Morningstar Economic Update April 23 2021
Outlook for Investment Markets
Although the global economy is strengthening, individual country differences are likely to remain important given that economies are handling the coronavirus pandemic with very varying degrees of success.
The potential for higher inflation in a stronger world economy has led to losses for bonds as yields have risen, and further challenges may lie ahead as the global recovery takes firmer and broader hold.
New Zealand is also recovering from the impact of the pandemic, and the global upswing has helped prices for New Zealand commodity exports, but present indications suggest that a moderate rather than strong recovery looks the most likely scenario.
New Zealand Cash & Fixed Interest — Review
There has been little change to short-term interest rates, and the 90-day bank bill yield remains close to 0.3%. Bond yields have continued to follow the US lead, rising up to the end of March but easing back more recently. For the year to date, the 10-year government stock yield is up 0.6%, to 1.61%. The New Zealand dollar is effectively unchanged for the year to date, with a marginal 0.1% decline in overall trade-weighted value. In headline terms, it is down 0.7% against the US dollar, at 71.75 US cents.
New Zealand Cash & Fixed Interest — Outlook
Annual inflation in the March quarter came in at 1.5%, in line with market expectations, but the big issue is where it will go next.
Early results from the ANZ Bank’s April business survey showed that “Pricing expectations hit a new high, in data that goes back to 1992.
The New Zealand Institute of Economic Research’s March Quarterly Survey of Business Opinion or QSBO said that “Supply chain disruptions are contributing to the intense cost pressures across most sectors,” and it may be that as supply chains normalise, the pricing pressures will recede. But it is also possible that the Reserve Bank of New Zealand may be getting closer to its 2% inflation target faster than previously thought.
The central bank (RBNZ) will be cautious about eventually tightening monetary policy: Investors will still be looking at very low cash rates for some time.
The futures market now picking a 0.25% increase in the official cash rate in the second half of 2022.
Both the ASB Bank and Westpac see the 10-year yield around the 2.2% mark by the end of next year: The ANZ and the BNZ sees it rather higher again, at around 2.5%.
Forecasters currently lean towards a higher kiwi dollar against the US dollar: The ASB and Westpac expect 74 US cents by the end of this year, while the ANZ and BNZ see it higher again, in the 76-77 cents area.
New Zealand Property — Review
Property shares, like the wider sharemarket, have been weak for the year to date. The S&P/NZX All Real Estate Index has lost 3.6% in capital value and returned an overall loss including dividends of 2.9%. While it may not be much comfort to out-of-pocket investors in the asset class, at least the return outperformed the 4.2% loss from the overall sharemarket.
New Zealand Property — Outlook
Emergence from the worst of the pandemic has, as in several other overseas property markets, led to improved investor sentiment.
A recent survey of institutional investors by JLL, for example, found that they believe transaction volumes will be back to pre-pandemic levels in the second half of this year or the first half of next year; 78% expect to be net buyers, and the remainder expect to maintain what they already have, with no takers for net selling; and returns are expected to be somewhat better, with the biggest vote (48%) favouring a small improvement.
The usual sectoral trends are still in play: The survey showed that industrial property remains by far the most popular target for increased exposure, and retail is the sector with the most votes for reduced allocation.
The survey respondents are very likely right in thinking that the recovery will improve the overall operating outlook for the asset class.
Australian & International Property — Review
The S&P/ASX 200 A-REITs Index was weak through to the second half of February but has recovered since, and it is now all square for the year in terms of capital value. With dividends it has delivered a marginally positive 0.7% total return, well behind the wider sharemarket’s 7.4%.
Global listed property has been strong. The FTSE EPRA/NAREIT Global Index in US dollars has returned 11.0% including dividends, but it very much been a case of the US market and everywhere else: The US equity REITs have returned 16.6%, whereas the rest of the world has returned 5.5%. The UK has been the pick of the non-American markets, with a 9.5% return; the eurozone has been the laggard, with a small loss of 0.3%.
Australian & International Property — Outlook
The worst looks to be over for Australian property. Cushman & Wakefield’s latest (March quarter) MarketBeat report, for example, says that “Investment activity continues to rebuild following the disruption caused by the COVID-19 pandemic.
Including improving business and consumer sentiment, Australia’s relative success in containing the pandemic as well as very low interest rates contributed to the increase in investment activity.
The latest (March quarter) ANZ/Property Council of Australia commercial property market survey showed similar patterns, with a sharp rise in industry sentiment as the coronavirus has receded.
The ANZ Bank’s commentary on the latest survey said that “industrial property expectations remain by far the strongest. Sentiment improved again across all [industrial] indicators in the latest survey, and construction, price and employment expectations are all now at record highs”
there is also strong interest in “alternative” subsectors such as data warehouses, social infrastructure, and healthcare, but offices and retail are lagging as they cope with challenges exposed or accelerated by the coronavirus.
