Thursday 7 May, 2020
Global Market View
Following the sharp sell-off in March, stock markets around the world posted impressive gains in April. The S&P500 index marked its best monthly return since 1987, while the longer-running Dow Jones industrial index saw the best April since 1938. In aggregate, our global benchmark MSCI All Country index (unhedged) rose 6.4%, retracing two-thirds of the prior fall.
While the headline market returns are encouraging, economic data released over the month suggests that we are not out of the woods by any means. The unprecedented global restrictions on people movement have caused a sharp rise in unemployment and workers surviving on reduced income. In the US alone, April saw over 20 million jobless claims, wiping out the economy’s entire job creation in the past decade. As at the end of April, U.S. (-4.8%), China (-6.8%) and the EU (-14.4%) reported Q1 GDP contraction. Q2 is almost certain to fall further.
Oil prices continued their freefall in April as consumer demand declined sharply. At one point, both the spot prices and the futures contracts dipped into negative territory, implying that a daily supply surplus of over 12 million barrels was just not sustainable. The commodity found better footing towards the end of the month as a multilateral production cut was finally reached, closing at just under US$20 a barrel.
So, what drove the strong stock market performance amid these significant uncertainties?
Firstly, central banks and governments came to the rescue much more quickly than they did during 2008 global financial crisis. The US Federal Reserve announced unlimited Quantitative Easing just days after the outbreak, with the extended capability to purchase corporate bonds, and slashed interest rates to near zero. US Treasury also announced a series of relief packages worth over US$2.8 trillion.
Secondly, the pandemic induced shock on economic supply and demand was not a result of a structural breakdown like previous crises, giving economists hopes that once the virus is contained, the recovery path could be straightforward.
Thirdly, Q1 corporate results turned out to be better-than-feared, particularly among large cap technology stocks. While the impact of pandemic has caused many companies to withdraw their forward-looking earnings guidance, results showed steady growth prior to the outbreak in January.
While we appear to be moving past the peak of the curve for the first wave of Covid-19, it is premature to expect a V-shaped recovery until the health risk is stamped out globally. Our expertise across multiple asset classes, including, Cash, Fixed Interest, Equities and Alternatives, which deliver different return profiles have consistently generated risk-adjusted value-add for our clients who stay the course. Should your risk tolerance or financial circumstances change, our advisers are available to conduct a review.
by Steffan Berridge, Senior Quantitative Strategist & Nathan Field, Portfolio Manager - Global Thematic
The Kiwi Wealth Growth Fund (Growth PIE) returned 7.7% after tax and fees in April, 0.3% behind the MSCI All Country benchmark. Global Thematic contributed positively to the relative return while Global Quantitative and Core Global lagged slightly. Alternative assets produced positive returns but could not keep up with the strong bounce in equity returns this past month.
Global Thematic managed to stay ahead of surging share markets in April, beating the benchmark by 0.5%. Top performing themes included online delivery leaders (Amazon, Chewy), convenience food chains (Chipotle, Wingstop), and online advertising (Alphabet, Facebook). Defensive themes like snack foods and mobile networks took a back seat in April after performing strongly in March. At a portfolio level, we were especially pleased to have fully participated in April’s rally after protecting investor returns from the worst of the March quarter sell-off
The Global Quantitative fund returned 6.2% in April, 0.2% behind the MSCI AC benchmark in NZD terms as equity markets regained some poise despite the dire economic outlook and a complete collapse in the WTI crude price mid-month. The equity market rally was poor quality however as sectors with poor fundamentals like Energy and Materials outperformed while more defensive sectors like Utilities and Staples underperformed. Value and Low Volatility were notable underperforming styles for the month.
Our best sector for the month was Financials where underweights in underperforming mega caps HSBC and Berkshire Hathaway led benchmark gains. Trailing sectors were Healthcare and Communications where Biogen lagged the market on delays to its Alzheimer’s drug Aducanumab. Our best position was eBay which was up nearly 20% on a surge in demand on the platform.
For Global Thematic, given the uncertainty surrounding the path of the pandemic, we have increased the number of themes and stocks in the portfolio to reflect the wide range of possible outcomes. This gives us the flexibility to respond quickly to changes in the corporate earnings outlook, for better or worse.
