Looking ahead, although the outlook for global growth has been marked down a bit, 2019 still looks like another year of global economic expansion. But it could easily be derailed, particularly by any acrimonious trade wars between China and the US or by other risks such as credit market disruptions. The outlook at the moment is consequently hard to call, with some chance of smooth sailing but also a good chance of markets hitting a sharp reef. Portfolio insurance via defensive assets looks worthwhile, especially as the outlook for bonds is looking better than previously. At home, the economy may be showing signs of hitting capacity constraints, and it may be difficult for local equities to keep their recent strong run going.
New Zealand Cash & Fixed Interest
The 90-day bank bill yield is a bit lower for the year to date and is now just below 1.9% having started the year at just under 2.0%. Long-term interest rates are also a little bit lower, with the 10-year government bond yield down 0.06% to 2.32%. The New Zealand dollar is a little bit higher for the year to date: The main movements have been a drop against the pound sterling and a rise against the euro, the net effect being a marginal 0.3% increase in overall trade-weighted value.
Until very recently, the conventional wisdom was that the Reserve Bank of New Zealand would keep to its previously announced aim of an eventual increase in the official cash rate: The bank had indicated that an increase was likely for the second half of 2020. Some forecasters still agree or even think an increase could come a bit earlier: The latest forecast from the Bank of New Zealand is for a 0.25% increase in the final quarter of this year. But opinion is shifting, and some forecasters now think that the next move from the RBNZ will be a cut in the OCR.
Listed property has shared in the general recovery of equity prices for the year to date, and the S&P/NZX All Real Estate Index has provided a capital gain and total overall return of 1.3%, a bit behind the 3.4% return from the overall share market.
The A-REITs did not provide much of an absolute return in 2018, with the S&P/ASX200 A-REITs Index delivering a total return including dividends of 2.9%, though it did provide useful protection against the wider weakness of Australian shares: The S&P/ASX200 Index lost 2.8% on a total return basis. Although it is still early days, for the year to date, the A-REITs have again outperformed the wider market, with a total return of 6.6% compared with the overall market’s 4.6%.
International property also provided some protection last year, but in the rather bittersweet form of a largish loss compared with an even larger loss. The FTSE EPRA/NAREIT Global Index was down 6.4% in terms of net return in US dollars, a modestly better outcome than the 8.9% loss from the MSCI World Index on the same basis. For the year to date, listed property has been a beneficiary of the global equity recovery, with a 7.6% net return in US dollars, slightly ahead of the MSCI World Index’s 6.3%. All the main regions participated, with the key North American market up 7.9%.
Operating conditions are still reasonable for New Zealand property, although the prospect of somewhat slower growth than previously is becoming evident. Although still positive overall, industry sentiment for Australian and International property has been weakening for the past year.
The New Zealand share market had a good 2018 by developed economy standards, although it was affected by the global sell-off in the final quarter of the year. More recently it has also benefitted from the improvement in global prices, and the S&P/NZX50 Index for the year to date is up 3.4% in capital value, and also by 3.4% in terms of total return including dividends, as it is too early in the year for any significant level of dividend distribution.
Australian shares have also shared in the global price recovery, and the S&P/ASX200 Index is up 4.6% in capital value and also up 4.6% in total return.
The New Zealand share market has been performing well on both an absolute and relative basis. While it is generally difficult to argue with repeated success, the outlook nonetheless suggests the market will struggle to keep this robust performance going. The economic outlook, while still positive, is showing some signs of slowing down; corporate profitability is under greater pressure; and valuations are expensive relative to other share markets.
In Australia, the outlook has seesawed between prospects of faster economic growth and a continuation of the more modest growth that has generally prevailed since the wind-down of the resource investment boom. Currently the outlook is still unclear, but the odds have tilted towards “more of the modest same” rather than to an acceleration in the pace of business activity.
International Fixed Interest
International fixed interest provided a good degree of capital protection in 2018 against the late-year equity sell-off. However, for the year to date, the converse has been true, with holders of bonds missing out on the equity recovery.
The outlook for international fixed interest remains difficult and hinges heavily on two factors: the evolution of US interest rates, and the resolution of the current uncertainties around the outlook for the global economy, in particular the outcome of the US-China trade negotiations.
The good news for investors is that world shares have been recovering from their sharp sell-off in the final quarter of last year.
The big sell-off last year reflected a variety of interlinked concerns: fears that the global economy was running out of steam after its long post crisis expansion; concerns about the outlook for some individual large economies, notably the US (as tax cuts fade) and China (if the authorities prove incapable of maintaining its recent 6.5% annual growth rate); over and above any slowdowns in the US and China, the further effect on them and the global economy of a trade war fallout between them; the possibility that the Fed might tighten monetary policy too much or too quickly; and the global financial crisis-style risks that might be lurking in a highly indebted world.
The IMF now thinks the world economy will grow a little more slowly this year than it had thought in October 2018, the time of its previous forecast. But the revision is marginal: The world economy is expected to grow by 3.5% this year and to grow by a slightly faster 3.6% in 2020, which is only marginally below the 3.7% the IMF had expected for both years last time. If the global economy does indeed grow by 3.5% this year, it will represent only a very small slowdown from the 3.7% achieved in 2018: For all practical purposes, the pace of the world economy will be much the same.
Diversification across asset classes and some emphasis within growth asset classes to investments less susceptible to cyclical setbacks is probably the best approach for the time being. Prepare for the worst, and perhaps prepare to be pleasantly surprised if the world economy actually emerges in better shape than feared from the politicians’ rough handling.
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