Friday 7 August, 2020
Global Market View
July saw the pace of daily new infections increase sharply across the US, as well as in Japan, Spain and Australia. Global cases closed in on the 18 million mark (starting the month at 10.5 million), with the US alone approaching 5 million cases. This outbreak in the US was initially centred in the North-eastern states, but throughout the month infections began to rise rapidly across the rest of the country. As a result, many states started to partly reverse or pause their reopening. Compounding the United States’ woes, second-quarter GDP came in at -32.9% (annualised), the worst quarterly figure reported since WW2, and trade tensions with China continued to escalate rapidly. All of this resulted in a rare month where the USD underperformed quite significantly versus other major currencies.
In spite of this, US stock markets continued to rally higher, with the S&P 500 finishing the month up 5.6%. More in focus for markets in July were second-quarter company earnings releases, the first to capture the full scope of the effects of COVID-19. Surprisingly, earnings have been overall largely positive, with most companies beating (admittedly in some cases reduced) estimates, and by a greater value than expected – this was led by the big tech names of Amazon, Apple and Facebook surpassing even the highest predictions. More importantly, of those who chose to give us a taste of the future, guidance has generally risen, albeit modestly.
Another market news flow favourite, positive progress on vaccine trials, continued to roll in. The team at the University of Oxford revealed their vaccine produced the desired immune responses without any adverse reactions. That was in a Phase II trial of over one thousand volunteers and has since moved on to Phase III. Another vaccine front runner, US biotechnology giant Moderna, experienced a boost in its stock price after its RNA based vaccine showed an antibody response, and have now also begun a Phase III trial intended to include 30,000 participants.
Regardless of when we get a vaccine, or the stock market’s seeming indifference towards rising case numbers, the real economic effects of COVID-19 are still on the horizon, likely to require even more swift and sizable support from central banks and governments. Central banks took something of a back seat over the past month, having already flooded the market with cash and slamming their rates close to zero. The narrative has shifted to governments to provide further support to pick up the slack. Congress debated how much unemployment benefits should be extended and whether supplementary stimulus cheques should be provided. This hasn't proven easy to get over the line, but we are confident it will. Across the Atlantic, the highly anticipated EU Recovery Fund was finally approved following a marathon negotiation that lasted over 72 hours. The agreed proposal will allow the European Commission to borrow up to €750 billion (NZD ~1.4 trillion).
The disconnect grew wider in July, with economic conditions telling one story, but markets another. Unprecedented central bank and government support, along with the scientists working tirelessly on a vaccine, are doing an excellent job at keeping the market upbeat in the face of the biggest shock to the economy in living memory. With these opposing forces in balance, we are disciplined in watching for opportunities. Should you have any concerns, please contact your adviser.
by Steffan Berridge, Senior Quantitative Strategist & Nathan Field, Portfolio Manager - Global Thematic
The Kiwi Wealth Growth Fund (Growth PIE) returned 3.08% after tax and fees in July, 0.47% ahead of the MSCI All Country benchmark. Both Global Thematic and Global Quantitative strategies contributed positively to relative performance, while Core Global and alternative assets were slight drags. The strengthening kiwi dollar against the US greenback was another headwind.
Global Thematic returned 2.57% in July finishing ahead of the benchmark by 0.78% as the impressive recovery in global equity markets continued. In terms of themes, we saw stocks exposed to US homebuilding outperform (DR Horton, Pulte Group), fuelled by low interest rates and early signs that the pandemic is encouraging a move away from major cities. There was also a big rally in semiconductor stocks, particularly TSMC which continues to leverage its position as the world’s premier pure-play foundry company.
Global Quantitative returned 2.37% in July, 0.58% ahead of the MSCI ACWI benchmark as global markets and the NZD continued to pick up on positive vaccine news and better-than-expected earnings, despite confirmation of the dire economic situation. Emerging Markets and the US led the market higher while Japan, Hong Kong and the UK were notable laggards. Consumer Discretionary and Materials were the standout sectors, with Energy and Financials lagging despite WTI crude gaining slightly. Treasuries rallied 11bps, pointing to a tick down in the economic outlook. Financials and Staples were our best sectors, with several small contributors adding up in Financials (T. Rowe Price, 3i Group, Gjensidige) and Church & Dwight leading the way in Staples as demand for personal & household care held strong. Our worst sector was Healthcare where Cigna and an underweight in Pfizer dragged. Best individual performers were driven by Intel’s next generation chip delay, with holdings in Taiwanese semis (TSMC and United Micro) gaining strongly, helped further by an underweight in Intel. Worst performer for the month was an underweight in Tesla which continued its recent rally.
