Inflation risks building
- Inflation is likely to surge through the Reserve Bank of New Zealand’s (RBNZ) 2% target in the coming months, reflecting mostly temporary factors that could easily reverse.
- But there is a risk that inflation becomes more persistent, something the market may be underestimating.
- We think medium-term inflation risks are skewed to the upside and have positioned portfolios accordingly.
Harbour Outlook: Markets balance higher earnings and yields
- Both New Zealand equity and bond market returns bounced back in March with the S&P/NZX 50 index returning 2.7% and the Bloomberg NZ Bond Composite 0+ year Index returning 0.6%.
- Globally vaccine programmes have gained speed, with the US and UK (alongside Israel) leading the way. The European vaccine rollout has been significantly slower, making re-opening difficult for many nations in the area as they battle rising infections.
- Following changes in New Zealand residential property “bright line” tests and tax deductions on investment properties, expectations of New Zealand’s official cash rate (OCR) increasing were pushed out, contributing to lower bond yields, as well as the New Zealand dollar weakening.
Social Spotlight I: Video
In relation to our first Social Spotlight research installment, Manager, ESG Research, Jorge Waayman sits down with Executive Director, Ainsley McLaren to discuss some of the initial findings.
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Still a large gap in New Zealand output
- The New Zealand economy shrank at the end of last year as the construction sector struggled to find the resources to continue to expand, while retail trade and accommodation activity dropped due to a lack of tourists.
- New Zealand is in a better position than many other economies, but there is still a gap between our potential output and where we are currently tracking, which is acting as a disinflationary force.
- It seems unlikely that the RBNZ will hike rate hikes in the next year; they have many other actions they could take before contemplating interest rate hikes.
- Longer-dated bond yields could be led higher by offshore developments as global growth beats expectations.
Social Spotlight I: Employee Engagement
- Employee engagement, among larger NZX-listed corporates, was assessed through company reports and a survey.
- We found a low level of disclosure on employee engagement scores, turnover and absenteeism with comparability between companies difficult.
- The majority of companies that did disclose showed improvements in their employee engagement scores and turnover, but not absenteeism.
- Sector dispersion is evident with the IT, Communication and Consumer Staples companies showing the greatest improvement in employee engagement survey
Harbour Outlook: Yields increase accelerating rotation
- Both nominal and real bond yields increased sharply over the month. This saw interest rate sensitive stocks, such as the gentailers in New Zealand and long duration growth stocks give back some performance. Cyclical stocks that would benefit from stronger growth outperformed.
- US earnings season was strong, with 77% of companies either in-line or beating earnings expectations. Our observation, both domestically and offshore, is that the earnings outlook is cautious, reflecting COVID-19 uncertainty, and wary as to the impact of declining government support packages and the on /off impact of lockdowns. In our view, this leaves room for earnings upside.
- The US economy is likely to grow by as much as 7% this year, assisted by a larger-than-expected US$1.9 trn (9% of GDP) stimulus package.
- New Zealand’s economic strength, coupled with a stronger global economic picture, has led to a marked change in interest rate expectations. Market pricing now expects an OCR hike in the middle of 2022. This is a far cry from the negative rates that were priced into markets late last year.
Harbour Outlook: Choppy markets…but with earnings upside
- The COVID-19 vaccine rollout gathered steam during January. Israel, who has given the initial jab to a third of its population, is showing positive early signs. The vaccine rollout has not been as smooth in all jurisdictions, with Europe and the US especially encountering teething issues.
- The US earnings season has shown broad-based strength. At the time of writing, 277 of companies in the S&P 500 had reported earnings, with 79% of companies reporting earnings in line or above consensus expectations.
- New Zealand economic data continued to beat conservative consensus expectations. Stronger inflation and employment data has seen the market no longer price in future interest rate cuts.
When will central banks react to inflation?
- Higher inflation and the prospect of a reduction in central bank support is becoming a concern among financial market participants.
- We think this risk is low given most economies have spare capacity that is keeping unemployment rates higher and inflation lower than central banks desire.
- The ongoing threat of higher inflation and reduced monetary stimulus, however, is likely to lead to choppy trading conditions as investors manage the transition away from the low inflation and falling interest rate environment seen in recent years.
- We hope that the following Q&A gives you an insight into our thought process.
‘Four More Years’
We’re staying
- Rio Tinto and Meridian have today announced an extension to the Tiwai contract through to December 2024.
- The government has not as yet needed to provide any support
- We would expect further announcements on project development with Contact progressing the Tauhara geothermal plant and Meridian developing their Harapaki wind farm.
Harbour Outlook: Growth continues to accelerate
- COVID-19 hospitalisations continued to increase globally with new strict lockdowns in the UK. However, countries have moved to fast-track vaccines to manage the pandemic. At the time of writing 24 million doses of COVID-19 vaccines have been administered across 41 countries including 7.7 million in the US and 1.5 million in the UK.
- Just before Christmas, the US approved USD900bn of additional fiscal stimulus (about 4% of GDP), much larger than the USD500bn expected by most analysts after the election resulted in a split Congress.
- The Democrats took control of the US Senate, by winning both seats at the January 5th Georgia runoff, increasing the prospect of large additional fiscal stimulus, increased corporate tax rates and further regulation.
- New Zealand Quarter 3 GDP data confirmed that economic activity has returned to pre-COVID-19 levels, consistent with high frequency activity indicators.
