Tuesday 7 July, 2020
Global Market View
Equity markets showed signs of stability in June following a few months of heightened volatility. The currency-hedged MSCI All Country index returned 2.8%, with Europe leading the gains (+6.0%). US equities lagged the rest of the world, as troublesome daily new cases offset some of the optimism from re-opening the economy.
While data releases continue to track below their pre-Covid-19 levels, key metrics in the US show meaningful improvement on a monthly basis. The employment report was very encouraging with non-farm payrolls returning to positive territory, adding 2.5 million jobs following a loss of 20 million jobs in the prior month. The recovery in restaurant and construction jobs was particularly strong, reversing nearly half of the decline in the Covid-19 lockdowns. Robust retail sales and manufacturing sentiment suggested that re-opening has boosted demand significantly. Consumer confidence also recorded one of the highest monthly gains in a decade.
The key message that emerged from the FOMC’s June meeting was that the Committee remains cautious about the economic outlook and the distribution of policy outcomes is skewed almost entirely to be more accommodative. Chairman Powell reiterated the dovish position through 1) interest rates will remain near-zero and likely through to 2022; 2) current asset purchases (quantitative easing) set the floor and the pace can be increased if needed; 3) yield curve control on government bonds which was used once before during World War II could be the next unconventional policy option. The US central bank now expects a 6.5% decline of GDP in 2020, but a sharp recovery afterwards with 5% and 3.5% growth in 2021 and 2022, respectively.
Taking advantage of the Federal Reserve (Fed) support, High-Yield (junk) issuers sold over US$57 billion of corporate bonds in June, surpassing the prior monthly record in September 2013. The rush into credit comes as the Fed began purchasing both investment-grade and high-yield corporate bond ETFs as part of the quantitative easing program announced in March. Among the High-Yield issuers, there are plenty of companies (e.g. Royal Caribbean Cruises) that are facing a degree of solvency distress as the pandemic has crushed their industries.
With new Covid-19 cases again on the rise and more hot spots emerging, it is not surprising to see some nervousness in the last few trading days in June. Market bears have also zoomed-in on the latest geopolitical developments between the US and China, and the looming US presidential election. Given the critical point in the pandemic’s trajectory, another spike in volatility over the coming months would not be a surprise.
by Steffan Berridge, Senior Quantitative Strategist & Nathan Field, Portfolio Manager - Global Thematic
The Kiwi Wealth Growth Fund (Growth PIE) returned 0.39% after tax and fees in June, 0.47% behind the MSCI All Country benchmark. The Core Global equity strategy contributed positively to relative performance, while Global Thematic and Global Quantitative dragged. The strengthening Kiwi Dollar was another headwind, offsetting some of the unhedged returns.
The Global Thematic strategy’s return fell short of the benchmark in June, although year-to-date relative performance remains strong. Our heavy exposure to US stocks dragged on returns as new Covid-19 cases surged and the market began to contemplate the increasing likelihood of a Democrat President in the US. Health care themes generally fared worse over the month while shares exposed to online payments and the semiconductor industry were among the best performers.
The Global Quantitative strategy returned -0.95% in May, 0.26% behind the MSCI AC benchmark as continued optimism drove both global markets and the NZD higher. More risky segments such as Emerging Markets and Europe led the market higher, while the US and Defensives lagged. Sector-wise, Technology and Discretionary were standouts while Utilities and Healthcare lagged. Crude oil continued its bounce, gaining a further 10% for the month. Staples and Utilities were our best sectors, with holdings in a2 Milk and AES and underweights in Walmart and NextEra proving profitable. Our worst sector was Discretionary where underweights in Tesla and Amazon caused a drag. Taiwanese semi-conductor producer MediaTek was our best position gaining 21% on the benchmark while NortonLifeLock was our worst at 16% behind.
In terms of positioning for Global Thematic, we have reduced our exposure to several US technology giants (Apple, Amazon, Facebook) following recent outperformance and the growing political pressure on multinationals with dominant market positions. Following a lacklustre June quarter, we increased our weighting in US discount retail (Walmart, Costco) given their defensive qualities in an uncertain environment.
