Investment Market Commentary
Investment – Quarter ended 31 December 2011
The commentary features contributions from AMP Capital Investors. The views expressed are not necessarily the views of the Board of Trustees of the National Provident Fund.
Themes for the December quarter
Ongoing uncertainty regarding the European sovereign debt crisis saw global share markets remain volatile over the December quarter, although within the same range since early August.
Shares rebounded in October, lifted by indications that European authorities were moving to recapitalise the region’s banking sector and by US economic data and profit results which confirmed that the US economy was still growing. Markets then fell back due to the lack of action from the G20 to address the European sovereign debt crisis and the failure of the US budget committee. Late in the quarter, share markets rebounded helped by better news out of Europe and the US. Global share markets ended the December quarter up 7.9%.
Easy global monetary conditions remained supportive of market sentiment, with interest rate cuts in Australia, Europe and Brazil.
The New Zealand share market materially underperformed global shares. The underperformance partly reflects the low-Beta nature of the New Zealand market, but was magnified by earnings revisions related to the downturn on the Australian construction/consumer sector.
Bonds rallied on concerns about Europe’s ability to implement tighter fiscal controls.
After shaking off the impact of New Zealand’s sovereign credit rating downgrade, the New Zealand dollar (NZD) rallied against most major currencies. The one exception was the Australian dollar, which performed stronger than the NZD, benefitting from investors seeking to take advantage of higher interest rates in Australia rather than New Zealand.
Looking ahead
Global monetary easing is positive. However, the European debt debacle means the short term outlook for shares still remains highly uncertain.
While government bonds are a good diversifier, the risk for global bonds is skewed to the downside over the medium to long term, given their low yields.
The NZD is likely to be range bound as favourable cyclical factors (interest rate differential and the terms of trade) are offset by the risks associated with the global growth worries and overvaluation in the currency.
Global economic review
The European debt crisis continued to dominate headlines. On 30 November, key central banks around the world announced a coordinated ‘liquidity swap’ arrangement with a lower interest rate to “ease strains on financial markets”. The US, Canadian, British, European, Japan and Swiss central banks agreed to provide multi-currently swaps at cost of overnight indexed swap +0.5% margin (previously the margin was +1%).
While these measures do not address the fundamental issues affecting markets, they at least enable European banks to fund their assets at cheaper levels than would otherwise have been the case.
American economic data was resilient in the face of global turmoil. The Institute for Supply Management manufacturing survey improved rising by 1.9 points to 52.7, suggesting that the US economy is growing at a sedate pace. The labour market recorded a modest gain of 120,000 jobs in November and the unemployment rate surprised by falling to 8.6%. US house prices drifted lower with the Standard & Poor’s Chase Shiller Major 10 cities Index recording a 1.1% decline in October. More encouraging was the Conference Board’s confidence survey, which rose almost 10 points to 64.5 in December suggesting that American consumers appear to be shrugging off recent pessimism. US nominal retail sales proved mildly disappointing in November recording a marginal monthly rise of 0.2%. The US Federal Reserve maintained the federal funds rate target range between 0% to 0.25% at its December meeting, reaffirming previous guidance that interest rates should remain “exceptionally low” until mid-2013. The central bank indicated that it will continue extending the maturity of bonds on its balance sheet, but failed to announce any further quantitative easing measures. After much wrangling the US Congress agreed to extend a payroll tax cut and increased unemployment benefits beyond their 31 December expiry, which should avoid a sharp fiscal contraction in 2012.
In the Eurozone, the regions leaders met on 9 December to address the sovereign debt crisis and generally agreed on a number of key proposals: A ‘fiscal compact’ of limiting government budtet deficits to -0.5% of nominal gross domestic product (GDP), and the European Financial Stability Facility will be “rapidly deployed and the European Stability Mechanism brought forward one year to start in July 2012. There is also a proposal to provide the International Monetary Fund with €200 billion of loans to “deal with the crisis”. On 15 December European Central Bank (ECB) President Draghi gave a speech in which he conceded that Europe’s banking and debt crisis “has not ended yet” and stated that Europe will need to “swiftly implement all those decisions” of the December summit. Yet the ECB President viewed the summit as a “breakthrough for clear fiscal rules in our monetary union”. Later in the month, the ECB announced that 523 European banks will take a total of €489 billion in cheap three-year loans under its long term refinancing operations. Such action should substantially reduce the risk of a bank collapse triggering another event similar to the global financial crisis. The ECB decided to lower its key policy interest rate at its December meeting by a further 0.25% to 1.0%.
In Japan, September quarter GDP rose 1.4% quarter-on-quarter (QoQ), revised slightly down from the previous estimate. Economic data releases were mixed. Vehicle sales improved rising 24.1% year-on-year (YoY) in November, bank lending picked up at +0.2% YoY in November and the tertiary activity index beat market expectations increasing 0.6% month-on-month (MoM) in October. Yet Japan’s exports fell again in November, providing another reminder of the global slowdown and the impact on Asia. During the month, the Bank of Japan downgraded its assessment of the economic outlook.
In China, the official purchasing manager’s index rose to 50.3 in December after dipping below 50 in November. Overall, this report is consistent with an economy slowing to around 8% growth in the first half of 2012. Elsewhere, Chinese economic data was positive. Retail sales improved 17.3% YoY in November, industrial production was up 12.4% in the month and fixed asset inventories rose 24.5% YoY year-to-date.
