Outlook for Investment Markets
Risk assets have had a strong November to date, partly due to some resolution of the political uncertainty around the U.S. elections and, more recently, a strong response to news of a possible COVID-19 vaccine. But just as markets may have initially overreacted on the downside to the emergence of COVID-19, now there is a risk they may be overoptimistic about a vaccine. It is yet to be approved, will take time to deploy, and in the meantime the scale of new COVID-19 cases has got dramatically worse in the U.S. and a number of European economies. There are still cyclical bumps in the road ahead, and it is not surprising that earlier this month the Reserve Bank of New Zealand has provided further monetary policy support to help with what is likely to be an extended period of post-COVID-19 recovery.
New Zealand Cash & Fixed Interest
The Reserve Bank of New Zealand, or RBNZ, kept the official cash rate, or OCR, at 0.25% at its most recent monetary policy statement on 11 November, and short-term interest rates have also been steady, with the 90-day bank bill yield at 0.27%. The 10-year government bond yield has edged up a little in recent days: it had ended October at 0.55% but is now up to 0.84%. The kiwi dollar has also risen, from USD 66.1 cents at the end of October to USD 68.3 cents now. Despite this recent rise, it remains lower year to date, with a 1.2% fall in overall trade-weighted value.
Although the RBNZ did not cut the OCR, it provided further monetary policy stimulus by way of a Funding for Lending Programme, which provides cheap three-year funding (at the OCR rate) to banks. The bank is likely to keep a strongly stimulatory stance in place for some considerable time, and remains likely to cut the OCR by Mid-2021.
New Zealand Property
The global equity rally in November did not rub off much on local listed property: the S&P/NZX All Real Estate index month to date is up by only 1.2% in capital value. Year to date the index is up by a marginal 0.9% in capital value, and by 3.2% including dividends, and continues to substantially underperform relative to New Zealand equities overall.
The relative stability of local listed property compared with overseas listed property reflects New Zealand’s atypical experience of COVID-19: a short, intense lockdown with large upfront costs (GDP dropped by a record 12.2% in the June quarter), but with considerable subsequent success at controlling the spread, whereas many overseas countries have experienced a resurgence of cases. Conditions were ripe for a relatively early return to more normal trading conditions. Property management software company Re-Leased has found that “Data for September shows [commercial rental] payment rates continued to improve over the last three months. For September, 88% of commercial rent was paid within 30 days, compared to 82% in June and the pre-COVID monthly average of 91%,” and but for the Auckland lockdown it is likely rental growth would have been back close to its historical average. New Zealand property is not completely out of the woods. Property linked to international travel and education will face ongoing border restrictions, probably till the end of 2021, and the ripple effects of the weak tourism sector will affect other sectors. Structural change is also lurking in the background: the latest Colliers data shows that office vacancy rates have risen in Auckland, for example, and it is not yet evident how much reflects the immediate lockdown impacts and how much reflects possible permanent changes to working practices. That said, an early return to relatively normal operating conditions is a plus for the investment outlook.
Australian & International Property
While New Zealand REITs did not benefit much, the global equity rally in November had a much bigger effect on the A-REITs, with the S&P/ASX 200 A-REITs index up by 12.3% month to date. The scale of the earlier COVID-19 setback, however, means the A-REITs even after this rally are still down by 7.9% year to date (down 5.8% including distributions).
Global listed property also benefited strongly from the wider global equity rally in November, with a month to date capital gain of 10.8% for the FTSE EPRA/NAREIT Global index in U.S. dollars. As with the A-REITs, the strong lift has not, however, been enough to make up for earlier sharp losses for the retail, hotel and office REITs most impacted by COVID-19 lockdowns, and year to date the index is still down by 15.1% in capital value and by 12.0% on a total return basis (including dividends).
Global Infrastructure
Global listed infrastructure, like global equities overall, shared in the strong November rally that has followed the U.S. election and news of a possible COVID-19 vaccine. The S&P Global Infrastructure index in U.S. dollars is up by 12.3% month to date. As with global listed property, however, the latest rally has only made a modest dent in the large year to date loss. Year to date the index is down 11.4% in capital value and is down 9.5% in net return terms (including the taxed value of dividends). Hedged into New Zealand dollars the net return has been a loss of 12.1%.
