By Craig Simpson
2016 started off as 2015 ended, markets in turmoil and investors fearing the worst. Equity prices continued to fall abruptly as investors failed to shake fears of a protracted Chinese economic slowdown.
Commentators are also highlighting China’s heavy debt load and their heated property market. Analysts see the debt burden as being one of the big risks to China’s growth outlook. If China’s property market should tip over, the impact could ripple globally and we would see a flight to safe haven assets (US Treasuries, German Bunds, USD, Yen, Swiss Franc etc).
Even if conditions do not improve in China one former World Bank chief economist and senior vice president believes China can meet its target growth rate.
Irrational investor behaviour
US equities had their worst January on record and the S&P 500 index fell as much as 10.5% at one point in February before bouncing back strongly to end the quarter up 1%. One US fund manager notes this is the first quarter since the Great Depression where the benchmark fell more than 10% and then rebounded to end higher.
The sell-off in US equities at least was an irrational panic and not supported by any economic fundamentals.
Investors are at times schizophrenic and a recent Wall Street Journal (WSJ) article illustrates this nicely. The WSJ article cites Citigroup research which said investors pulled out US$4.97 billion from global equity funds in January and then poured US$7.49 billion back in. The only ones winning in these situations are the stockbrokers who keep clipping the ticket.
NZ shares continue to be the shining light across the equity world with positive three and twelve month returns being recorded. Globally it is a different story with most major international equity indices in the red over the same period.
Hedged global shares (either fully or majority hedged position) performed better than unhedged assets over the past month as the NZD was strengthened against most major trading partners. The last three and twelve months will have seen unhedged positions continue the recent trend of out performing fully or majority hedged positions.
Bonds and gold provided some protection for investor portfolios with many bond indices (government and corporate) showing positive returns in the region of 3% to 5% in NZD terms and gold was up 16%.
Although bond returns were solid and provided some offset to losses from equities, the volatility that was griping markets saw global credit default swap (CDS) spreads widen significantly. In the latter part of the quarter CDS spreads narrowed as some of the perceived volatility in the market eased, however bond markets are expected to continue to be choppy and volatile.
Central Bank activity
The ECB are trying their best to quell the risks to the Eurozone with ECB President Mario Draghi signaling policy reviews. The ECB have indicated previously they are prepared to do what ever it takes to get the eurozone out of its current predicament. Overnight cash interest rates were set at -0.4%, yes investors are being charged to have funds on deposit.
Bank of Japan (BoJ) also introduced negative interest rates in a bid to get more spending occurring in the economy. David McLeish from Fisher Funds, notes in his latest article The War on Cash, negative interest rates theoretically encourage banks to lend money out because the value of the cash held in their vaults is ever decreasing. Because individuals and businesses don't get rewarded for saving money, they will instead choose to borrow and spend, thereby boosting economic activity. Sometimes the theory and actual practice don't quite play ball. In Japan's case, there has been a surge in the sales of personal safes - better there than under the mattress I guess.
The Fed maintained their overnight cash rate at 0.5% after the first hike in 9-years late in 2015. The Fed committee is closely monitoring economic and financial developments and the implication these have on the US labour market and their outlook for inflation. The market is still forecasting rate hikes in 2016 but the number is likely to be closer to two rather than the four initially expected.
The RBNZ surprised some corners of the market and cut the Official Cash Rate (OCR) by 25 basis points to 2.25%. This cut is on top of the one made on December 10, 2015. Since mid-2015 there have been five, 25 basis point cuts to the OCR. If the latest research out of ASB's owners, Commonwealth Bank is to be believed, we could see the OCR as low as 1.50%.
Under a scenario where the OCR was sub 2%, the NZ bond market becomes increasingly less attractive to offshore investors. The interest rate differential between NZ and offshore rates would compress and we could see some investors electing to seek other investment avenues. Having said this, there would still be some interest in pockets of our debt market, particularly our government bonds which are included in global sovereign debt indices. Local government and some corporate debt securities may still appeal as the current interest rate (coupon) on our higher rated and ranked securities would be in excess of what could be received elsewhere for equivalent securities.
Early evidence is positive
Based solely on the unit prices collected thus far for various KiwiSaver funds, we are seeing some strong bounce backs in returns during March compared to earlier months. Only a small number of funds are showing negative three month returns on a change in unit price. Some of the best performing funds for the past quarter have again been Australasian equity portfolios and we are seeing returns in excess of 5% coming through for the past three months. Other funds that have greater levels of global diversification and lower levels of volatility are performing well but the returns are considerably more modest.
We are also seeing some negative quarter returns coming through which correlates with downward movements in global equity markets.
For KiwiSaver investors who are saving regularly, falling unit prices simply provide an opportunity to purchase a greater number of units each month.
Investors who are close to retirement or saving for a first home deposit may want to seek advice on the most appropriate strategy as increased volatility across markets will impact on your short term savings goals.