Outlook for Investment Markets
Local and international equity markets continue to take comfort from the prospect of vaccinations bringing the coronavirus pandemic under control, even if in the near term the number of new cases in some regions (notably Western Europe) is still alarmingly high. There is indeed a good chance that global and local economies will gradually move back toward normality, and to that extent current optimism is warranted. There are important caveats, however: the virus is mutating, the efficiency of vaccination rollouts remains to be seen, and the current wave of optimism may not be allowing for the permanent impact of COVID-19 on sectors such as commercial property. Post-vaccine optimism has also taken some risk-asset markets into expensive valuation territory.
New Zealand Cash & Fixed Interest
Short-term interest rates remain very low, with the 90-day bank bill yield at just under 0.3%. Bond yields have moved slightly higher, echoing a rise in the U.S. bond market, but the 10-year government-bond yield is still very low at 1.07%. As with other financial markets, it is early days and year-to-date movements may not mean much, but for the record the New Zealand dollar is 0.4% lower in overall trade-weighted value since the start of the year.
There is a chance the Reserve Bank of NZ may follow Australia’s lead and drop the official cash rate (OCR) to 0.1%. However, with the latest inflation rate a bit higher than expected at 1.4% in the December quarter it is not a given although interest rates are expected to remain low for the near future.
The recent uptick in local bond yields may carry on a bit further, but there is not much scope for any significant rise as the RBNZ would be likely to deploy its "large scale asset purchase" programme to keep long-term interest rates at low levels.
Because of New Zealands very low incidence of COVID case and the optimism and risk appetite of foreign exchange investors, forecasters are currently inclined to the view that the kiwi dollar will appreciate against the U.S. dollar: ANZ expects USD 0.74 at the end of the year, Westpac expects USD 0.75, and the BNZ has picked USD 0.76.
New Zealand Property
New Zealand listed property underperformed in 2020 relative to the overall share market, and although the year is young, the pattern has continued in early 2021. The S&P/NZX All Real Estate Index is down 0.9% year to date, compared with the 1.8% gain for the S&P/NZX 50 index.
In the retail sector, COVID-19 dramatically accelerated the pace of online shopping at the expense of physical shops and created a two-tier market with (as Colliers' forecast for retail in 2021 put it) the "high calibre retail premises with strong tenant covenants and long lease terms the more sought after."
The outlook for the office sector is still uncertain as the pre-COVID status quo may not re-emerge if office demand is reduced thanks to the likes of Zoom and other changes to work practices.
Australian & International Property
The same 2020 pattern of substantial underperformance relative to the wider equity market was evident in Australia and has also continued into this year. The S&P/ASX 200 A-REITs Index is down by 2.5% in capital value year to date, compared with the wider market's 3.2% gain.
The global listed property market shows a similar outcome. The FTSE EPRA/NAREIT Global Index in U.S. dollars is essentially unchanged (up 0.1%) so far this year, lagging the 2.5% return from the MSCI World Index.
Australian listed property shares the same issue of contending with the longer-term impacts of the virus.
While the "hotels, tourism, leisure" sector is obviously the big loser, the proportion picking offices has been steadily rising. ANZ said that the December result "likely reflects ongoing weakness in office occupancy rates, and the more permanent shift to partial work-from-home models by a number of large businesses."
Retail remains under a cloud: referring to the surge in online shopping, the ANZ Bank said, “The probability that some of this shift to online sales will be permanent is clearly weighing on the outlook."
Global Infrastructure
Global listed infrastructure was very much out of favour in 2020: The S&P Global Infrastructure index in U.S. dollars fell by 8.7% in capital value and recorded an overall loss including dividends of 5.8%. The good news, year to date, is that prices have been steady rather than falling (the index is marginally lower, by 0.1%), but the bad news is that the sector has remained on the sidelines despite gains for the wider equity market indexes.
The outlook remains mixed. Some subsectors have ridden out the COVID-19 pandemic in good shape: Utilities like electricity, gas, and water have always had appeal as relatively cycle-proof assets and delivered on this occasion as well.
In the United States, for example, the earnings estimates collected by data company FactSet suggest that in 2020 utilities earnings grew by 1.9%, compared with the sharp profit setbacks for the likes of consumer discretionary stocks (down 31.4%)or industrials (down 48.6%).
Assets linked to increased online activity, such as data centres and mobile data towers, have also done well.
Australasian Equities
New Zealand shares have started the year well: the S&P/NZX 50 index is up 1.8% in capital value with gains across the board ranging from 2.9% for the smaller caps to 2.2% for the top 10 and 1.0% for the mid-caps. The utilities sector (up 5.9%) continues to be very strong, pushing on from its previous gains in 2020, when the sector had risen by 35.1%.
Australian shares have done better again, with the S&P/ASX 200 Index up 3.2%. The resources sector did especially well, up 6.1%, and for once financials, which had been a major drag on performance in 2020, helped the outcome with a 5.1% gain. Consumer discretionary shares were up 4.4%, and the runaway star of 2020, the IT sector, chipped in with a 3.5% gain.
In the short term, the key moving part has been the sharp bounceback in business activity from the COVID-19 setbacks. The December quarter business survey from the New Zealand Institute of Economic Research showed that business confidence and actual trading activity continued to recover, and the NZIER said that the survey "suggests a rebound in annual GDP growth to around 2% at the end of 2020 from the lockdown lows in mid-2020." There is a large backlog of delayed and new projects which is likely to keeping the construction sector, in particular, in buoyant shape.
