Key points
- Volatility across global financial markets, which had been building since October, picked up sharply in December.
- Many countries, including the US and Australia, are experiencing high employment, solid consumer spending, reasonable business investment trends and mild inflation that should result in a reasonable backdrop for the equity market.
- The current environment is likely to remain sensitive to any signs that domestic growth is easing and, with that, renewed speculation that the Reserve Bank might cut rates. Our core view remains that this is currently unlikely.
Key developments
Volatility across global financial markets, which had been building since October, picked up sharply in December. Earlier in the year, emerging markets had been hit by tightening global liquidity conditions and this spread to developed markets. Equities, bonds, oil and currencies were all affected. In December, the hawkish tone adopted by the US Federal Reserve had been cited as a catalyst, but slower economic momentum, trade anxieties and the feedback loop from the volatility itself were all factors behind poor equity performance and a rally in bond yields. New Zealand markets essentially followed the global moves.
The primary focus in the New Zealand bond market shifted from domestic factors to global ones. The sharp and widely covered turbulence in global equity markets generated a classic flight-to-quality move that drove bond yields lower across the developed world. The New Zealand 10-year NZ Government Stock yield fell by 0.2% to 2.3%, while the US counterpart fell 0.3% to 2.7%. In New Zealand this is the lowest yield traded since 2016 and is just 0.6% above the Official Cash Rate.
The New Zealand equity market continued to outperform global equity markets over the December month with its high weighting to companies with defensive, relatively certain, earnings remaining attractive in a period where global uncertainty is high. Strength in the a2 Milk (positive trading data), Mainfreight (positive earnings trend), and Fletcher Building (sale of Formica) stock prices, and further merger and acquisition activity (Trade Me and Methven takeover offers), also supported the New Zealand equity market’s relative performance over the December month.
The month of December saw Australian materials, resource, healthcare, utilities and property sectors outperform, whilst the communications, technology, banks, energy and consumer discretionary sectors delivered negative returns. The eclectic sector contributors to the Australian market outperformance against global equities over the December month perhaps reflects increased investor uncertainty.
What to watch
Equity market weakness can be alarming and cause investors to question their strategy. Volatility can also raise concerns.
Right now, we still view the fundamental economic foundations as supportive for long term corporate earnings growth. Disruptive technologies, demographics and the rise in consumer spending in Asia remain core medium term influences on markets.
In recent months concerns regarding a slowdown in global growth, trade wars and the impact of tighter financial conditions in the US have provided new storylines for market participants. However, many countries, including the US and Australia are experiencing high employment, solid consumer spending, reasonable business investment trends and mild inflation that should result in a reasonable backdrop for the equity market.
NZ markets have recently taken their lead from global changes in sentiment. However, there are important differences. There appears to be a very high hurdle for the RBNZ to change interest rates. Growth in NZ has moderated, and the source of economic expansion has shifted towards the government sector. Locally some wage pressures, continued capacity constraints and many ongoing regulatory inquiries have added to business uncertainty. Weakness in the Auckland housing market may also have some impact on both turnover and wealth.
Market outlook and positioning
Credit markets have also been under pressure. This has been most notable in the high yield sector of the market, which is most closely aligned with equities and the economic cycle. Spreads on US High Yield indices have widened by 1.50%. To a moderate degree, this has flowed through into New Zealand. We have been fairly cautious about credit exposure for some time. It is typical for the local market to lag offshore moves and we expect further spread widening through the March quarter. However, there are substantial bond maturities in the local market over the next 3 months and the proceeds from principle repayments will most probably be reinvested. This may provide some resilience. Looking ahead, the current environment is likely to remain sensitive to any signs that domestic growth is easing and, with that, renewed speculation that the Reserve Bank might cut rates. Our core view remains that this is currently unlikely, with the Bank preferring to watch and wait. But as 2018 and many other years have proven, there is plenty of scope for markets to surprise.
In equity portfolios, we expect equity markets to remain volatile, with the portfolio’s focus on companies with long term structural drivers likely to deliver above market growth over time. In our view, this period of elevated market volatility has provided he opportunity to invest in companies that can grow faster than the broader economy at what may prove to be attractive stock prices.
In our multi-asset portfolios, we have moved to a small overweight in equity markets, buying back into these positions at more attractive valuation levels on equity market weakness.
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