.9% (6.6% including imputation credits). It has significantly underperformed the wider share market. A-REITs are currently one of the few subsectors of the Australian share market in the red for the year. The S&P/ASX 200 A-REITs Index has lost 3.7% in capital value for the year to date and is still narrowly on the losing side of the ledger (down 0.4%) even after including dividend income. Global property has performed rather better than its Australian equivalent but has also been an underperformer.
Share prices initially took the news of a Labour/New Zealand First/Greens government quite badly, with prices dropping by a little more than 1% immediately after the announcement late in the afternoon of 19 Oct. The following day, however, the S&P/NZX Index recovered all the lost ground, and for the year to date the index is up 14.0% in capital value and by 18.1% in total return terms including dividend income.
After largely missing out on the global bull market in equities this year, Australian shares have finally shown some vitality. For the month to date, the S&P/ASX 200 Index is up by 4.8%, and this month’s rise has been sufficient to take the year-to-date capital gain to 4.3% (8.0% total return, including dividends). Nearly all the subsectors (other than A-REITs) are now in the black for the year, led by the industrials (14.3% capital gain) and IT (12.0%). There have also been decent gains for the miners (10.5%) and consumer staples (10.1%). The financials, which have been a drag on performance all year, have continued to lag, with only a small 1.8% gain.
Up to the news of the coalition makeup, the economy was looking in reasonable shape but the outlook has now become more uncertain: while a National/NZ First coalition would have represented a fair degree of policy continuity, the impact of the actual Labour/NZ First/Greens outcome is more difficult to assess, but could be considerable. As one veteran political commentator put it, “New Zealand may be about to see the biggest change of economic direction since the reforms that started 33 years back in 1984."
International Fixed Interest
The outlook remains as before: In the US, UK, and the eurozone, though not Japan, monetary policy is likely to be slowly and carefully normalised after an extended period of exceptionally low interest rates, which will make life difficult for bond investors.
After the setback in August and early September caused by the North Korean missile tensions, world equities have recovered strongly in the remainder of September and into October. Currently the MSCI World Index of developed economies, in the currencies of its component markets, is up 5.8% from its North Korea related low on 21 Aug. For the year to date, the index is up by 13.1% in its local currencies and by 16.2% in USD terms (18.1% including the taxed value of dividends). The S&P 500 is up 15.0% in capital value for the year to date. European shares as measured by the FTSE Eurofirst300 Index are up by 7.2%: Eurozone markets have reflected the improving eurozone economy, with German shares up 13.2% and French shares 10.5%, but UK shares have lagged on Brexit uncertainties, with the FTSE 100 Index up by only 5.3%. Japanese shares, which had meandered for most of the year, have risen sharply since Prime Minister Shinzo Abe called a snap general election on 25 Sept, and the Nikkei Index is now up 12.3% for the year to date. The emerging markets have done even better again. The MSCI Emerging Markets Index is up 25.6% in the emerging markets’ own currencies and by an even stronger 29.9% in USD terms. The main BRIC markets have led the way, with strong rises in Brazil (Bovespa Index up 26.8%) and India (Sensex Index up 21.6%), a smaller contribution from China (Shanghai Composite up 8.9%), but little or nothing from Russia (FTSE Russia Index up 3.3% but the RTS Russia Index down 1.6%). The global macroeconomic outlook remains supportive for equity performance.
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