Longer term, however, the outlook is less upbeat. As the NZIER said, outside the construction sector "businesses are generally still cautious about general economic conditions ahead
A Recent ANZ Bank business survey of 2020 had showed that, while expectations about profitability had turned positive, they were still well short of the levels that would be typical in periods of sustained economic growth.
Valuations are expensive for what, beyond the immediate bounceback, is looking like reasonable rather than robust corporate profitability: The S&P/NZX 50 Index is trading at 37 times expected earnings (on S&P's calculations).
The outlook in Australia is along very similar lines. In the near term, the outlook is for continued recovery from the various COVID-19 episodes, the latest news is encouraging. Both Victoria and New South Wales have recently reported no new local community cases, and roll backs of restrictions are likely in NSW.
Business surveys show the impact of the improvement: the most recent (November) National Australia Bank survey found that "both confidence and conditions are now above average, and stronger than the period right before the pandemic.
The big issue, however, is the outlook beyond the immediate V-shaped bounce. Crédit Suisse, for example, shares the immediate optimism about near-term earnings: it expects earnings per share at the ASX 200 companies to grow by 20% in 2021 after a drop of 19% in 2021, but it expects no further growth in 2022.
International Fixed Interest
Global bond yields have moved a little bit higher, led by the U.S. Treasury bond market, where the yield on the benchmark 10-year Treasury note has risen from 0.9% to 1.1% this year. The resultant capital losses mean that at this early stage of the year bond investors are out of pocket. The Bloomberg Barclays Global Aggregate Bond Index in U.S. dollars is down by 0.7% year to date.
The rise in U.S. yields, and the smaller rises in other markets, reflect two developments. One is the general improvement in investor sentiment about the prospect of COVID-19 coming under progressive control as vaccination is rolled out. Meaning demand for safe haven assets such as Government bonds has reduced.
A Democrat majority in Congress means there was greater political scope for a sizable fiscal stimulus, again adding to the likelihood of faster growth and boosting the likely supply of Treasury bonds as the Biden administration borrows to fund the stimulus.
The recent rise in bond yields is expected to continue, at least in the U.S. The latest (January) Wall Street Journal survey of U.S. forecasters found that the median view is that the 10-year Treasury yield will rise to around 1.25% by midyear and to 1.4% by the end of the year. Whether this increase eventuates is still an open issue, however: the Federal Reserve at its latest policy pronouncement made it clear that it will not be tightening monetary policy anytime soon, and its ongoing programme of bond buying may keep bond yields lower than the forecasters expect.
International Equities
Although the trading history is still limited to only a few weeks, the early data for 2021 show world share markets carrying on where they left off in 2020—with further price gains. The MSCI World Index of developed economy share markets is up 2.4% in U.S. dollars. So far this year, the big American tech shares have continued to make the running—the Dow Jones U.S. Technology Index is up 4.0% and the Nasdaq is up 5.1%—but otherwise U.S. markets have not dominated overall returns as they did in 2020. Ex the U.S., the MSCI World is also up 2.4%. Japan has made a good early showing, with the Nikkei up 4.3% (in yen), and European shares have also contributed, with the FTSE Eurofirst 300 up 2.6% (in euros).
Emerging markets have made a strong start to the year. The MSCI Emerging Markets Index is up by 7.9% in U.S. dollars, and the core BRIC markets (Brazil, Russia, India, China) are up by a similar 8.2%. The vast bulk of the performance has come from China, where the MSCI China Index is up 11.8%, with small gains in India and Russia and a 5.6% loss in Brazil (based on the MSCI Brazil Index).
The outlook remains heavily COVID-19 entwined. On the plus side, the global economy had been showing every sign of a faster-than-expected recovery from the first wave of COVID-19 in early 2020.
The latest second wave has, however, complicated the picture. The global number of new cases had steadied at around 300,000 a day in August and September (according to the data compiled by The New York Times) but then rose sharply in the later months of last year and by early January was running at around 700,000. In recent weeks there has been some modest good news, and the daily number has dropped to around 600,000, but other indicators remain worrying.
Equity markets, however, appear to be looking through the latest COVID-19 outbreaks and lockdowns, and the rather worrying emergence of new strains of the virus, and are more focussed on the ultimate outcome of widespread vaccination and a reasonably rapid return to more-normal conditions.
Markets have also been buoyed by the prospect of a large USD 1.9 trillion fiscal package in the U.S., where the Biden administration hopes to send USD 1,400 cheques to people on lower incomes, to extend a temporary boost to unemployment insurance payments, and to roll out various other supports, including a rise in the federal minimum wage and funding for a national vaccination programme.
But there are also signs of valuation stress. Bitcoin and tech shares were seen by the fund managers as the two most crowded trades, where there may be potential for a correction.
The three big risks the managers worried about were also suggestive of over-optimism. Their top risk was setbacks to the rollout of vaccines, where currently investors may be too bullish. Their second-rated risk was a taper tantrum, or in other words a setback to high equity and other asset valuations if bond yields start to rise. And their third-rated risk was the possibility of a market bubble, where various indicators, including rising levels of online trading by retail investors, are looking symptomatic of the top of a bull market. Ideally, the long game of eventual post-COVID recovery will prove the right move, but it would not be surprising if episodes of overexuberance get punctured along the way.
See the Full MorningStar Economic update here.
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