Monday 10 February, 2020
Global Market View
2020 started on a promising note for financial markets as many of last year’s lingering fears faded into the background. Trade tensions between the US and China took a turn for the better as an initial deal was struck. Brexit was met with a shrug of resignation and in many quarters, relief. Even a fiery geopolitical spat between the US and Iran quickly disappeared from the headlines.
Equity markets rose to the occasion, helped along by earnings results that were generally better than expectations. A broad range of blue-chip companies posted positive surprises, particularly in the US, and at one stage the S&P 500 was up more than 3%.
However, the wind came out of the market’s sails towards the end of January as a new fear emerged from Wuhan, China. The coronavirus was initially regarded by financial markets as an isolated incident that the global economy would quickly bounce back from. But as the number of infected people climbed, and questions about the nature and spread of the virus grew, equities began to reflect investors’ unease.
Airlines, luxury goods companies and hotels came under intense selling pressure as travel bans were announced around the world. Companies that rely on Chinese consumption and tourism were hit especially hard.
As a result, global equities finished the month in the red, wiping out all the positive news from the corporate earnings season. The risk-off environment also took its toll on the NZD, which lost a sizable chunk of its recent gains, and the bond market, with the key US 10-year yield slipping back towards 1.5%.
At the time of writing, the coronavirus threat is still ongoing, and it’s too early to say what the impact will be on the global economy. At best, the virus will be swiftly contained, and the financial impact will largely be felt in the first quarter of 2020. But at worst, along with the tragic human toll, there could be prolonged disruptions to travel and commerce, supply shortages, and a potential inflation spike.
We don’t believe it’s prudent to make investment decisions based on so many unknowns. Nevertheless, we have tweaked several positions to help bolster the portfolio against a worst-case scenario.
Markets are a long way from panic mode, perhaps because history has shown that financial markets bounce back strongly from major epidemics. It’s also worth remembering that central banks are ready to soften the blow should the coronavirus have a dampening impact on global growth. However, given the increased importance of China to the global growth story, we must always be open to the possibility that this time it’s different.
by Steffan Berridge, Senior Quantitative Strategist & Nathan Field, Portfolio Manager - Global Thematic
The Kiwi Wealth Growth Fund (Growth PIE) performed well in January, returning 1.72% after tax and fees in October, 0.69% ahead of the MSCI All Country benchmark. Positive contributors include the Global Thematic fund and the alternatives which outperformed relative to the hedged equity benchmark. Global Quantitative produced a slight drag as it returned just shy of its benchmark.
January was a strong month for Global Thematic with the portfolio outperforming the global benchmark by more than 2%. Stocks exposed to defensive industries like electricity distribution (NextEra Energy, Sempra Energy) and waste management (Republic Services, Waste Management) were among the month’s best performers. There was also a strong showing from food and beverage stalwarts like Nestle and Pepsi which had sold off in the previous quarter. US health insurers (United Health, Humana, Cigna) were a drag on returns as Bernie Sanders surged in the polls, bringing investor fears of a health industry overhaul to the fore again.
The Global Quantitative fund returned 2.94% in January, 0.18% behind the MSCI AC benchmark as the SARS-like novel coronavirus infected market sentiment and created a new wall of worry for global equities. The impact on Chinese markets was masked by the lunar new year holiday, with official figures showing Shanghai a modest 0.8% behind MSCI AC compared to a 7.0% lag for Hong Kong listings of Chinese companies. Energy was the worst-hit sector, returning -8.9%, while Utilities showed its defensive colours at +4.8%. Our best sectors for the month were Financials (S&P Global, underweight Wells Fargo) and Communications Services (JOYY, Alphabet), and worst were Healthcare (Amgen, Biogen) and Consumer Discretionary (underweight Amazon). The latter as the online retail giant surprised the market with better-than-expected earnings on the last day of the month. Global Quantitative continues to tread the fine centre line on key risk factors as shown in the plot.
In Global Thematic, we trimmed several positions in companies most exposed to a downturn in Chinese tourism and consumer spending (LVMH, Starbucks, L’Oreal), while increasing our weighting to companies leveraged to US consumer demand (Costco, Lowe’s). We continue to favour highly cash-generative stocks that are resilient to economic cycles and can carve their own growth path.
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 Communications Services (AT&T, Discovery) and Consumer Discretionary (Yum China, Yum! Brands) while trimming Materials (Sherwin-Williams, Dow Inc) and Real Estate (TAG Immobilien, Invitation Homes). Technology and Communications Services are our favoured sectors.
by Diana Gordon, Head of Fixed Interest
The Kiwi Wealth Fixed Interest Fund (Fixed Interest Fund) returned +0.92% in January underperforming its benchmark which returned +1.42%. 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 Coronavirus outbreak.
Fears over Coronavirus dominated fixed interest markets in January, the brief US-Iran conflict now seemingly an afterthought. We often talk about New Zealand being a part of this world however distant we are from the fray. The Coronavirus epidemic is a menacing reminder of that reality whether individual Kiwis are directly affected or not. Interest rates started to plummet around the world as the virus’s impact began to hit. This is a classic flight to quality move as investors shed risky assets like equities and snapped up so-called "risk-free" government bonds. The interest rate on the US 10 year government bond started the month at a 1.9% and ended the month at 1.5%. New Zealand rates fell too, from 1.7% to 1.3% slightly less than those of the US. A few examples: China accounts for fully a 1/3 of whole milk powder sold in the NZ milk auctions. Tourism is ~6% of our economy and over 8% of our workforce with over 10% of visitors coming from China. It’s hard not to imagine that there will be a cadre of people in China and elsewhere who will take New Zealand off their bucket list – at least for now.
No doubt a whole swathe of industries will be disrupted in the first quarter. However, there is no evidence that the Coronavirus epidemic (and SARS and MERS viruses prior) will have a long term effect on the global economy. Even the central banks have indicated restraint taking a wait-and-see stance. This is quite the contrast to last year when they shot-first-and-questioned-later by cutting interest rates aggressively due to US-China Trade War concerns. That restraint is partly due to global economic gauges turning positive in the last quarter of 2019 with the prospect of a truce in the Trade War. Closer to home, the rate of inflation rose in New Zealand in the fourth quarter partly driven by an uptick in the housing market. That’s a little above the Reserve Bank’s expectations and is good evidence that the doom and gloom has been a bit overdone. That all being said, a lot can change quite quickly and we are keeping more than a weather eye on the epidemic.
The watchword for January was protection and we added only very highly rated bonds to the portfolio. We added 10 year maturity US government bonds (rated AA+) partly as an insurance policy, these bonds being a very liquid store of value. We also added bonds of Asian Development Bank (AAA) and Bank of New Zealand (AA-).