The Harbour Outlook summarises recent market developments, what we are monitoring closely, and our key views on the outlook for fixed interest, credit and equity markets.
Globally, equity markets bounced back in April, with concerns abating from earlier in the year on global inflation risks, trade wars, political threats to the tech sector, and funding pressures. In particular, global markets were comforted after conciliarity comments from China’s President Xi. The steps towards peace on the Korean peninsula were also part of a broader easing in market tensions. Base metals and oil were particularly strong on both supply curtailments and strong global demand.
In this environment, global bond yields continued to rise with the US 10-year touching 3% for the first time since 2014. The US dollar was strong driven by rising US yields, and the dampening of trade tensions and geopolitical risks. Locally, the fixed interest market was more stable, with bond yields continuing to trade in relatively tight ranges. The release of March quarter CPI, at 1.1% year-on-year, reinforced the sense that with CPI inflation still struggling to lift comfortably and settle at 2% there would be no OCR hikes for some time. In May, the new RBNZ Governor, Adrian Orr, will lead his first Monetary Policy Statement and OCR decision.
With global equity markets recovering, the New Zealand equity market returned 1.5% and the Australian equity market returned 3.9% over the month. Large caps outperformed small/mid-caps with Fletcher Building leading the charge following its capital raising. In Australia, healthcare out-performed from a weaker Aussie dollar, alongside energy and material sectors strong following strength in commodity prices. With global bond yields higher, bond sensitive sectors such as property, utilities and telcos were the laggards. Financials were weaker as evidence from the Australian Royal Commission highlighted widespread misconduct across the sector.
What to watch
We see a number of politically-influenced themes to watch in the months ahead.
While the Australian ‘Royal Commission into Misconduct in the Banking, Superannuation and Financial Services’ was established in December 2017, it has become an increasing focal point for Australasian markets in recent months, and we expect this to continue. Over April there was a particular focus on financial advice. AMP was hit hard with the CEO resigning followed shortly after by the Chairman and General Counsel. The banks have also not been immune, underperforming the wider equity market, with news to digest on fines, higher capital charges and the prospect of having to restructure businesses to separate wealth management operations from the core banking services. While the review and disclosures are made public in real time, there is an ongoing risk to the equity market of more revelations of misconduct and ensuring regulatory actions. Over the medium-term, in debt markets, we see the potential for the Royal Commission ultimately improving the credit quality of the Australian banks, by strengthening their capital positions, governance and risk processes.
There is a broader macroeconomic risk, however, that the Royal Commission results in a near-term contraction in credit availability, which leads to a correction in the Australian housing market and ends in a broader fall in consumer confidence and economic slowdown. Rather than a central view, we see this as risk scenario that will need to be monitored closely.
The other main political development on the horizon is government budgets in both Australia and New Zealand.
In Australia, after a number of years of self-imposed austerity, the Australian economy is on a firmer footing with tax revenues increasing. This latest budget is likely to emphasise that turnaround, with projected surpluses on the horizon, and the prospect of the government delivering household tax cuts. With Australian business confidence high, infrastructure spending elevated, and consumer confidence resilient to date, this budget could provide an additional tailwind to the Australian economy.
In New Zealand, the government has more of balancing act. Financial media and analyst commentary had become quite focused on the competing pressures of fiscal prudence and identified spending plans. The need to invest in infrastructure, combined with wage claims from the public sector had raised the prospect that the government having to pull back on its commitment to run surpluses and take debt/GDP down to 20%. However, both the Prime Minister and Minister of Finance have reiterated the desire to stick to their targets for fiscal prudence. One way they may end up navigating this balancing act, is to push more of the debt raising needs to local authorities and government agencies, such as Housing New Zealand. This effectively changes the mix of funding to the broader public sector.
Sources: ANZ and NAB.
In many respects, the underlying market environment has remained consistent through the year, with a backdrop of higher global bond yields and higher equity market volatility and dispersion of stock returns.
In fixed interest portfolios, the expected stability of the OCR enables us to invest with some confidence in the 1-5 year maturity range without a material risk that rates will jump significantly higher. However, longer-dated maturities are more subject to global pressures. Further upside in global yields is likely over time, but we have already seen a significant move over recent months. With a fair degree of policy, normalisation is priced into the market now, the merits of continuing with a protective short duration position have diminished.
In our view, credit markets could face challenges if activity data continues to ease back, or if inflation rises enough to frighten bond markets. Valuations still reflect a benign environment, so we have emphasised high-quality issuers within our fixed interest funds.
In equities, our portfolios continued to be overweight versus the benchmark in selected quality growth companies in the financials, information technology, consumer staples and healthcare sectors, where the potential rate and sustainability of growth may not be fully reflected in share prices. Conversely, we tend to be underweight in the consumer discretionary sector where disruption risk remains high, and the utilities, real estate and telecommunications sectors, where valuations are high relative to their potential growth.
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