The economic cycle is broadly supportive for the overall asset class, provided bond yields do not rise significantly, and it could well show better performance in coming months than it has so far this year, but subsector selection is likely to remain an important driver of outcomes.
The same sector trends can be seen overseas, overlaid by country-level differences in progress in dealing with the coronavirus: Recent global REIT performance has closely reflected containment success, with relatively good performance in the US and the UK, in both cases after poor starts at containment and vaccination, contrasting with new waves of the pandemic in the eurozone and in important emerging markets like Brazil and India. Investor interest is unlikely to return to the currently lagging REIT economies until there is a realistic prospect of vaccination or other effective responses.
As the economist for NAREIT, the US REIT trade group, put it recently, the four issues are the longer-term future for e-challenged retail property; the future of the office (“It may be several years before a stable new model for office work emerges”); changes in residential property, as many people moved “from dense environments in or near downtown areas to places in farther-out suburbs or smaller, less expensive cities”; and the role of “digital economy real estate” such as data centres and industrial logistics sites.
While the strengthening global economy (again assuming no surge on bond yields) is good for the asset class, sectoral prioritisation of industrial and alternative “new economy” subsectors looks likely to remain key to delivering the best results.
Global Infrastructure — Review
Global listed infrastructure has made solid progress for the year to date, and the S&P Global Infrastructure Index in US dollars has recorded a capital gain of 4.9% and a net return (including taxed dividends) of 5.5% (6.0% hedged back into kiwi dollars).
Global Infrastructure — Outlook
On the plus side, the strengthening of the global economy is on balance progressively improving the prospects of patronage-dependent infrastructure assets, though full reopening of sectors such as international tourism is still a long way away, and in some areas (such as listed central European airports) a new wave of the virus means the immediate outlook has worsened. Energy prices are holding up well: For the year to date the world oil price is up 26%, helping energy infrastructure. And the prospect of somewhat higher inflation and higher bond yields has helped build a case for regulated utilities as a hedge, given that their allowed returns are typically adjusted by their regulators to compensate them for increases in costs and in interest rates.
On the downside, investors had been hoping that President Biden’s infrastructure package would present a pipeline of potential private sector co-investment opportunities: In the event, the USD 2.3 trillion proposal, which has still to get through Congress, plans to rely entirely on public spending, financed by taxes. Overall, the sector may well continue to attract support as a relatively defensive way of participating in the global cyclical upswing, with the best sector performance likely to come from digital economy support infrastructure and renewable energy investments.
Australasian Equities — Review
Despite the recent good news of a trans-Tasman travel “bubble” opening, New Zealand shares continue to struggle this year, and so far the S&P/NZX 50 Index is down by 4.9% in capital value and by 4.2% including dividend income. The weakness has been down to some large declines in the large-cap stocks, notably A2 Milk (down 31.5%), Meridian (down 24.3%), and Contact (15.9%). As a result the S&P/NZX10 index is down by 7.5%. The mid-caps have fared better, with a smaller loss of 1.4%, while the small caps are up for the year, with a 5.9% gain.
Australian shares have been doing well, and the S&P/ASX 200 Index up is by 6.2% in capital value and by 7.4% including dividends. By sector the big winners have been the financials (ex the A-REITs), up 13.3% helped by strong housing lending and a resumption of normal dividends, and consumer discretionary stocks, up 12.7% on the prospect of previously pent-up household demand being spent in the shops post-pandemic. The miners, up 7.0%, have benefited from a firming world economy. IT shares have reflected the global rotation out of tech and into more cyclical sectors and are down 1.9% (though still up 86.5% on a year ago). The latest significant IPO, for nonbank lender Latitude, got off to a reasonable start, and at AUD 2.65 has made a small gain on its AUD 2.60 offer price.
Australasian Equities — Outlook
The recent divergence between weaker New Zealand equities and stronger Australian equities, while partly reflecting some equity-specific setbacks among the larger New Zealand corporates, is also explicable by rather different cyclical economic outlooks.
The latest New Zealand indicators suggest that the outlook is positive, but it does not look like the stronger upswing happening in Australia. Parts of the economy are doing very well, notably construction and manufacturing: The BNZ/BusinessNZ survey of manufacturing, for example, hit an all-time high in March (the series goes back to 2002), with respondents mentioning “more construction activity, a buoyant primary sector, increased government activity, movement toward domestic sourcing, and improving external demand.”
