World economic growth is still supportive for global equities, and fund managers currently expect equities to make further gains. But the outlook, particularly this late in a sustained global business cycle, is becoming more vulnerable to various risks, notably higher bond yields (especially in the U.S.) and various geopolitical risks. Bonds and bond proxies are likely to continue to struggle.
New Zealand Cash & Fixed Interest
Short-term interest rates have been steady since the Reserve Bank of New Zealand left the official cash rate at 1.75% at its most recent policy announcement on May. 10, and the 90-day bank bill yield continues to trade a little under 2.0%. Somewhat unusually, local bond yields have not followed their usual pattern and taken their broad direction from U.S. bond yields. Instead, they have risen only a little this year even as U.S. yields have climbed. The local 10-year government bond yield (currently 2.86%) is up only 0.1% year to date, compared with the equivalent 0.65% rise in the U.S. The likelihood is that local bond yields will head higher over the next year or two, partly because local inflation is likely to rise back towards 2% and partly because of some re-emergence of the traditional relationship with U.S. yields. Local forecasters see the 10-year rate at around 3.5% at the end of next year.
The New Zealand dollar is weaker year to date, both in headline U.S. dollar terms (down 3.0%) and in overall trade-weighted value (down 2.5%). There is not a lot of disagreement about the outlook for short-term rates but forecasters (and the bank’s own projections) think the next move will be up. Whatever the next move is, it is unlikely to materialise before mid-2019 at the earliest; the RBNZ’s own view is a 0.25% increase towards the end of 2019, and another somewhere in 2020.
Local listed property has continued to underperform the broader sharemarket. The S&P/NZX All Real Estate index year to date is down 2.3% in capital value whereas the overall market is up 1.7%, and is down 1.4% including dividend income compared with the 3.1% gain for the S&P/NZX50.
The A-REITs have also underperformed relative to the overall Australian sharemarket, with the S&P/ASX200 A-REITs index down 2.8% in capital value and down 1.9% in total return, compared with the 0.4% capital gain and 2.2% total return for the S&P/ASX 200.
It is the same overseas, where year to date the FTSE EPRA/NAREIT Global index has turned in a 2.6% loss in terms of net return in U.S. dollars, compared with the 1.7% net return from the MSCI World index.
Most equity markets have struggled to show any decent gains year to date, and the New Zealand sharemarket is no exception. The S&P/NZX50 index is up 1.7% in capital value, with dividend income taking the total return to 3.1%. The Australian market has shown similar results, with a small 0.7% capital gain for the S&P/ASX 200 index and a total return of 2.2%. The latest business surveys suggest the economy is in reasonable though not outstanding shape. Both the RBNZ and Treasury believe there is still further growth ahead. In its Monetary Policy Statement, the RBNZ forecast that growth will be a little more than 3% a year all the way out to March 2021. However, how much of that growth will flow through to corporate profits and higher equity prices is more debatable.
International Fixed Interest
More of the same looks likely. Although there has been a variety of factors behind the recent outcomes, the main driver—normalisation of monetary policy in the U.S., and to a lesser degree elsewhere—is intact, and has further to run. The likelihood is that the U.S. Federal Reserve will go on raising short-term interest rates and withdrawing its previous programme of buying bonds, which had helped keep longer-term interest rates low.
The good news is that faced with a trio of worries in rising interest rates, trade wars and other geopolitical tensions, and in recent weeks, some suggestion that the world economy may not be growing as rapidly as expected—world shares are slightly up for the year. The bad news is that they have yet to regain the ground lost from the two big sell-offs in January and March which occurred when investors first started to take these concerns more seriously.
Year to date, the MSCI World index of developed markets is up 1.3% in the markets’ own currencies, and up 0.8% in U.S. dollars (1.7% including the taxed value of dividends). Few of the major markets have stood out from the pack, with most registering small increases in local currency terms. In the U.S., the S&P500 is up 1.5%; in Japan, the Nikkei has gained 1.2%; and in Europe, the FTSE Eurofirst 300 index is up 1.2%, with the French market a rare example of a larger gain (CAC40 index up 5.7%).
Until very recently, the emerging markets had been handily outperforming their developed economy counterparts, but they have faltered in recent weeks, with the MSCI Emerging Markets up only 0.7% in the emerging markets’ currencies and making a 1.8% loss in U.S. dollars. Investors who stayed in the key BRIC markets (Brazil, Russia, India, China) fared relatively well, with the MSCI BRIC index up 0.9% in U.S. dollars, but anyone off the main beaten path ran into trouble.
Overall the global economic outlook remains solid. But there are growing risks. The global economic cycle is getting long in the tooth although as both forecasters and fund managers believe, it does not look as if it is going to fall over imminently.
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