New Zealand economic review
During December there were three key developments in New Zealand. First was the Reserve Bank of New Zealand (RBNZ) monetary policy statement. The RBNZ was moderately positive on the domestic economy, but stressed the “high degree of uncertainty around the global outlook”, with the possible downside risk scenarios effectively taking interest rate hikes off the table in the immediate term. The second key economic development was September quarter GDP results, with quarterly economic growth of 0.8% being higher than expected. The main source of growth was private consumption, while investment was subdued and net exports were a drag on growth. On an industry basis, manufacturing was strong, as was the retail and hospitality sector (thanks to the Rugby World Cup). Finally, the third notable development was the current account data, which showed a widening of the current account deficit in the September quarter to an annual 4.3% of GDP on the back of a lower trade balance and worse investment income balance.
New Zealand data during the September quarter continued to indicate that the economy is on a solid footing and set to pick up towards the end of the year and into 2012.
Investment Markets
New Zealand shares
The New Zealand market materially underperformed global equities over the quarter. Underperformance was partly the reverse of the low-Beta driven outperformance of previous periods but was magnified by earnings revisions related to the downturn of the Australian construction / consumer sector.
Weak economic data moderated growth forecasts (lower commodity prices, slowing trading partner growth, softening business and consumer sentiment and ongoing deferral of the Christchurch rebuild).
The general election and the Rugby World Cup were major events over the quarter – neither had material market impacts.
Corporate news was dominated by the demerger of Telecom New Zealand Limited and the listings of Trade-me and Summerset and the successful capital raising for Metlifecare. Corporate mergers and acquisitions activity continued to percolate over the month with acquisitions by Freightways, Nuplex and the sale of Turners & Growers.
New Zealand cash and fixed interest
New Zealand bond yields fell in December, continuing the rally which began in mid-October. Ongoing and increasing concerns that the euro region politicians are failing to produce a solution to the debt crisis were the principal reason for falling yields.
Global rates range traded at lower levels and Australian and New Zealand rates continued to converge. A recession in Europe is now likely, extending the period of very low interest rates. This has increased the appeal of both New Zealand and Australian bond yields.
10-year government bond yields were 0.20% lower, closing at 3.81%, while 10-year swap rates were 0.27% lower closing at 4.03%. Shorter term rates did not fall as much given the global nature of the rally with the 2-year swap rate 0.09% lower at 2.71%.
International fixed interest
International fixed interest markets were volatile over the December quarter. Bonds rallied in October on positive US economic data releases and in anticipation of a comprehensive proposal from the European Union Summit. Bond markets then fell back in early December on news that central banks worldwide had implemented measures to boost liquidity, before moving higher again towards quarter-end on concerns about Europe’s ability to implement tighter fiscal controls.
The best performing sectors over the quarter were the Corporate, Treasury and Government-related sectors, while securitised issues lagged the broader market.
Bond yields in developed markets generally remain unrealistic in anything bar a systemic crisis scenario.
International shares
Global share markets continued to experience significant volatility over the December quarter, although within the same range since early August. Shares rebounded in October, lifted by indications that European authorities were moving to recapitalise the region's banking sector and by US economic data and profit results which confirmed that the US economy was still growing. Markets then fell back due to the lack of action from the G20 to address the European sovereign debt crisis and the failure of the US budget committee. In early December, shares surged on central bank action and hopes that a fiscal union in Europe would occur, but then fell back on worries leading up to the European leaders’ summit. Late in the month, share markets rebounded helped by better news out of Europe and the US.
A leading measure of global share market performance, the MSCI World (ex-Australia) Accumulation Index, returned 8.0% in local currencies. The US S&P 500 Accumulation Index returned 11.8% in local currency terms. In the European region, the Eurostoxx Accumulation Index returned 5.6% and the UK FTSE 100 Accumulation Index returned 9.4%, both in local currency terms. Shares in Asia fell back, with Japan’s Topix Accumulation Index returning -4.2% and China’s S&P/CITIC 300 Total Return Index returning -8.8%.
Volatility remains at historically high levels, and markets continue to rise and fall significantly based on the latest news headlines.
Global property
Global real estate securities closed the quarter up and were in line with global equities. Recent property transactions reiterate two key emergent themes among real estate securities during 2011: highly attractive financing terms and the continued division of high versus low quality assets.
Global credit markets became more selective in the second half of 2011; however, well-capitalised real estate investment trusts (REITs) continue to tap debt and equity markets, exploiting the current low interest rate environment. This trend illustrates that in the current market environment, publicly listed real estate companies maintain a competitive advantage in access to, and cost of, capital.
Amid continued global uncertainty, high quality properties with low lease-up risk in high barrier to entry markets have fetched top dollar in property transactions.
New Zealand dollar
After shaking off the impact of New Zealand’s sovereign credit rating downgrade, the Kiwi rallied early in the quarter against most of the key currencies we track. The one exception was the Australian dollar, which performed stronger than the New Zealand dollar (NZD); benefitting as investors sought to take advantage of higher interest rates in Australia than New Zealand.
As for the rest of the quarter, the market continued to deliver accustomed levels of volatility. The NZD hit a low for the quarter around $0.74 against the US dollar, as risk assets globally sold-off on the back of rising concerns around the European sovereign debt crisis.
The NZD gained the most against the euro over the quarter, and climbed marginally higher against the other majors such as the yen, and the pound. On a MSCI weighted basis the NZD was up 2.2% for the quarter.
Looking ahead, the NZD will likely be pulled and pushed by a mixture of short and longer-term influences. Over the medium term, the fundamentals such as fair value will likely pull the NZD down versus currencies which it’s overvalued against, like the US dollar and British pound. Meanwhile in the shorter term the NZD will be at the mercy of the “risk-on, risk-off” mentality that has gripped the markets in recent times, with risky assets like the NZD weakening in times of global uncertainty. Interest rate movements will continue to play a role, particularly as the time comes for the Reserve Bank of New Zealand to start raising rates, which may be later in the year.