The past few weeks have been dominated by geopolitical uncertainty, particularly the prospect of a US-China trade war and its potential impact on global business activity: Equity markets have whipsawed as trade tensions have risen or receded. The other major development has been further declines in local and global interest rates to even lower levels. Looking ahead, investment outcomes remain hostage to Washington and Beijing: A deal could see the long post-global-financial-crisis world expansion carrying on into next year or even beyond, but there is a real risk that ongoing conflict triggers a cyclical setback either directly (though supply chain disruptions, for example) or indirectly (through reduced business and consumer confidence and hence lower capital investment and retail spending).
At home, while income-oriented buying has boosted equities, it is now getting harder to find attractive investment options. Interest rates have dropped sharply, and equities are expensive given the subdued outlook for the local business cycle.
New Zealand Cash & Fixed Interest
The Reserve Bank of New Zealand had been expected to cut the official cash rate by 0.25% on August 7. In the event, it surprised the markets with a 0.5% cut, taking the OCR to a record 1.0% low. Short-term interest rates have consequently moved lower: the 90-day bank yield is now 1.2%, down nearly 0.5% since the start of the year, and at the long end, the 10-year government bond yield is down from 1.75% at the start of the year. The New Zealand dollar has weakened, particularly against the yen and the US dollar, and year to date has dropped by 2.1% in overall trade-weighted value.
The RBNZ’s rationale for the cut was that “GDP growth has slowed over the past year and growth headwinds are rising. The bank also indicated that it has been researching the unconventional monetary policy techniques, such as quantitative easing, or QE, that have been employed by central banks overseas when interest rates have been pushed as low as they can feasibly go.
Property & Infrastructure
Listed New Zealand property has continued to perform very strongly. Year to date the S&P/NZX All Real Estate Index has delivered a capital gain of 25.3%, and a total return including dividends of 28.0% (28.6% including imputation credits). The total return handily outperformed the itself-impressive 23.2% from the overall share market.
Much the same story has played out in Australia, with the A-REITs also outperforming the wider share market. The S&P/ASX 200 A-REITs Index has registered a year-to-date capital gain of 20.1% and a total return including dividends of 23.1%, beating the 18.9% return from the overall market.
Overseas the picture has been a bit different. Global property shares have done well enough: The year-to-date net return (including taxed dividends) in US dollars from the FTSE EPRA/NAREIT Global Index is 13.8%. But it has lagged a little behind the 14.8% from the MSCI World Index, mainly because of particularly poor outcomes in the Brexit-affected U.K. (net loss of 2.4%) and in emerging markets in Europe, the Middle East, and Africa (net loss of 6.6%).
Global equities may have had a difficult few weeks, but New Zealand shares have been relatively unaffected. Prices dropped in early August, as in many overseas markets, but, unlike them, prices quickly bounced back to where they had been previously. The S&P/NZX50 Index year to date has consequently recorded a capital gain of 21.1% and a total return including dividends of 23.2% (23.8% including imputation credits).
Australia, on the other hand, conformed to the international pattern: It dropped in early August and has not regained the lost ground. Even so, the strong gains earlier this year mean that the year-to-date performance is still respectable. The S&P/ASX200 Index is up 16.3% in capital value and has returned 18.9% including dividend income.
It is possible that the RBNZ’s relatively upbeat view of the economic outlook is correct. In the August Monetary Policy Statement it argued that, “Low interest rates and increased government spending will support a pick-up in demand over the coming year.
International Fixed Interest
Just when it had seemed that world interest rates could go no lower, they dropped even further again.
World share prices had gone sideways for much of July but at the end of July and into the first week of August prices fell sharply. The immediate reason was an unexpected intensification of trade tensions between the US and China, with President Donald Trump threatening higher tariffs from September on USD 300 billion of imports from China. Tensions worsened further after the US Treasury Department later designated China as a “currency manipulator,” after the Chinese currency had dropped below CNY 7 against the US dollar.
At time of writing, the US had just announced that the new tariffs would be delayed to December on just over half of the Chinese imports, and equity markets had a relief rally, but not enough to repair the earlier damage. The MSCI World Index of developed markets is still 3.7% below its July 26 peak.
Even so, strong price rises earlier in the year mean that world shares are still well ahead for the year to date, with the MSCI World up 13.7% in the overseas markets’ currencies and up by 13.3% in US dollars (14.8% including taxed dividends).
The MSCI Emerging Markets year to date is up by only 2.2% in the emerging markets’ own currencies, and scarcely at all (up 0.3%) in US dollars. The core BRIC markets (Brazil, Russia, India, China) are up 4.0% in US dollars, though the figures are somewhat flattering. On paper, the statistics appear to show that the Chinese market has done well: The Shanghai Composite is up 12.2% year to date. While formally true, all the performance relates to the period up to late April. As one would expect, the trade conflict has weighed heavily on the Index since then, and it is currently 14.5% below its April 19 peak.
The unusually low levels of global interest rates have the potential to provide ongoing support to world shares through their impact on the relative valuations of bonds and shares, and through the resultant hunt for dividend income. The major central banks will be keeping monetary policy at supportive levels for some time.
Beyond ongoing monetary policy help, the outlook for world shares depends heavily on two other factors. One is the outlook for the world economy, and in particular the outlook for the US economy, which has been responsible for more than its fair share of global equity performance. The other is the potential economic and financial impact of political uncertainty, very largely around the prospects for the US-China trade conflict but also encompassing a variety of other issues (Brexit, Hong Kong, emerging-markets governance, and general geopolitical uncertainty).
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