Friday 6 March, 2020
Global Market View
Global equity markets tumbled in February as the coronavirus outbreak spread to all corners of the world and clobbered investor confidence. Most of the dip came in the last week of the month, when the S&P500 fell 11.5%, the steepest weekly fall since the global financial crisis of 2008. Fear was also evident in bond markets, with the flight to safety pushing the US 10-year yield down to 1.15%.
The harsh market reaction to the coronavirus cannot be dismissed as blind panic. Economists are ratcheting down estimates for 2020 global growth, and corporates have been busy trimming 2020 earnings estimates due to weaker consumer spending and disrupted supply chains. Central banks are also worried, with emergency interest rate cuts rippling across the globe.
The outbreak’s impact on this year’s growth and profits is not in dispute. The key question now for financial markets is whether the coronavirus can be reasonably contained, and how long the negative effects will linger.
These are impossible questions to answer at present, hence the rise in volatility we’re currently seeing in equity markets. But investors who hit the panic button run the risk of locking in losses and missing out on potential rallies. For example, on the first trading day of March, the Dow Jones rose 5.1%, its biggest one-day percentage gain since 2009.
Trying to time markets is usually a losing strategy, and investors who stay the course are likely to achieve better outcomes (just ask Warren Buffet!). While we don’t have an answer to where markets are heading short-term, nothing that has happened over the past two months has shaken our core investment beliefs and principles. Namely, global equities are a fantastic wealth builder over the long term, and diversification will protect investors against extreme episodes of wealth destruction.
These periods of volatility can be difficult to stomach, but there is a silver lining for active managers. For example, in our Global Thematic strategy, we are seeing great buying opportunities in quality companies we’ve long had on our shopping list. When the dust settles on the coronavirus storm, we believe these companies will emerge with their long-term earnings prospects fully intact.
by Steffan Berridge, Senior Quantitative Strategist & Nathan Field, Portfolio Manager - Global Thematic
The Kiwi Wealth Growth Fund (Growth PIE) returned -5.23% after tax and fees in February, 0.97% ahead of the MSCI All Country benchmark. All three of the equity strategies (Global Thematic, Global Quantitative & Core Global) contributed positively to the relative return. Alternative assets stood out by producing positive returns against the market, along with a weakening Kiwi dollar which together buffered the overall return of the fund.
Global Thematic outperformed the benchmark in February, although it wasn’t immune to the steep sell-off in world equities, registering a -3.39% return for the month. But it’s important to note, even after February’s drop, the strategy is sitting on a healthy 12 month return of 21.74%. A defensive bias in the portfolio helped Global Thematic avoid the worst of the month’s carnage, with US electricity companies (NextEra, Dominion Energy) and multinational food and beverage companies (Nestle, Pepsi) among the best performers. Banks were heavily represented within the worst performers, with the sharp fall in bond yields denting net interest margins.
The Global Quantitative fund returned -3.97% in February, 0.08% ahead of the MSCI AC benchmark in NZD terms as COVID-19 continued to disrupt financial markets. Its spread outside of China saw the rest of the world playing catch-up, with MSCI China eking out a small gain for the month while the rest of the world took its turn to sneeze. Our best sectors for the month was Energy and Industrials with our underweight to large cap Energy names like Exxon Mobil and Royal Dutch Shell proving valuable on the poor short-term demand outlook while in Industrials United Rentals outperformed, following through on its well-received earnings report at the end of January. Our worst sector was Financials with Ally Financial losing equity value on its plan to acquire CardWorks.
There were plenty of buying opportunities in the month for the team in Global Thematic, as we started to nibble at some quality companies with robust earnings outlooks such as creative software leader, Adobe, and diversified consumer products company, Colgate Palmolive.
For Global Quantitative, our top-down macro positioning continues to favour North America and Europe versus Asia Pacific, focusing on those companies with attractive metrics across earnings quality, capital efficiency, valuations, sentiment and sustainability. Over the month, we’ve increased our allocation to Industrials (Vestas Wind Systems, Expeditors International) while trimming Technology (Intel) and Energy (Equinor). Technology, Industrials and Communications Services are our favoured sectors.
by Diana Gordon, Head of Fixed Interest
The Kiwi Wealth Fixed Interest Fund (Fixed Interest PIE) returned 0.77% in February, slightly underperforming its benchmark which returned 1.07%. This was due to an underweight to more volatile longer maturity bonds whose prices increase more when interest rates decline. These bonds rose sharply in the face of the widening coronavirus outbreak. It has been a great outcome to have preserved capital and tracked so closely to the government bond benchmark while carrying corporate credit exposure during this unprecedented time.
Coronavirus fears dominated February as the disruption to global supply chains sparked talk of a global recession. While extreme containment measures in China seem to be working, health professionals are increasingly stepping up their efforts to combat the spread across the globe. In the face of such unknowns it’s almost guaranteed that money flows to high quality bonds like US or NZ government bonds - and this was no exception. The yield on the widely followed US 10 year treasury declined from 1.51% to 1.15% over the month.
At time of writing, the US Federal reserve has just cut its overnight interest rate 50 basis points from the 1.5-1.75% range to 1.0-1.25% with the Australian Central Bank cutting its rate 25 basis points from 0.75% to 0.5% the day prior. That cut saw the interest rate on the US 10 year treasury to drop to all-time lows just below 1%. The markets are currently expecting at least a 25 basis point cut of our own Overnight Cash Rate (OCR) to 0.75% potentially at the next March 25th meeting of the Reserve Bank. However, it’s quite possible that may come earlier as news unfolds and the final low point in the OCR could potentially be as low as 0.25% according to the market. But the reality is that cutting interest rates is a blunt instrument in the face of a viral outbreak. It won’t make one tourist set foot on a cruise line. (They almost certainly wouldn’t be able to get coronavirus-related travel insurance anyway). That support will most likely come down to governments, very likely including our own. There is a lot of discussion in the markets whether there will be a sharp economic snap back as the world gets used to coronavirus. Our own view is that the outbreak is a shock, not the beginning of a prolonged downturn – but that we are still in the early innings of coming to terms with its implications.
We’ve discussed for almost a year that we haven’t been enthused about the price of company bonds. That’s left us favouring higher quality bond issuers which are good places to hide out because they tend to perform well when risk markets like the equity markets are down. They also tend to be more liquid, meaning that they can be bought and sold more readily when needed. Bond purchases in February tended to stay at that very conservative end of the risk spectrum.
We added New Zealand Government (AA+) and New Zealand Local Government Authority (AA+) bonds as well as International Bank of Reconstruction and Development (AAA) and Westpac (AA-) new issues. Company bonds tend to trade a bit with government bonds and a bit with the equity markets. It was the dam breaking with the equity markets falling and subsequent sharp increase in credit spreads (the extra interest rate that you get for owning a company bond over a government bond) that has made us more likely to be active in selected company bonds going forward. We dipped our toe in in February, purchasing bonds of Meridian Energy (BBB+) and Aker BP (BBB-).