The Harbour Outlook summarises recent market developments, what we are monitoring closely and our key views on the outlook for fixed interest, credit and equity markets.
- Share markets rallied at the prospect of the US Federal Reserve pausing interest rate increases and hopes that trade talks between US and China may ultimately reach a positive conclusion
- US economic data has continued to paint a picture of an economy in good health, while data in Asia and Europe remains soft. China especially is showing signs of consumer weakness in demand, though this has received a positive stimulatory policy response
- Domestically, the economic outlook is looking softer, though at this point, the transition appears to be from strong to moderate growth
Global equity markets rebounded strongly in January, led by the S&P 500 which had its strongest January since 1987. The sharp recovery in risk appetite reflected more dovish statements from the US Federal Reserve (the Fed) which is now expected to pause its interest rate hiking cycle until the cross currents of slowing global growth, market volatility and “tightened” financial conditions pass. A better than expected kick off to the US earnings season further whetted investors’ appetite towards risk assets.
New Zealand and Australian equities, which weathered the volatility in the latter part of 2018 remarkably well, underperformed during January, reflecting the more defensive mix of companies in these markets. Within both markets higher growth (including technology) and more economically-sensitive sectors (including resources and energy) outperformed. Pre-earnings “confession” season delivered some negative surprises which were punished by the market. This saw notable falls in Kathmandu (down 13% during the month) and Air New Zealand (-9%). These confessions provided insights into their respective sectors causing a contagion effect and smaller scale sell-offs in companies exposed to similar industry dynamics.
After benefiting from a flight to quality in December as equity markets fell sharply, bond yields did not reverse their previous move in January. We ascribe this to a combination of factors, including a more dovish Fed, softer Chinese and European macroeconomic data and moderating growth. NZ core inflation is rising but below 2%, which is likely to enable the RBNZ to retain loose monetary policy for a considerable period to come.
What to watch
Looking forward, we see three main things to watch:
- US China trade negotiations. The “trade truce” deadline between the US and China looms on March 2, leaving negotiators a short period of time to reach a satisfactory outcome. While Trump has touted that a “great deal” is in the works, which helped buoy markets in January, if Brexit has taught us anything, it is that negotiations can take time and can often meet an unexpected impasse.
- As earnings seasons gather pace in NZ, Australia and the US, we will be looking for hard evidence of corporate performance. Currently earnings growth expectations in these markets have been pared back to low single digit numbers. The US corporate earnings season thus far has been more favourable than expected, which assisted in re-igniting a share market rally. We see potential for this trend to continue as company earnings results beat what may now be conservative earnings expectations.
- Finally, we will be closely watching developments in the financial sector.
- While the review of the Hayne Royal Commission (RC) yielded little fresh news for banks, the report did reinforce the significant challenges facing the wealth management sector. These changes disrupt business models which have existed for some time and, as Australia moves into an election cycle, there is plenty of potential for the Hayne report to continue to generate attention.
- Closer to home, the proposed changes to bank capital requirements could have wide-ranging implications for investment markets. The Reserve Bank is considering a very large increase in Tier 1 capital requirements to 16% of total assets. This is estimated to reduce the risk of bank failure to 0.5%. As banks hold a little over 10% capital at present, it is estimated that banks will need to raise up to $20bn over the next five years. In order to do this, most analysts agree that banks will need to raise lending rates and pay less for term deposits. Other second round effects are difficult to estimate at present; however, we deduce the Reserve Bank does not think it will have as large of an impact as does the balance of academic literature we have reviewed. Thus, we see the risk from these proposed changes to the economic outlook as skewed to the downside.
Market outlook and positioning
The combination of bank capital requirements and softer growth has led some economists to argue that the Reserve Bank will cut the Official Cash Rate. Our central case remains that the RBNZ remains on hold for a considerable period. However, we would not rule out the chance of cuts if there was a material deterioration in the domestic or global outlook.
Domestic credit markets have remained stable despite the fall and subsequent retracement in global credit spreads. Outside AAA-rated Kauri deals, there has been no issuance in New Zealand, so investor appetite has not been tested. That is likely to come over the next two months as other issuance matures. We have been positioned cautiously and have scope to invest if we are presented with attractive pricing.
In the equity growth portfolio, we prefer exposure to selected quality growth companies in the consumer staples, information technology and financial sectors, where the potential rate of growth over time may not be reflected in share prices. Conversely the portfolio is underweight NZ consumer discretionary and energy sectors where disruption risk remains high, and the utilities, real estate and telecommunications sectors where valuations are high relative to their potential growth.
In multi-asset portfolios, we retain an overweight equities position which we added to in December following equity market weakness.
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Harbour Asset Management Limited is the issuer and manager of the Harbour Investment Funds. Investors must receive and should read carefully the Product Disclosure Statement, available at www.harbourasset.co.nz. We are required to publish quarterly Fund updates showing returns and total fees during the previous year, also available at www.harbourasset.co.nz. Harbour Asset Management Limited also manages wholesale unit trusts. To invest as a Wholesale Investor, investors must fit the criteria as set out in the Financial Markets Conduct Act 2013. This publication is provided in good faith for general information purposes only. Information has been prepared from sources believed to be reliable and accurate at the time of publication, but this is not guaranteed. Information, analysis or views contained herein reflect a judgement at the date of publication and are subject to change without notice. This is not intended to constitute advice to any person. To the extent that any such information, analysis, opinions or views constitutes advice, it does not consider any person’s particular financial situation or goals and, accordingly, does not constitute personalised advice under the Financial Advisers Act 2008. This does not constitute advice of a legal, accounting, tax or other nature to any persons. You should consult your tax adviser in order to understand the impact of investment decisions on your tax position. The price, value and income derived from investments may fluctuate and investors may get back less than originally invested. Where an investment is denominated in a foreign currency, changes in rates of exchange may have an adverse effect on the value, price or income of the investment. Actual performance will be affected by fund charges as well as the timing of an investor’s cash flows into or out of the Fund. Past performance is not indicative of future results, and no representation or warranty, express or implied, is made regarding future performance. Neither Harbour Asset Management Limited nor any other person guarantees repayment of any capital or any returns on capital invested in the investments. To the maximum extent permitted by law, no liability or responsibility is accepted for any loss or damage, direct or consequential, arising from or in connection with this or its contents.