Friday 5 March, 2021
Global Market View
February was a month of two halves for equity markets, with a positive first half followed by days of violent selloff in the second half. The MSCI All Country Index (unhedged) managed to hold on to a modest gain of 1.5% as Europe and Japan offset weakness in Australasia and US large-cap.
Beneath the positive headline return, global equity markets went through an aggressive style and sector rotations away from secular growth themes to value and cyclical companies such as those companies which had sold off but are now expected to benefit from reopening. Energy (particularly Oil and Gas) was the best performing sector while Technology was the worst.
The month kicked off with a bullish wrap to the fourth quarter 2020 earnings reporting season, which saw companies in aggregate deliver positive ~3% earnings growth versus the -11% expected by Wall Street. Economic data in the US also exceeded expectations for the most part, with both Retail Sales and Industrial Production showing meaningful improvement thanks to the US$900bn fiscal stimulus passed late last year. The combination of fiscal expansion, monetary policy support, and a very strong, synchronised global economic rebound prompted investors to speculate that inflation could be racing ahead of forecasts and an earlier than expected tapering to pandemic support is inevitable. This led to multiple days of sharp drawdowns late in the month coupled with sovereign bond yields rising, particularly the long bonds like the US 10-year Treasury yield.
At home, New Zealand equities (-6.9%) underperformed global shares as several of the larger names in the index, such as Fisher & Paykel Healthcare, A2 Milk and the gentailers, struggled. This was partially offset by a solid increase in re-opening stocks, such as Vista, Australian banks, and Skellerup, which reported stand-out H1 2021 results. The NZD strengthened over the month as the RBNZ held OCR at 0.25%. Although not being completely ruled out, the likelihood of a negative OCR in the near-term has drastically diminished.
While market volatility can be unsettling, the sharp rebound following the Covid-19 selloff last March is a good reminder to all of us that staying the course is often the best way to avoid selling low and buying high. With more stimulus cheques now on the horizon (~US$1.9 trillion as proposed by the Biden administration) and a dovish Federal Reserve that is committed to easing policies, we remain cautiously optimistic on the market’s ability to generate shareholder return this year.
by Nathan Field, Portfolio Manager - Global Thematic and Steffan Berridge, Head of Quantitative Strategy.
The Kiwi Wealth Growth Fund returned 1.07% after tax and fees in February, 0.66% behind the MSCI All Country benchmark which returned 1.73%. Two of the three underlying equity strategies contributed negatively to relative performance this month, the alternative assets on the other hand outperformed both equities and cash. The Kiwi dollar had another strong month which was yet again a headwind for returns denominated in foreign currency.
Global Thematic trailed the global benchmark in the topsy-turvy month of February but still managed to eke out a positive absolute return. The sharp rise in interest rates put pressure on defensive stocks that feature high dividend payments, such as American Water and Nestle. Technology favourites like Apple and Amazon also sold off as investors shunned secular growth stories in favour of more cyclical companies. On the positive side, our recent increase in diversified US banks such as Morgan Stanley and Bank of America performed strongly in February.
Global Quantitative returned 0.73% in February, 0.72% behind the MSCI AC benchmark as the improving economic outlook saw 10-year US treasury yields up 34bps and crude oil up 17%, keeping the Energy and Financial sectors buoyant. The optimism is in large part driven by the reduced Covid-19 case count and vaccine momentum against background messages from central banks that they will tolerate higher inflation to secure an economic rebound. Our top sector for the month was Technology (Verint, HP Inc, Au Optronics) with Verint rallying on its Cognyte cyber intel spinoff and HP Inc beating expectations on strong demand for PCs and printers. Our poorest sector was Financials (underweight JPMorgan, Bank of America) which benefited from the yield rally and expectations of economic pickup despite showing relatively poor fundamentals.
In Global Thematic, we have shifted some of our investments and weightings to reflect the higher interest rate environment and rising inflationary pressures. This has seen us reduce exposure to defensive themes like discount retail and snack foods, while increasing our tilts to re-opening beneficiaries, particularly in the banking and semiconductor industries.
In Global Quantitative, our top-down positioning targets higher quality companies and sectors seen as more suited to the current environment. Stock selection favours companies with attractive metrics across earnings quality, capital efficiency, valuations, sentiment and sustainability. Over the month, we increased allocation to Financials (Moody’s, ORIX Corp) and Technology (Texas Instruments, Synopsys), and reduced Healthcare (Novartis, Anthem) and Staples (Coca-Cola, Procter & Gamble). Technology, Materials and Industrials are favoured sectors while Energy and Utilities are largest underweights.
by Diana Gordon, Head of Fixed Interest.
