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Harbour Outlook: From stagflation to low growth?

Harbour sails 7
Harbour team | Posted on Jul 8, 2022

Key points 

  • The MSCI All Country World (global shares) Index fell -4.1% over the month in NZD-unhedged terms, and -7.7% in NZD-hedged terms. The index ended the quarter -5.7% in NZD-unhedged and -14.3% in NZD-hedged terms. 
  • The New Zealand equity market (S&P/NZX 50 Gross with imputation) finished the month down -3.9% (-10.3% for the quarter), whilst the Australian equity market (S&P ASX 200) fell -8.8% in AUD terms in the month (11.9% for the quarter), and -8.4% in NZD terms (-9.8% for the quarter). 
  • Bond yields continued to push higher with New Zealand 10-year government bond yields ending the month at 3.86%, representing a 0.25% increase for June, and 0.64% increase for the second quarter. The story was similar in the US where 10-year yields ended at 3.01%, an increase of 0.17% and 0.67% for the month and quarter respectively. 

Key developments 

Global equity markets were weak and volatile over the month and quarter. While elevated inflation data continued to support official interest rate increases by central banks, equity markets increasingly focused on downside earnings risk associated with a cyclical slowdown in economic activity as central bank stimulus is moved from easy to tight.  Higher earnings certainty, defensive sectors outperformed while more cyclical parts of the market, particularly consumer discretionary stocks, were weak. During the month a pull-back in commodity prices, reflecting slowing growth, hit resource stocks.

The market sell-off at home was widespread - only 8 S&P/NZX 50 stocks delivered a positive return over the month, while only 5 generated a positive return over the quarter. Weakness in Mainfreight, Ryman and F&P Healthcare led the market lower over the month and quarter, with Fletcher Building also hitting quarterly returns. Defensive stocks with high earnings certainty outperformed over the quarter and the month. Financials and cyclical industrials were the weakest sectors over the month and quarter. In Australia, resource stocks traded lower with commodity prices, and bank stocks were weak as investors allowed for Reserve Bank of Australia (RBA) tightening. Financial year end tax loss selling hit the Australian market hard into month end.

Fixed income markets continued a tug-of-war between two intrinsically linked questions: how aggressively will central banks hike rates and how likely does that make a sharp economic downturn that would lead to a policy reversal further down the road?  These respective issues are considered simultaneously but early in the month rate hikes were front of mind, while recession fears dominated thinking later. This ebb and flow occurred in thin market trading conditions domestically, which added to volatility considerably.

What to watch

Inflation, interest rates, and economic growth: The macro narrative is now torn between persistently high inflation necessitating higher interest rates and the negative impact this is having on the activity outlook. US and euro area inflation continue to increase. US economic data, however, are likely pointing to a slowing economy as consumer confidence declines further and ISM manufacturing indicates a slower rate of expansion. Given the size of the global inflation problem, and an expected Fed tightening cycle that only takes the Fed Funds rate 0.75-1.00% above the neutral 2.5% level, the risk for global bond yields remains skewed higher.


Market outlook and positioning

After moving at warp speed to reflect higher interest rates, including one of the fastest periods of stock market valuation multiple de-rating, we may now face a period of sub-trend economic growth as higher official interest rates suppress economic activity. This sub-trend economic growth may contribute to lower profit forecasts and earnings downgrades relative to consensus market expectations, with earnings downgrades being the ‘next shoe to drop’ weighing on equity market returns. Given bearish investor positioning, equity markets may show some recovery if inflation shows signs of peaking with slowing economic activity and modest improvement in supply chains.

Economic data is continuing to move from surprising to the upside to surprising on the downside. Lead indicators such as purchasing manager indices (which lead inventory and hiring intentions), business confidence and consumer surveys all point to a rapid drop in demand (which is what central banks want to help cool inflation). Ease of sourcing inputs is improving, supplier delivery and order backlogs have eased, and shipping rates have come off recent highs. Some inventory surveys show inventory levels are back to more normal levels, but our view is businesses will continue to hold ‘just-in-case’ excess inventory for the foreseeable future with a halting re-opening of supply chains. While Australian data has yet to roll over, the ramp up of fixed home loan rates by big banks as the RBA tightens rates has weighed on market sentiment.

