Outlook for Investment Markets
Markets have had two bits of good news that have boosted growth assets: The first coronavirus vaccinations are underway, and in many countries (including New Zealand) the economic bounceback from the initial lockdowns has been stronger and faster than earlier expected. On the downside, however, vaccination is likely to be a prolonged and patchy process, and in the meantime, there has been a second, larger wave of infections and deaths across a number of large economies, triggering a second phase of disruption.
New Zealand Cash & Fixed Interest
There have been no formal monetary policy changes in recent weeks. The 90-day bank bill yield remaining close to 0.25%. Bond yields have also been quiet: While they rose in early November in response to news of vaccines and resolution of uncertainty over the U.S. presidential election, they have stabilised since then, and the 10-year government bond yield has been steady in recent weeks, close to 0.85%.
The kiwi dollar, which had been weak for much of the year, is now slightly stronger: In overall trade-weighted value, it is up 0.6% for the year to date. Much of the turnaround reflects its recent 3.4% rise against the U.S dollar: A month ago, it was worth 68.5 U.S. cents, compared with its current 70.8 cents.
At one point it appeared a given that the RBNZ would cut the official cash rate by the middle of next year, with an OCR of negative 0.5% a popular forecast. But as last month’s update said, “In the more optimistic climate following news of a potential COVID-19 vaccine, forecasters are having a rethink about the extent of OCR cuts”, and opinion has continued to shift. As BNZ put it, “Rate hikes still look off the agenda for a long time, which will cap the topside, but the positive backdrop--both globally and domestically--means the market sees relatively small odds on any further rate cuts”. Either way, short-term rates will stay very low.
Local bond yields have reflected changes in global sentiment about the upside from a COVID-19 vaccine. Some forecasters are starting to think that, in addition to the upward move from less demand for insurance against risk, the faster than expected economic recovery from COVID-19 may also push yields higher: The ANZ and Westpac see the 10-year yield only a tad higher (at 0.9%) by the end of next year, while the BNZ sees a slightly larger rise, to 1.1%.
The outlook for the currency remains linked to global investor sentiment. In recent weeks, sentiment has firmed on news of vaccine development, and this has had two consequences. Investors have felt less need to huddle in the safety of the U.S. dollar, which has dropped in overall value by 3.4% since the end of October. They have also felt more confident in buying ‘risk on’ currencies like the kiwi dollar, possibly also influenced by New Zealand’s effective COVID-19 control by international standards. While this mood prevails, further appreciation may well be on the cards, with (for example) both the ANZ Bank and Westpac expecting a 74 U.S. cent exchange rate at the end of next year.
New Zealand Property
Listed property has lagged the wider share market. The S&P / NZX All Real Estate Index for the year to date is marginally down (negative 0.9%) in capital value and has returned 2.3% including dividends, well behind the overall share market’s 9.2% capital gain and 11.7% total return.
Forecasts for 2021 show the outlook for commercial property is a mixed bag. It helps that the rebound from the COVID-19 lockdown is happening quicker and more strongly than earlier thought. But of the three main subsectors, only industrial looks strong: Colliers say that “The accelerated adoption of online shopping which COVID-19 drove has seen a sharp increase in demand for space from the logistics sector”, and already-low vacancy rates are likely to head even lower.
For offices, Colliers expect that while there will be some ongoing increase in work flexibility, “from 2021 we expect to see a great number of employees return to the office”. This could be on the optimistic side, but in any event, nobody can be quite sure yet what the future configuration of work will look like. For retail, the situation is more serious: There were some winners--Colliers mention the supermarkets, and retailers that had proactively gone “omni-channel”--but “Retailers that are not equipped for a more online world are likely to struggle”.
Australian & International Property
Although they enjoyed a good bounce in the post-vaccine-news market rally, for the year as a whole, the A-REITs have had a difficult time, and the S&P / ASX 200 A-REITs Index is down by 7.3% in capital value and returned an overall loss including dividends of 5.2%.
There was a similar outcome, only worse, for global REITs. Again, there was a relief rally on the vaccine news, but it did not compensate anywhere near enough for the previous COVID-19 losses, and for the year to date the FTSE EPRA / NAREIT Global Index in U.S. dollars is down and has delivered a capital loss of 14.3% and an overall 11.1% loss including dividends.