The NZIER’s March QSBO found that a net 11% still expect business conditions to worsen in coming months. Early results from the ANZ Bank’s April business survey also showed some modest weakening from March levels and also showed that expected profitability has turned down: As the ANZ commented, “cost pressures are intense, and subdued profitability expectations suggest firms are not optimistic about their ability to recoup all of it.”
It is not all doom and gloom: Firms said in the QSBO that they are hiring and plan to hire more again. They are also keen on investing, especially in plant and equipment, and it is possible that some of the current wariness may be down to transient issues with still disrupted supply chains. But at the moment it is not adding up to a strong case for cyclical tailwinds behind New Zealand equity performance.
Australia’s immediate outlook, on the other hand, is looking robust. Employment is already doing a good deal better than expected: The March labour force statistics showed a surge of 70,700 extra jobs, way better than the 35,000 jobs forecasters had anticipated, and consumer and business surveys suggest there is more good news to come.
The April Westpac – Melbourne Institute consumer confidence survey was, according to Westpac, “an extraordinary result. The Index is now at its highest level since August 2010 when Australia’s post-GFC rebound and mining boom were in full swing.”
Businesses are also in good shape. The NAB March business survey found that “Business conditions rose to a record high in March, driven by strong increases in all sub-components [trading, employment, profits] – which are now also all at record highs. The strength in conditions is evident across all states and industries. Forward orders – which also rose to record levels – point to ongoing strength in activity with the pipeline of work rising further ... This is a very solid survey result. Businesses are telling us activity continues to increase at a very healthy rate as we have moved past the rebound phase in activity with the earlier removal of pandemic-related restrictions. Overall, the recovery over the last year has been much more rapid than anyone could have forecast.” Other surveys, such as the Australia Industry Group suite of sectoral indexes, also show strong business momentum.
There are, as always, things that might go wrong, with a renewed outbreak or mutation of the coronavirus top of the list, the removal of JobKeeper support may weigh on some firms, rising input cost pressure may crimp profits, and the RBA could yet step into the housing boom with some form of macro-prudential brake. Overall, however, the strengthening domestic cycle and robust prices for the miners look to provide a supportive basis for further equity gains.
International Fixed Interest — Review
Bond yields in the US rose steadily in February and March, and by the end of March the yield on the 10-year Treasury note had reached just shy of 1.75%, an increase of 0.8% for the year. Yields in other major bond markets also rose, though by less: The (negative) yield on the benchmark 10-year German government bond, for example, rose from negative 0.57% at the start of the year to its negative 0.23% peak on 25 Feb. Since then, however, the US yield has eased back to 1.57%, and other major market yields have also dropped a little. The recent reversal has eased the scale of capital losses for global bond investors but still left them out-of-pocket for the year to date. The Bloomberg Barclays Global Aggregate Bond Index in US dollars is down by 2.9%.
International Fixed Interest — Outlook
Overseas central banks are confronting the same issues as our own Reserve Bank: How much of recent inflation is a temporary pandemic-related phenomenon, and can consequently be ignored from the point of view of monetary policy, and how much might be a more permanent increase in inflation? If mostly the latter, and inflation is genuinely moving back towards the inflation rate central banks would like to achieve (generally around 2%), then ultra-easy monetary policy may no longer be needed.
Much the same issues arise with central banks’ full employment mandate: Is much of the recent global recovery a one-off recovery from the depths of the pandemic, and progress towards full employment might consequently need ongoing monetary policy support? Alternatively, economies could be on their way to sustainably strong growth, in which case the monetary policy levers could be moved from their current ultrasupportive settings.
The issues are most acute in the US In March: Consumer price inflation was 2.6%, and although the outcome was boosted by some one-offs (particularly petrol prices, and comparison with depressed prices in the early stages of the pandemic), many analysts also feel that inflation has genuinely moved higher than before. The April consensus forecasts collated by The Wall Street Journal showed that inflation is expected to be just over 3% by June and to run above 2% all the way to the end of 2022. On the growth and employment front, GDP growth is expected to be a remarkable 6.4% this year, and a solid 3.2% in 2022, and the unemployment rate is expected to have fallen to 4% by the end of next year.
If these forecasts eventuate, the Fed’s work would effectively be done. It has said that it would be happy to let inflation run above target for a time to make up for when it had been below target, and it is likely to be cautious in any event before dismantling its support for fear of inadvertently choking off the upswing. But, as in New Zealand, financial markets are starting to think the US central bank may move to normalise policy settings earlier than previously thought. The same applies to other central banks in economies that are also coming out of the pandemic in strong shape: The Bank of Canada has already taken the first steps to start unwinding its ultra-easy policy.