Australasian Equities
Like the overseas share markets, New Zealand shares eased off going into the U.S. election uncertainties, and then rallied strongly more recently as the election results became clearer and there was good news on a potential COVID-19 vaccine. The latest rise means that year to date the S&P/NZX 50 index is now up by 8.3% in capital value and by 10.5% in total return including dividends. The big names in the top 10 index continue to do best (up 14.4%) and the utilities, which include the big electricity gentailers, have also done very well (up 16.1%).
It has been the same story in Australia, where the S&P/ASX 200 has had a strong November: to date the index is up 8.1% since the end of October. The rally has not however been strong enough to counteract the COVID-19-related weakness earlier in the year. The index is still down 4.2% year to date (down 1.6% allowing for dividend income). IT shares continue to do very well, up 45.3%, but the poor outcomes in the larger financial and industrial sectors (down 14.0% and 10.3%, respectively) have kept overall performance on the loss side of the ledger. The miners have made a small gain of 3.0%.
Recent surveys show businesses are doing better as they emerge from the COVID-19 lockdowns, but the improvement is modest rather than strong. As the ANZ Bank said in its (preliminary) November business survey, “business confidence and own activity barely moved and remain at subdued levels but definitely in the 'could be worse' category.” Importantly, businesses remain pessimistic about profitability. The Bank of New Zealand was similarly cautious about the results from the BNZ/BusinessNZ surveys of manufacturing and services for October. Taken together, the bank said, “folk shouldn’t get too carried away with Q3 GDP marking the beginnings of an extended period of solid growth. The coast is not clear ... we remain wary of elements of the economy that have yet to adjust to the COVID context, before a sure base is found.”
The RBNZ in the November monetary policy statement made the same point about the most COVID-19-exposed sectors. International tourism and education, which together account for 6% of GDP, “will remain weak for at least as long as border restrictions are in place,” which in the bank’s view is likely to be until the end of 2021.
The risk is that stronger equity prices may be prematurely picking the timing of recovery and possibly overestimating its extent. As the RBNZ warned, “few firms are looking to increase staff, and those more impacted by the alert level restrictions have laid off staff. Businesses are uncertain about the future and are holding off further changes until there is more certainty about future demand.” The bank thinks the economy will not get back to its pre-COVID levels of output until 2022. Global optimism about the vaccination may help take the market further, but current valuations (35.4 times expected earnings) are looking pricey set against the likelihood of a slow rebuild where profit growth will be hard to come by.
In Australia, there is the same picture of near-term recovery from the worst of the lockdown impacts, but outstanding longer-term challenges. The latest (October) National Australia Bank business survey, for example, found “the economy has rebounded from the sharp fall in activity in H1 2020 and will likely continue to recover as the economy reopens. However, it will likely take some time for activity to fully recover, with capacity utilisation restored and the pipeline line of work replenished. The improvement in confidence is encouraging but remains fragile, and it will likely remain that way until a vaccine is available.”
The latest (September) Westpac/Melbourne Institute leading indicator is also signalling an upturn. Westpac said that “growth in both the September and December quarters will be clearly in positive territory, as the Australian economy opens up. We have also revised up our growth forecasts for 2021 and 2022 following the announcement of the Federal Budget. Consistent with the steady progression in the leading Index we expect growth of 2.8% in 2021 and 3.5% in 2022.”
But whether you go by the Westpac forecasts, or the RBA’s in its latest Monetary Policy Statement on 6 November, either way the answer comes out the same—it will be 2022 before the Australian economy will get back to pre-COVID-19 levels of activity. Profits have taken a big hit—the RBA pointed out in the Statement that outside the miners and the financials, the companies in the ASX 200 index in aggregate racked up a loss in the first six months of this year, and it will take an extended period to rebuild. The recent share price rally, while welcome, may be taking an overly upbeat view of the timescale involved.
