• The June quarter produced a dramatic change in global sentiment. From a new cycle high in April, share markets quickly fell as debt concerns in Europe increased. Peripheral Europe (PIIGS) yields rose quickly as the chance of default increased (supported by sovereign credit rating downgrades of some of these members). Central European yields fell as a slowing growth, low inflation, picture emerged.
• Slowing world growth became the dominant theme for the rest of the quarter. This was further supported with US data tending to be weaker than anticipated by the market and accompanied with weaker company reporting.
• China also showed signs that recent policy tightening is beginning to work, with the edge being taken off recent data.
• New Zealand data continued to support a recovery, although slower than in previous cycles. Unsurprisingly, the RBNZ raised the Official Cash Rate (OCR) in June to 2.75% from 2.50%. This is the first change since April 2009 and marks the beginning of the removal of stimulus.
• Short term rates for both government bonds and swaps rose during the quarter in line with the actions of the RBNZ.
• Long term rates fell aggressively as global rates fell, triggered by the European debt crisis.
• The cost for non-governments (including banks) to borrow rose back towards 2009 peaks.

Outlook

• New Zealand’s broad based recovery is likely to continue and GDP is expected to average 3.5% over 2010 and 2011. This should be in line with global growth of around 4%, largely as a result of Asia and emerging markets. European growth remains the weak link and is at risk of spreading debt concerns to other developed regions.
• The RBNZ is expected to raise the OCR by 25 bps at each meeting, until it reaches 4.50% in 2011. The main risks to this interest rate track are around the ability of the New Zealand banks to fund their activities. The current debt concerns in Europe have closed credit markets and access to funds. This should be temporary, but it is possible it will continue for an indefinite period. Higher funding costs would remove the need for the RBNZ to raise the OCR to the same extent.
• Long term rates remain attractive and are significantly higher than short term rates. This difference is expected to reduce. Most likely it will be through the continued rise in the OCR with short term rates rising.  However, if there is contagion to global growth from the European crisis, it may be through long term rates continuing their recent falls.

Review

• The increased risk of a lower than expected global growth outlook renewed the bond market rally and international bond yields fell across the board in the June quarter.
• The US 10 year bond yield fell by 89 bps to 2.94% and Japan’s 10 year bond yield fell by 31 bps to close at 1.09%. In Europe, the UK 10 year bond yield fell by 58 bps to close the month at 3.36% and Germany’s 10 year bond yield fell by 51 bps to 2.58%.
• The continuing eurozone sovereign crisis triggered a wider bout of risk aversion which, along with concerns that austerity measures in Europe would dampen European Union and world growth prospects, resulted in a flight to quality in the government bond market.

Outlook

• Europe’s sovereign debt crisis has seen investors pursue ‘safe havens’ in German Bonds and US Treasuries. The crisis is likely to gradually abate, provided that the package developed by the European Union and the International Monetary Fund stabilises the vulnerable countries and prevents them from infecting global growth. Later in 2010 and 2011, rising private credit demand and the legacy of funding large budget deficits are expected to produce modest upward pressure on sovereign bond yields.
• As credit spreads return to the more ‘normal’ levels, typically seen through economic downturns, investors are expected to revert to a more stock-specific focus. The pace of spread tightening should begin to ease over the short term, as mutual fund inflows into investment grade credit appear to be slowing. The ‘yield dilemma’ remains in many developed countries, i.e. the yield on credit is beginning to appear less compelling due to base government bond yields, while longer term spreads remain wide compared to previous cycles and appear to provide attractive entry points into non-financial credit spreads. Lower-quality issuers, particularly those in cyclical industries which are traditionally more exposed to periods of economic contraction, will likely be most impacted by global economic events. However, many strong companies have been caught up in market repricing as well, with spreads widening beyond levels that are appropriate from a fundamental viewpoint in many cases. From a risk-adjusted return perspective, the prospects for these investments over the medium term look to be attractively priced.

International shares

Review 

• International shares, and particularly Chinese shares, suffered a sharp correction during the June quarter, impacted by concerns over global growth being hampered by austerity measures throughout Europe, continuing sovereign debt concerns in the eurozone and a slowdown in China due to its recent monetary policy tightening.
• The leading measure of global share market performance, the MSCI World Gross Accumulation Index, returned -11.0% in local currencies (or -9.9% in unhedged NZD terms). The US S&P 500 Accumulation Index returned -11.4% in local currency terms. In the European region, the Eurostoxx Accumulation Index returned -9.3% in local currencies and the UK FTSE 100 Accumulation Index returned -12.6% in local currency terms. Shares in Asia also suffered with Japan’s Topix Accumulation Index returning -13.9% and China’s S&P/CITIC 300 Total Return Index returning -22.4%.

Outlook 

Global growth momentum is slowing after a strong initial burst out of recession, but world GDP growth is still expected to comfortably exceed 4% this year. Europe is likely to remain a weak link and contagion risks to other areas remain a genuine threat to the global recovery. Growth momentum in the developing world is also slowing, but will remain well above developed world growth for many years to come.

Global property

Review

• In Asia, the UBS Asia ex Australia Investors Index returned -3.2% in local currency terms. Hong Kong was Asia’s strongest performer, outperforming the broader share market on the back of better than expected news on the residential front and stronger fundamentals. Meanwhile, Japanese real estate stocks were the region’s worst performer, underperforming the broader equity market and giving back recent gains amid company downgrades and weaker than expected economic and real estate data.
• In Australia, the UBS Australia Investors Index returned -1.4% in local currency terms.
• European real estate securities returned -10.6% in local currencies, as per the UBS Europe Investors Index. European real estate securities outperformed the broader share market over the quarter. Investor sentiment continued to be broadly affected by macroeconomic events, including the oil spill in the Gulf of Mexico and continued pressure on credit spreads.
• In North America, the UBS US/Canada Investors Index returned -4.2% in local currencies. Investor uncertainty carried over into June amid the ongoing European debt crisis, fears for China’s economy, proposed US financial regulation reform and the escalating clean-up and cost of BP’s oil spill in the Gulf of Mexico. While this uncertainty weighed on investor sentiment, defensive REIT sectors nonetheless remained in favour. Notably, US REITs fared significantly better than general equities during the June quarter.

Outlook

• Investor uncertainty will remain until macro economic issues are resolved

New Zealand dollar

Review

• The New Zealand dollar (NZD) fell by 1% on an MSCI-weighted basis over the June quarter, with divergent cross rates largely cancelling each other out.
• The euro was particularly weak, as investors worried about the size of the fiscal deficit and debt of some of the European Monetary Union countries and the ability of those governments to issue new debt at reasonable interest rates.  Countries like Greece, Portugal and Spain were seen to be weak links in the euro area and a possible source of financial instability in the region. The Australian dollar (AUD) was also particularly weak, with industrial commodity prices weakening and the region’s strong link to a slowing Chinese economy.  In a world of reduced risk appetite, the yen and US dollar (USD) represented relative safe havens.
• The NZD rose by 7% against the euro and 5% against the AUD.  The NZD weakened against the other major currencies with an 8% fall against the yen, a 3% fall against the USD and a 2% fall against sterling.

Outlook

From a long term perspective, the NZD is overvalued, but such conditions can be sustained over many years.  New Zealand’s strong terms of trade, rising New Zealand-global short term interest rate differential and more favourable fiscal position relative to the major countries, would point to the NZD remaining richly priced for some time to come.  That said, the NZD appears to be highly correlated with global shares at the moment, moving up or down in line with risk appetite.