The outlook for the world economy continues to strengthen, particularly in the formerly moribund eurozone, and it provides greater support for growth-oriented assets. But valuations remain expensive across all asset classes, and are vulnerable to an eventual normalisation of interest rates, which is already under way in the United States and the United Kingdom, although it is still some time away in the eurozone and Japan. Investors also appear overly complacent about potential risks that could kick away the props for today’s expensive valuations. In New Zealand, the full shape of the new government’s policies is not yet clear, but early analyses suggest the current strong cycle has further to run.
New Zealand Cash & Fixed Interest
Short-term interest rates are again unchanged, with the 90-day bill yields staying just under 2.0%. The stability reflects the latest Monetary Policy Statement of 9 November, with the Reserve Bank of New Zealand (RBNZ) keeping the official cash rate at 1.75%. Longer-term yields have been more volatile, but have broadly followed U.S. yields upwards, with the 10-year government bond yield now just shy of 3.0% at 2.95%.
The post-election New Zealand dollar has continued to weaken—dropping initially on news of the inconclusive result from the September 23 general election, and later the October 19 news of the eventual coalition. The decline also reflects the global strengthening of the U.S. dollar. In headline terms the New Zealand dollar has dropped from USD 0.734 before the election to its current USD 0.688, and in overall trade-weighted terms it fell by 4.0%. Year to date it is down by 5.9% in overall value.
Operating conditions for property remain strong. Although the impact of the new government’s policies is still unclear, the RBNZ’s take is that the short-term impact will be positive for growth, with this year’s 3.0% gross domestic product growth maintained into 2018 and then picking up a little in 2019. Private sector surveys show that the positive impact for property is being felt across most regions and sectors. While the wider Australian sharemarket has shown some signs of picking up from a long period of underperformance, the A-REITs have continued to miss out. The S&P/ASX200 A-REITs Index is marginally down (0.6%) in capital value year to date, and its total return of 2.8% lags well behind the overall market’s 9.1%. Global property has continued to lag the performance of the wider global equity market. Year to date the FTSE EPRA/NAREIT Global Index in U.S. dollars has registered a total net return (including taxed dividends) of 10.9%, well behind the 17.4% net U.S. dollar return from the MSCI World Index.
In New Zealand, the change of government and the potential for possibly significant changes in policy direction have taken centre stage as the key factor for the investment outlook. Businesses’ initial reactions were downbeat. The ANZ Bank’s October business confidence survey showed a weaker outlook, and it might weaken a bit more again. Fortunately, the election seems to have made much less difference to households’ expectations. Although households have become a bit less positive about economic conditions, they are still upbeat by historical standards. The potential implications are not easy to assess. The RBNZ, at its latest Monetary Policy Statement, picked up four issues—increased government spending, and a boost to home construction, probably boost business activity, but tighter immigration restrictions work the other way, while a higher minimum wage could go either way.
In Australia, the October sharemarket rally suggested that investors were coming round to the view that the Australian economy was finally emerging from the unwind of the mining project boom. But it remains difficult to be sure that business activity is indeed beginning to pick up enough pace to make a real difference to corporate profitability.
International Fixed Interest
After a strong rise in September on renewed prospects of tax cuts, U.S. bond yields have shown little net trend in recent weeks: The 10-year Treasury yield peaked at 2.47% on October 26, and has since been trading a little lower (currently 2.34%). Other major markets have generally shown similar patterns of an initial rise but more recent stability or modest retracement.
The economic outlook continues to be broadly supportive for global equities. Most focus, particularly given the high valuations of American equities, is on the outlook for the U.S. economy. While the data has been knocked about by the impact of hurricanes, the latest indicators have been good. More widely, the pace of business activity in the overall global economy appears to be accelerating. It has helped that two of the more mediocre economic performers of recent years, the eurozone and Japan, are both—at least cyclically—on the mend.
Risk also continues to be underappreciated. In the last few days one of the bellwether indicators of investor anxiety—the level of volatility expected from the S&P 500, as measured by the VIX Index—has picked up a little. It is currently 13.1, but it is still well short of its long-run average of about 20, suggesting the outlook is seen as substantially less risky than usual. To date, investors have been generously rewarded for taking the view that all would turn out well, and it is helpful that the latest global economic data provide further support for holding risk assets. But it is likely that coming months will see investors’ insouciance around risks tested more vigorously.
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