In terms of positioning for Global Thematic, the portfolio continues to tilt towards defensive themes (stay-at-home winners, food and beverage giants), given the limited success of re-openings to date, undermining the prospects of a V-shaped economic recovery. We have also added stocks to our theme of solitary leisure (Deckers Outdoor, Wyndham Hotels), which focuses on changing consumer preferences in a post-COVID world.
For Global Quantitative, our top-down positioning targets higher quality sectors more suited to the current crisis like Tech and Healthcare, although a brightening outlook from low levels has seen us increase exposure to select cyclicals, particularly Discretionary and Industrials. Stock selection favours companies with attractive metrics across earnings quality, capital efficiency, valuations, sentiment and sustainability. Over the month, we’ve increased our allocation to Materials and Industrials (CCL Industries, Rockwell Automation) while trimming Healthcare and Energy (Merck, INPEX). Discretionary, Industrials, Technology and Healthcare are favoured sectors, while Energy and Financials remain out of favour.
by Diana Gordon, Head of Fixed Interest
The Kiwi Wealth Fixed Interest Fund (Fixed Interest PIE) returned 0.55% after fees and taxes in July slightly underperforming its benchmark which returned 0.64%. Performance was driven by an overall lower average maturity profile in longer dated NZ government bonds which performed more strongly. This was offset by a position skewed to the longest (and therefore best performing) maturity NZ government bonds and continuing tightening credit.
“I just will say the following, that this pandemic and its fallout really represents the biggest shock to the U.S. economy in living memory…In terms of inflation, I don’t know. I think fundamentally, this is a disinflationary shock. I know there is a lot of discussion about how this might lead to inflation over time, but we’re seeing disinflationary pressures around the world, going into this. Now we see a big shock to demand, and we see core inflation dropping to 1%. I do think for quite some time, we’re going to be struggling against disinflationary pressures, rather than against inflationary pressures”. – Jay Powell, US Federal Reserve (Fed) Chair, 29 July 2020
The price of tradeable debt, or bonds, is determined by inflationary expectations. If real-life prices are declining, the value of the principal on a bond in - say - 10 years’ time increases in today’s money because the interest rate you require to compensate for inflation goes down (prices and interest rates move inversely). And when the ‘Central Banker’ to the world predicts lower real-world prices amidst a worsening pandemic? So go the bond markets with the interest rate on a 10-year US Treasury government bond declining 13bp to 0.53% over the month.
Back in the lucky country, a title stolen (for now?) from Australia, the NZ economy has been snapping right back. We have a good story and international investors have been lapping up our government bonds. A new $4.5billion 2041 maturity syndication performed particularly well aided by the news that the government has $12 billion of unused dry powder from the budget for use in the event of a second round of infection. However, it’s fair to say that we are not immune from global weakness and of course we are impacted directly from the loss of international tourists and students. Additionally, the imminent end of the wage subsidy is looming over the employment market. So it’s not surprising that there have been of signs of softening towards the end of the month. That sentiment drove the interest rate on a 10-year NZ government bond down 17bp to 0.73% over the month, much in line with its US peer.
With the Fed distorting the credit markets to extremely expensive levels, we only dipped our toes into company bonds in July, purchasing Aussie-denominated bonds of US telecom giant, Verizon (BBB+). We also added, Transpower (AA-) and Local Government Authority bonds (LGFA) (AA+) in Kiwi dollars. However, the major event of the month was our purchase of the new 20-year maturity New Zealand Government bonds (AA+) which were priced attractively as often new maturity issues are. We aren’t quite in Jay Powell’s dour disinflationary camp, but we do certainly expect central banks to continue to squelch interest rates for some time.