Global Infrastructure
Global listed infrastructure has suffered principally from the cyclical impact of lockdowns on patronage of transportation and tourism infrastructure such as toll roads, trains, and airports, and the impact of lockdowns has dominated the rarer examples of infrastructure that has benefited from lockdown (such as assets that facilitate remote working). For the year to date, the S&P Global Infrastructure index in U.S. dollars is down 10.5% in capital value and down 7.8% including dividend income.
Global listed infrastructure faces many of the same challenges as global listed property. Some of the subsectors have been severely impacted by the COVID-19 shock, and even though vaccine news is highly positive, with airport share prices rallying strongly, for example, the realistic time frame for reopening remains uncertain. It is also unclear what permanent impacts COVID-19 may have inflicted. It would be understandable, for example, if tourists were permanently more wary about exposure to international travel or if businesses shortened their supply lines to favour domestic suppliers (which might benefit railroads but be at the expense of shipping and ports).
The sector has also been waiting for the catalyst of the long-promised but long-delayed U.S. pickup in spending on its infrastructural deficit. President-elect Biden may be able to effect some legislative progress, but without control of the Senate, it is not clear that his renewable-energy-focused ‘Green Infrastructure and Jobs’ plan will gain political traction. The general theme of greener infrastructure is, however, a promising longer-term strategy as fossil-fuel-related infrastructure comes under stricter scrutiny (December’s float on the ASX of coal terminal Dalrymple Bay did not go well). In the meantime, investors may continue to sit out the COVID-19 cycle at the more defensive utilities’ end of the asset class and wait to get further clarity on vaccine rollout and on any longer-term COVID-19 effects on infrastructure patronage.
Australasian Equities
New Zealand shares have done well for the year to date. The S&P / NZX50 Index is up 9.2% in capital value and has delivered a total return including dividends of 11.7%. Most of the action was at either end of the market-cap scale: The big-cap S&P / NZX10 Index is up 14.5% and the Small Cap index is up 18.9%, but in the middle not much happened, with the Mid Cap index up only 2.1%. Among the big names, the utilities did especially well (up 26.1%) because of their defensive qualities in a volatile year, plus their ongoing ability to pay dividends in a world where fixed-income yields have been very low.
Australian shares have not done as well, with the S&P / ASX200 Index slightly down (negative 0.4%) in capital value and returning 2.4% including dividends. There have been some very strong sectors, notably IT, which is up 51.7% thanks to the stellar performance of companies such as ‘buy now pay later’ Afterpay (which is now about to join the top 20 stock index), and the resources have also done well (the miners are up 16.3%). But the financials (down 6.5%), the A-REITs (down 7.3%), and the industrials (down 12.5%) have been a drag on overall performance.
New Zealand has bounced back from its COVID-19 lows more quickly, and more extensively, than earlier feared. The New Zealand Activity Index is a post-COVID measure designed to give a more timely view of the economy rather than waiting for the eventual publication of gross national product: On its latest (November) reading, it is signalling that economic activity is back above its levels of a year ago.
Business surveys are also showing significant improvement.
The main risk for the local equity markets is that it over anticipates the speed and scale of recovery. As modelled by the Treasury, the recovery from Covid is likely to be more of a long slog, than a fast V shaped recovery, which it seems the markets are expecting.
International Fixed Interest
At the start of 2020, many investors may have wondered whether bonds could make capital gains this year, given that yields were already so low. In the event, COVID-19 led, on the demand side, to a further surge in ‘safe haven’ buying of government bonds and, on the supply side, led central banks to push yields even lower again to support faltering economies. Even though yields rose again more recently, particularly after news of vaccines, the net effect is that bonds have indeed made further gains and have proved a useful asset class both in absolute and relative terms. The Bloomberg Barclays Global Aggregate Index in U.S. dollars is up 8.5% for the year to date. The higher-quality end of the bond spectrum fared best, while the riskier subsectors lagged: ‘High yield’ was up 5.9%, and emerging markets were up 5.7%.
