Cash and bond yields have dropped to new lows as central banks have sought to boost growth and inflation and as investors have sought safe assets like government bonds in a climate of high political risk from the US-China trade tensions. Lower yields have boosted the valuation attractiveness of equities, and income-oriented sectors like property and infrastructure have been in particularly high demand. Looking forward, the most recent analyses suggest the world economy can keep the current business expansion going into 2020, but against a background of sizeable downside risks, notably from the trade conflicts. In New Zealand, the economy has slowed down from 2018’s pace of growth, and although the profit outlook for 2020 looks better, local equities are now expensive by both historical and international standards. They may continue to be supported, however, by further cuts in local interest rates.
New Zealand Cash & Fixed Interest
Short-term interest rates are 0.4% lower for the year to date, reflecting an easing in monetary policy: the 90-day bank bill yield is now just under 1.6%. Long-term interest rates have continued to fall and the 10-year government bond yield of 1.67% is now 0.7% below where it started the year. The New Zealand dollar has also moved lower, and for the year to date is down by 2.7% against the US dollar and by 1.9% in overall trade-weighted value.
The Reserve Bank of New Zealand cut interest rates on May 8, and the general expectation at the moment is that it will cut again: Inflation has persistently been running below the bank’s target 2%, and some extra policy oomph will be needed to drive it higher. Futures pricing suggests another 0.25% cut by this time next year, but some economists see the bank cutting twice. Either way, returns from bank deposits are heading even lower.
Property & Infrastructure
In a world where interest rates on cash and bonds have fallen to even more unusually low levels, it is not surprising that asset classes with relatively attractive dividend yields have been doing well. The S&P/NZX All Real Estate Index for the year to date has delivered a capital gain of 15.4% and a total return including dividends of 17.8%, modestly outperforming the (itself strong) wider share market.
As with New Zealand listed property, the A-REITs have also been buoyed by lower yields on fixed interest. The S&P/ASX 200 A-REITs Index is up 18.8% in capital value and has returned 19.6% including dividends, again outperforming the wider share market.
It has been exactly the same story overseas, where global REITs have also outperformed by a modest margin. Including the taxed value of dividends, the FTSE EPRA/NAREIT Global Index is up 15.2% in US dollars, a bit ahead of the MSCI World Index’s equivalent return of 14.4%. Other than in the emerging markets, which recorded a small loss, gains were widespread, led by the strong North American market (net return of 18.2%).
Listed infrastructure has also been as buoyed by lower bond yields and the subsequent search for yield as other income-oriented asset classes. For the year to date the S&P Global Infrastructure Index in US dollars has returned 17.5% (including the value of taxed dividends), and slightly more (18.3%) when hedged back into New Zealand dollars.
New Zealand equities have enjoyed a long run of good performance–over the 10 years to end May, the S&P/NZX 50 Index delivered a remarkable total return of 13.9% a year–and the good run has continued this year, with the index for the year to date up 14.3% in capital value and delivering a total return including dividends of 16.2%.
Australian shares have generally underperformed in recent years–at the start of this year prices were still roughly where they had been four years earlier–but the past few months have been a good deal better. With a local interest-rate cut and an unexpectedly business-friendly outcome from the general election, for the year to date the S&P/ASX 200 Index is up 16.1% in capital value and has returned 18.3% including dividends.
The latest indicators show a consistent picture of the New Zealand economy hitting a slower patch of growth while in Australia, the economic indicators continue to be mixed.
International Fixed Interest
There has been a sharp drop in US bond yields, where the 10-year Treasury yield is now only 2.08%, down 0.6% since the start of this year. Yields in other major markets have also dropped.
UpWorld shares have performed well in June but have not yet retaken all the territory lost when fractious US trade disputes with China, and more recently Mexico, threatened to disrupt global economic growth.
Fortunately, the good spell of share performance before the trade talk setbacks, added to the past few weeks’ gains, mean that for the year to date the MSCI World Index of developed markets is up 13.1% in US dollars (14.4% including taxed dividends).
In the developed markets, gains have been dependent on the US market, where the S&P 500 is up 15.2%: ex the US, world shares would have gained a more modest 9.4%. European shares have done better than the European economic outlook might suggest, and the FTSE Eurofirst 300 Index is up 12.0%, while UK shares have managed a 9.2% gain despite the hash its politicians are making of Brexit. The weakest of the major markets has been Japan, where the Nikkei is up 5.5%.
Emerging markets’ potentially large exposure to global trade shocks means that equity gains have been considerably more subdued than in the developed world. The MSCI Emerging Markets Index in US dollars is up 5.1% for the year to date, with the core BRIC economies (Brazil, Russia, India, China) up 7.8%.
Looking ahead, the most likely outlook–absent trade war setbacks–is that the world economy will continue to provide some fundamental backdrop support for equities, which will also be boosted by the increased attractiveness of equity dividends in the new low-bond-yield environment.
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