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 Industrials, Financials and Discretionary (Ferguson, DBS Group, McDonald’s) while trimming Staples and Tech (Costco, Keyence). Healthcare, Discretionary and Tech are favoured sectors, while Energy and Financials are out of favour.
by Diana Gordon, Head of Fixed Interest
The Kiwi Wealth Fixed Interest Fund (Fixed Interest PIE) returned 0.09% after fees and taxes in June, outperforming its benchmark which returned -0.49%. The positive relative performance reflected an underweight to longer maturity New Zealand Government bonds whose yields rose (and hence prices fell) as the Reserve Bank edged away from its bond buying regime. Relative performance was also helped by a strong rally in corporate credit with the US Federal Reserve indicating ongoing support for company bonds.
“We are not even thinking about thinking about raising rates”. Those were the words that US Federal Reserve Chair Jay Powell used this month underpinning that hackneyed word, “unprecedented” about the times we live in. Improving economic data driven by mass reopening buoyed sentiment despite the backdrop of social unrest and exploding COVID infections globally. While risk assets like stocks stayed high despite second-wave Covid-19 fears, US interest rates traded in a very tight range in June reflecting the extreme support of the Fed for both interest rates and company bonds (the yield on a 10 year US government bond stuck at 0.65% for the month). In short, what the Fed wants it gets – and what it wants is to help fund a massive deficit with low interest rates. For example, the Fed also announced that they would begin buying individual company bonds as part of their US$250 billion Secondary Market Corporate Credit Facility (SMCCF) and further stated that their goal is to increase market functioning to where it was before the COVID-19 market disruption in March. As if it never happened? Extraordinary.
New Zealand interest rates bucked the global trend much as we bucked the infection trend, with the interest rate on a government New Zealand 10-year bond rising from 0.79% to 0.91%. Are we losing the popularity contest globally so that foreign investors don’t want our bonds? Quite the opposite actually. Indeed, the Treasury ably managed to sell a $7 billion of a 2024 maturity bond in June. This was the largest by far on record and $4 billion more than they expected to raise (and a shout out from us to all those unsung heroes who have sold the New Zealand story abroad over the years). The New Zealand story is good one with a standout story from the country’s cohesive approach to COVID-19 and coming from a relatively low debt level to begin with. That’s been part of the reason that the Kiwi dollar has risen to the mid-60s cents vs. the US dollar. No, the reason rates rose is more related to new issuance. In particular, longer maturity bond purchases are skewed towards offshore buyers who typically look to Australia and the US to work out at what interest rate they feel comfortable buying our bonds. It’s no surprise that the Treasury would prefer to issue bonds with as long a maturity as possible locking in these historic lows in interest rates and it announced a mid-July issuance of 2041 maturities, the longest on record. Now the Reserve Bank has undertaken to buy up to 50% of all outstanding government bonds. However, that leaves the other 50% to set the price. During June the Reserve Bank took its foot a little off the pedal with these buybacks, we think allowing longer maturity rates to rise enough in particular with respect to Aussie rates so that they look attractive to foreign buyers. There is some talk of the Reserve Bank upping its NZ government bond buyback level from current $60bn to $90bn in August as we begin to hit the wall of the global economic storm. Whether that happens or no, we don’t expect longer dated New Zealand or any other geography’s interest rates to spike absent hard evidence of a working vaccine.
We continued to focus on quality and liquidity in June. We purchased bonds of Inter-American Development Bank IADB (AAA), Finnish state housing provider, Munifin (AA+) and Norwegian state housing provider, KBN (AAA). With strong Reserve Bank liquidity sloshing around the markets, banks are unlikely to need to issue bonds again this year to fund their activities. Consequently, their bonds have become very expensive. We therefore switched out of 2024 maturity Westpac (AA+) bonds into higher yielding term deposits. Likewise, the Fed’s intervention is making US company bonds look highly expensive, but they can be bought cheaper in currencies like Aussie dollars where we purchased bonds of telecom behemoth, Verizon (BBB+). But the main event for June was reversing somewhat out of our position in Australian Government bonds (AA+) back into New Zealand Government bonds (AA+) taking profits as the two countries’ yields began to converge.