For Global Quantitative, we have started to target our top-down positioning more specifically, particularly favouring sectors more tuned to the lockdown environment like Technology and Healthcare, with stock selection favouring those companies with attractive metrics across earnings quality, capital efficiency, valuations, sentiment and sustainability. Over the month, we’ve increased our allocation to Healthcare and Communications (Novo Nordisk, Charter Comms) while trimming Financials and Consumer Discretionary (Munich Re, Kering). Healthcare and Technology remain favoured sectors, while Energy and Materials remain out of favour.
by Diana Gordon, Head of Fixed Interest
The Kiwi Wealth Fixed Interest Fund (Fixed Interest Fund) returned 1.9% after fees and taxes in April matching its benchmark which returned 1.9%. The strong positive performance reflected a world where both credit spreads and interest rates declined, pushing bond prices up. Relative performance was helped by a strong rally in company bonds offset by the portfolio having a lower average bond maturity than the benchmark. As New Zealand Government bond interest rates declined, the price of longer maturity bonds went up more than shorter ones.
Share markets around the world rallied hard in April and the same was true for company bonds. Much of the sentiment change was due to the extensive intervention of governments and central banks which came with a bang in March and which continued to be refined in April. However, that same ebullience did not play out as expected in the government bond markets. Usually a risk rally results in higher government bond interest rates (and hence lower prices) because investors sell them when times are good to buy riskier assets like shares. Much of the economic sentiment decline was already baked into the bond markets in March and the interest rate on a US 10-year government bond barely changed over the month moving from 0.67% at the beginning to 0.64% at the end. It’s fair to say times are not good with US GDP -4.8% for the first quarter, a drop not seen since the Global Financial Crisis and which is likely to worsen. For sure there will be enormous issuance of new government bonds to pay for the variety of US government programs which in normal times should also push up interest rates. However, an ever-seemingly available US central bank, the Federal Reserve (Fed) has been there to sup these up.
Likewise, the Reserve Bank (RBNZ) is the buyer of last resort for New Zealand Government bonds having announced in March that it will buy up to $30 billion (40%) of all outstanding bonds issued. This is widely believed to be a low number with up to NZ$55 billion expected to be the final tally. Indeed, the RBNZ was particularly aggressive in the market last month, purchasing ~13.4% of the outstanding putting it on a track for that higher number as we issue bonds to pay for the Covid-19 crisis throughout the year. That brute force brought the interest rate on a 10-year NZ Government bond down 38 basis points from 1.22% at the start of the month to 0.84%. The suggestion by Westpac that the RBNZ may decrease rates to -0.5% by yearend also helped push interest rates down. Could Governor Orr go for negative interest rates, an unthinkable idea so few months ago? Our view right now is never say never when it comes to the Reserve Bank, but they are likely to stick to their 0.25% for at least the next 12 month pledge they made in March. In any case, our banks just aren’t ready for negative interest rates at the moment.
Key to opening up the gummed up NZ company bond market was the RBNZ’s decision to add the Local Government Funding Authority (LGFA) (rated AA+) bonds to its bond buying roster, agreeing to purchase up to $3bn or 30% of the $10 billion outstanding over 12 months. This should allow large corporates to potentially begin to issue again to tide them over any Covid-19 related weakness.
We continued to focus on quality and liquidity in April. We purchased 10+ year maturity bonds of New Zealand Government (AA+), Australian Government (AA+), LGFA (AA+) and Housing New Zealand (AA+). The central thesis is that we may well see another bout of volatility and that extreme Covid-19 disruption is likely to push inflation down at least in the short term as demand for raw materials (think oil) and consumer goods decline further. Longer maturity bonds typically do better than shorter maturity bonds when that happens.
We took advantage of the Fed-induced credit rally to exit positions in hotel company Hilton Hotels (BB+), corporate and sporting caterer Aramark (BB+) and car loan provider Ally (BBB-) near 100 cents on the dollar. While we were comfortable that the three had adequate liquidity to make it through Covid-19, their bonds had all rallied to a point where the risk/reward didn’t look attractive. We believed those three companies were at particular risk when the reality of the US economic downturn hits. That doesn’t mean we won’t be buying company bonds as we think there will be select opportunities. While the Fed and the RBNZ have made it clear they want to ungum the pipes in the company bond markets, both central banks have stepped away from directly supporting weaker businesses. We think that neither that distinction nor the potential for successive waves of infection and a more likely prolonged downturn have been adequately priced into the market.