Even if the Fed and other similarly placed central banks do not make many near-term changes, the writing is on the wall for bond markets: Even if the Fed stands pat, and barring any shock that might re-ignite safe-haven buying of bonds, bond market investors are unlikely to accept 1.5% yields on 10-year bonds for long when inflation has been running above 2% for some time. The Wall Street Journal forecasting panel thinks that the 10-year US Treasury yield will be over 1.9% by the end of this year and will rise a bit more to 2.2% by the end of 2022. Bond market conditions are likely to remain challenging.
International Equities — Review
World shares have continued to rise as the world economy comes out of the worst of the pandemic. The MSCI World Index is up 9.0% for the year to date in US dollars. The pattern of recovery is rather uneven, however, and global equity outcomes continue to be disproportionately affected by the strong US market: Excepting the US, where the S&P 500 is up 11.1%, world shares are up 6.2%. European shares have done well, with the FTSE Eurofirst 300 Index up 9.5% in euros, while Japan has lagged: Although the Nikkei is up by 3.9% in yen, it is slightly down in US dollar terms after allowing for the yen’s 4.4% depreciation.
Emerging markets have been relatively subdued: The MSCI Emerging Markets Index is up by 3.5% in US dollars, and the core BRIC markets (Brazil, Russia, India, China) are marginally lower, by 0.1%. The Russian market has made modest gains (the MSCI Russia Index is up 3.2%), China and India have shown little change, while the overall poor result for the BRIC group was driven by lower prices in Brazil, where the MSCI Brazil Index is down by 7.7%.
International Equities — Outlook
In aggregate, the world economy is currently looking in good shape. The latest JPMorgan Global Composite indicator of manufacturing and services, for example, found that “The pace of global economic expansion remained close to decade highs in March, as manufacturing growth stayed solid and the service sector shows signs of revival. Intakes of new business strengthened, supporting improved job creation and brighter business optimism.” The upswing is also becoming more broadly based. Nineteen of the 21 sectors surveyed reported increases in output, the most in two and a half years, and it appears that the worst is past for the most pandemic-affected sectors: Transportation recorded an increase in activity for the first time since the depths of the crisis in July 2020, and tourism and recreation fell only marginally.
The upswing is expected to continue through the rest of this year and into next. The IMF, for example, in its April update to its World Economic Outlook forecasts, now estimates that the pandemic setback to world GDP in 2020 was smaller than it first thought – it now thinks there was a contraction by 3.3%, rather than its first estimate of 4.4% – and it expects global growth in 2021 and 2022 to be stronger than it first expected. It is picking global GDP growth of 6.0% this year, and 4.4% next year.
The upswing is not evenly distributed: As the IMF said, “Economic recoveries are diverging across countries and sectors, reflecting variation in pandemic-induced disruptions and the extent of policy support.” Recent events have confirmed the Fund’s assessment: Global new cases of COVID-19 have surged to new highs in some countries even as it has come under better control in economies like the US and the UK. The increase to more than 800,000 new global cases a day has been led by India (some 265,000 new cases a day, according to the New York Times’ count) and Brazil (64,000), and parts of the developed world are also experiencing new waves, notably France (32,000 and into its third lockdown) and Germany (16,400).
In these circumstances, it is not surprising that equity market performance has been disproportionately driven by one of the clear winners of the post-pandemic upswing. As noted earlier, growth is expected to be very robust this year in the US, and American corporate profits are strongly on the rebound after an 11% decline for the S&P 500 companies in 2020. At time of writing, only 9% of the S&P 500 had reported their March quarter results, but according to data company FactSet, which combine actual results to date with estimates of what those yet to report will say, March quarter earnings will be up 30.2% on a year ago, which would be the fastest rate of growth since 2010.
Admittedly, the increase looks better than it really is: As FactSet says, “These above-average growth rates are due to a combination of higher earnings for 2021 and an easier comparison to weaker earnings in 2020 due to the negative impact of COVID-19 on numerous industries.” But even after allowing for the comparison with a low base, the outcome is shaping up to be impressive. Share analyst expectations, collated by FactSet, are that for 2021 earnings will have rebounded by 27.9%, led by the more cyclical sectors (industrials, consumer discretionary, materials, and financials), and will grow by a further 13.9% in 2022.
The fundamental backdrop supports further gains for equity prices, and probably along the recent lines of gains concentrated in the countries and regions best coping with managing the pandemic. As time goes by, and more countries get on top of the pandemic, equity gains may become more evenly distributed. The main risks are that the coronavirus evolves in new, unpleasant ways; that actual performance falls short of high expectations for corporate profits in the countries doing relatively well; that bond yields rise more than currently expected, which would have the potential to upset the valuation of growth assets; and that the geopolitics of major power confrontations resurfaces after being largely sidelined as an investor concern during the pandemic.
Performance periods unless otherwise stated generally refer to periods ended April 21, 2021.
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