The Kiwi Wealth Fixed Interest Fund returned -1.82% after fees and taxes in February, outperforming its benchmark, which returned -2.64%. As a rule, bond prices decline when interest rates go up, with longer maturity bonds being disproportionately affected. Much of the outperformance is reflected in our reduction of longer dated bond exposure since September last year.
The sun rose in February with the prospect of an end to 12 months of the equivalent of our Level 2/3 lockdowns around the world. Help is on the way in America with its $1.9 trillion stimulus package and the promise that all its citizens will have access to a vaccine by the end of May. Europe and other countries are a bit behind, but the direction of travel is clear. Now, think how we all felt coming out of lockdown in New Zealand and square it, or cube it. 2021 looks set for a FOMO (fear of missing out)/YOLO (you only live once) year and then some for consumer spending. Governments are also expected to support their economies by spending on infrastructure, thus pushing up the price of commodities, notably copper and oil. The cherry on the top is disruption to global trade and stockpiling. We are not the only people to find it hard to buy electric bikes. Semiconductor shortages have stymied some manufacturers, like carmakers. In this environment, it’s hard to see the price for goods and services would go down. Quite the opposite. All this was wormwood to the global bond markets, which sold off in February on the prospect of higher inflation. The interest rate on a US 10-year government bond rose 34 basis points from 1.06% to 1.40% over the month. Typically, bond interest rates rise when inflation rises so that you keep the purchasing price of the money that you lent in a bond. When bond interest rates go up, their value goes down, all the more so for longer maturity bonds (>10 years).
New Zealand bonds followed the global pattern. The interest rate on a 10-year government bond rose a whopping 78 basis points from 1.13% to 1.91%, underperforming the US 10-year in a choppy market. Indeed, the New Zealand bond market had its worst month ever as measured by the S&P Government Bond Index since 1993. The world sees us as the canary in the coal mine when it comes to getting through Covid-19. In a huge stamp of approval, global bond rating house S&P upgraded New Zealand government and local government debt to AAA, the highest possible rating. That reflected our status as the No. 1 Bloomberg Index Covid-19 responder country in the world. Our economy has snapped right back, with a fourth-quarter 2020 unemployment rate of 4.9% shocking the market. Milk prices have spiked with robust Chinese demand, and we are still in our own FOMO/YOLO world. Try getting a builder these days. The Reserve Bank (RBNZ) is expecting an (albeit temporary) spike in inflation by the second half of the year, perhaps as high as 2.5%, as all the global supply and commodity issues are augmented by these stronger economic numbers. This expected inflation spike led the market to price in OCR (Official Cash Rate) interest rate hikes as early as the end of next year. However, the Reserve Bank remained dovish (lower interest rates for longer) in its February meeting and were quick to point out that some of the air is coming out of our post-Covid elation with some sectors like tourism really hurting through the summer. Enter Deputy PM Grant Robertson. Faced with the prospect of another year of 15%+ increase on house prices, he sent another letter to the RBNZ wanting them to consider the level of house prices as a secondary concern to unemployment and inflation when setting monetary policy. That set up a fundamental conflict between a lower for longer interest rate protecting the economy from Covid-19 and a higher OCR, which realistically is the only way to tamp down house prices – hence the greater underperformance of our bond market. Although Reserve Bank Governor, Adrian Orr, has indicated he still isn’t considering hiking the OCR any time soon, shorter maturity bonds began to price in more aggressive future OCR hikes. However, we think Orr will stand his ground here, at least for the foreseeable future.
We continued to reduce our interest rate risk in February as interest rates rose, focussing on selling longer-dated bonds ahead of higher expected inflation numbers. Consequently, we sold the last of our 16-year and 20-year maturity New Zealand Government bonds (AAA). We take the view that there will be a time to buy longer bonds again, but that will likely be in our spring. Yes, the market may “see through” a temporary blip in inflation, and we may miss the turn in inflation and some of the subsequent rally in bond prices. The big unknowns are the effect of deep economic damage on small businesses or whether the Brazilian Covid variant could upend global optimism. It’s also likely that the Federal Reserve will step in to suppress interest rates of long-maturity bonds, and we’ve seen the Australian central bank having to step in and buy longer-dated bonds, as have our own Reserve Bank. In the medium term, will we revert to a world where cheap automated mass-produced goods will tamp down inflation again? All worth pondering but we are very much keeping to a better-safe-than-sorry approach right now towards long-term interest rates.
We’ve been keeping cash levels quite high, waiting for better times to add company risk. We dipped our toes in the water in February, beginning to buy short-dated bonds of IQIVA (BB+), a pharmaceuticals-testing powerhouse and Twitter (BB+), a premier global franchise we think has a strong path to a higher rating. We also purchased global equipment provider, United Rentals (BB).