As can be seen from their latest decisions, this month’s monetary policy decisions by the Fed and the European Central Bank made the big picture clear: For the next year or two, the big central banks are likely to stick with their current policies of keeping both short-term and long-term interest rates close to their current ultra-low levels.
International Equities
Despite the disruption to the global economy in 2020 from COVID-19, world shares are up for the year. The MSCI World Index of developed markets in U.S. dollars is up 11.1% for the year to date. Unfortunately for local investors, the strength of the New Zealand dollar against the U.S. dollar--it is up by 5.6%, much of which has occurred in the past month--has eaten into the overseas return.
As has been the case all year, returns have depended disproportionately on the U.S. market, and in particular on the big names in its tech sector: The S&P 500 is up 12.9%, and the tech-heavy Nasdaq is up by 38.6%. Ex the U.S., the MSCI World is up by a much more modest 3.0%, with Japan, where the Nikkei is, up 13.0%, the best of the other major markets. European shares have been weak, with the FTSE Eurofirst 300 Index down 6.8%: Within Europe, the U.K. has been especially poor, with the FTSE 100 Index down 13.4%.
The emerging markets have also done well against this year’s difficult economic backdrop. The MSCI Emerging Markets Index is up 12.2% in U.S. dollars, and its core ‘BRIC’ members are up 11.6%, with gains in China and India offsetting losses in Russia and Brazil.
The gains made by global equities reflect three main factors: enthusiastic investor reception of news of the development of new vaccines; evidence that economic activity in many countries had bounced back quickly from its sharp fall earlier in the year in the immediate wake of the COVID-19 outbreak; and strong fiscal and monetary stimulus in a wide range of countries designed to counter the damage from the pandemic.
The global recovery in business activity was clearly evident in the latest J.P. Morgan Global Composite indicator, for November, which showed that the world economy was growing for the fifth month in a row, currently growing at a respectable 3% or so annual rate. In addition, the breadth of the recovery is improving: In November, output increased in 18 of the 21 industry sectors surveyed. Unsurprisingly, healthcare activity was by a margin the busiest sector, but there were also strong output gains for many other sectors, such as the car and machinery industries.
In the circumstances, it is not surprising that investors have been upbeat. The monthly fund manager survey run by Bank of America Merrill Lynch turned very positive in November, as news of the vaccines was breaking, and the U.S. presidential election returns were in. They turned more positive again in December. Cash was taken to even lower levels, and allocations to equities rose to levels last seen in November 2010 in the emergence from the GFC.
Share market analysts are also positive about the outlook for the key U.S. share market. Their latest forecasts, collated by data company FactSet, are for a strong 21.9% rebound in S&P 500 profits in 2021, which would more than erase the estimated 13.7% setback of 2020. The analysts think the S&P 500 will just tick over the 4,000 mark over the coming year, which would be a 9.7% gain from its level at the time of writing.
All that good news noted, it is hard to avoid the impression that world equity markets have been swinging from one extreme to the next and have not yet reached a fully balanced view. Fund managers, for example, are currently very upbeat about the progress that will be made with vaccinations in the first half of next year. That is not only an ambitious time scale for rollout, for both developed and (especially) emerging markets, but it also ignores the serious worsening of the pandemic in the meantime. A number of European countries, for example, have had to impose tight new lockdowns, and the latest headline in the Daily Telegraph newspaper in the U.K. reads “London plunged into toughest [lockdown] tier as ministers warn of new virus strain”. In the U.S., new cases and new deaths continue to run at very high levels, with hospitalisations at a new record and the cumulative death toll now near 300,000.
The current upbeat mood also glosses over the likely permanent damage from COVID-19. With vaccination progress likely to be gradual, and countries likely to vary in the effectiveness of their rollout programmes, border controls are likely to remain a serious challenge for some time. The J.P. Morgan global indicator, for example, shows that the tourism, recreation, and transportation sectors remain in a depressed state, and there will be a swathe of businesses that will not survive a further extended period of travel controls.
All going well, the world economy will indeed gradually pull out of its COVID-19 difficulties, and corporate profitability will be rebuilt. At the moment, however, market sentiment looks overly focused on early widespread vaccine deployment.
See the Full MorningStar Economic update here.
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