While a degree of earnings slowdown may be reflected in earnings forecasts and valuations the earnings impact of an economic hard landing may not be. The upcoming New Zealand and Australian June company profit reporting season is setting up to be a more volatile period than normal. Earnings risk may be elevated for cyclical companies which have benefited from over-stimulated economies and reduced competition while supply chains have been stretched. While historical results being reported for the period may be better than market expectations, forward-looking comments may be conservative with elevated costs and a fading revenue growth outlook leading to opaque profit guidance. Increasing labour costs and constrained availability, higher energy costs and increasing compliance costs are likely to see operating costs track higher. Investment in sustainability programmes aimed at reducing carbon and energy cost, meeting consumer demand and limiting regulatory impost may continue to increase. And borrowing costs are likely to increase with both base interest rate cost and risk adjusted margins increasing. We may see the announcement of cost cut/efficiency programmes and capital management. Overall, the July profit ‘confession’ period and August formal reporting period for June results is likely to be volatile.

Within equity growth portfolios, our focus remains on investments that benefit from revenue and profitability driven by structural drivers that are less dependent on cyclical activity. Pricing power – the ability to recover cost increases and more – is likely to remain a key influence on share price performance. During the period we continued to increase investment in healthcare stocks with pricing power that can grow returns through an economic slowdown.

Within fixed interest portfolios, our current strategy continues to be focused on the New Zealand macroeconomic situation, where we expect domestic inflation may fall from the current 6.9% as the year progresses, but probably more so in 2023. During this time, we also expect domestic economic activity to weaken, perhaps sharply. This combination is a supportive backdrop for bonds. Consequently, we have an emphasis on a long duration position, primarily in the 2 – 5-year maturity sector, which captures a timeframe that could capture expectations of eventual rate cuts.

Within the Active Growth Fund, during June we trimmed our underweight position to bonds. New Zealand bonds currently offer an attractive 4%+ running yield with potential for price return should the RBNZ ultimately not hike rates as much as what is priced into interest rate markets; a scenario that we believe is more likely than not. We also sold down some of our global listed infrastructure which has held up well in 2022, and rotated into US healthcare which, while also a more defensive part of the equity market is trading at more attractive valuations.

Within the Income Fund, whilst equity markets deal with the prospect of pressure on earnings, we are of the view that the phase of revaluing forward earnings downwards as bond yields rise and rise is largely over, which may bring a move back towards growth equities. A shift away from cyclical equities is still possible, so while we are only tentatively looking to add to equity exposure, the change may be more pronounced within sectors.

Harbour Asset Management Limited is the issuer and manager of the Harbour Investment Funds. Investors must receive and should read carefully the Product Disclosure Statement, available at We are required to publish quarterly Fund updates showing returns and total fees during the previous year, also available at  Harbour Asset Management Limited also manages wholesale unit trusts. To invest as a Wholesale Investor, investors must fit the criteria as set out in the Financial Markets Conduct Act 2013. This publication is provided in good faith for general information purposes only. Information has been prepared from sources believed to be reliable and accurate at the time of publication, but this is not guaranteed. Information, analysis or views contained herein reflect a judgement at the date of publication and are subject to change without notice. This is not intended to constitute advice to any person.  To the extent that any such information, analysis, opinions or views constitutes advice, it does not take into account any person’s particular financial situation or goals and, accordingly, does not constitute financial advice under the Financial Markets Conduct Act 2013. This does not constitute advice of a legal, accounting, tax or other nature to any persons.  You should consult your tax adviser in order to understand the impact of investment decisions on your tax position. The price, value and income derived from investments may fluctuate and investors may get back less than originally invested.  Where an investment is denominated in a foreign currency, changes in rates of exchange may have an adverse effect on the value, price or income of the investment. Actual performance will be affected by fund charges as well as the timing of an investor’s cash flows into or out of the Fund.. Past performance is not indicative of future results, and no representation or warranty, express or implied, is made regarding future performance. Neither Harbour Asset Management Limited nor any other person guarantees repayment of any capital or any returns on capital invested in the investments. To the maximum extent permitted by law, no liability or responsibility is accepted for any loss or damage, direct or consequential, arising from or in connection with this or its contents.