International Fixed Interest
The key international bond yield, the yield on the U.S. Treasury 10-year note, has been gently trending upwards since its low point in the wake of the COVID-19 outbreak. It had reached a low of just above 0.5% on 4 August, but by the end of October had moved up to 0.88%. More recently, the outcome of the U.S. election, and news of a promising vaccine, sent the yield higher again, hitting 0.96% on 10 November. At the time of writing, it had eased back a little to 0.9%.
Despite the recent yield rise (and the associated capital losses), international fixed interest is still ahead for the year to date, reflecting the sharp falls in yields earlier in the year. The Bloomberg Barclays Global Aggregate index in U.S. dollars is up 6.7%. Long maturity U.S. Treasuries remain the big winner, with a 17.6% gain, while the riskier sub-sectors continue to underperform: global "high yield" (low credit quality) is up 2.8%, and emerging market bonds up 4.2%.
International Equities
World equities had been in subdued mood in the second half of October, with the MSCI World index of developed markets in U.S. dollars dropping by 7.5% between 12 October and the end of the month. Since then, however, there has been a strong rally following the resolution (in most people’s minds) of the U.S. presidential election and the news from BioNTech and Pfizer that they had had promising results from their new COVID-19 vaccine.
The MSCI World index is up by 10.3% since the end of October, and year to date is now up 7.2%. The outcome continues to depend heavily on the U.S. market, where year to date the S&P 500 is up 11.0% and the Nasdaq up 31.8%: ex the U.S., world shares year to date are down by 2.2%. European shares in general (FTSE Eurofirst 300 index down 8.3%) and U.K. shares in particular (FTSE 100 down 16.0%) have been notably weak.
The emerging markets are up 6.6% in U.S. dollars on the MSCI index, with the core BRIC members (Brazil, Russia, India, China) up 9.5%. Chinese shares account for virtually all of the gain, with Indian shares little changed and Brazilian and Russian shares markedly weaker.
It is easy to see why the markets have been cheered by the news of a potential vaccine, on top of the earlier evidence, pre the vaccine announcement, of a pickup in global economic activity from the shock setbacks of the first half of the year.
The J.P. Morgan global composite indicator of business activity, for example, has continued to improve. The bank commented that “October saw the fastest expansion of global economic output for over two years. Growth was underpinned by rising intakes of new work, improving business optimism and the continued stabilisation of trends in new export orders and staffing levels.”
IHS Markit, which organises the national surveys that go into the J.P. Morgan global composite indicator, runs a business outlook survey three times a year. Its latest survey, in October, also showed that the world business cycle seemed to be turning for the better. According to IHS Markit, it “recorded the strongest degree of optimism among companies since late-2018. The business activity net balance rose from a near survey low of +15% in June to +26%. Hopes that a vaccine could be rolled out over the coming 12 months underpinned the improvement in confidence from the lows earlier in the year.”
On the plus side, the executives’ hopes were realised in November, with the vaccine news. On the down side, however, respondents’ fears were also realised: “the recovery in business sentiment is largely pinned on hopes of a reduction in COVID-19 case numbers, as well as the roll-out of a vaccine over the course of the next 12 months, meaning any renewed controls to halt the spread of the virus could derail this recovery ... An increase in worldwide COVID-19 cases means further containment measures look set to be introduced in coming months. Hence, businesses may have to brace themselves for some tough months ahead before any sustainable economic recovery takes place.”
The recent upsurge has been alarming. Three months ago, there were about 250,000 new cases a day worldwide, according to the tally maintained by the New York Times. At the time of writing, there are around 550,000 new cases. In the U.S., in particular, new cases have skyrocketed, with new records being registered every day (159,000 on 14 November alone). President-elect Biden is mulling a national lockdown under his administration, while a range of European countries have reimposed tight lockdowns.
Fiscal and monetary policies everywhere are on maximum stimulus settings, and there may well be an effective vaccine starting to be deployed in the first half of next year. But it is hard to avoid the conclusion that local and global equity markets may currently be glossing over the difficulties that still lie ahead. As one example, at the moment the sharemarket analysts surveyed by data company FactSet think that the S&P 500 companies in 2021 will make back all the profits lost in 2020 and a bit more (an earnings gain of 22.1% compared with 2020’s 14.5% decline). With the likelihood of business disruption rising sharply, that looks a big ask.
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