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Slowing but still growing

Harbour sails 1
Harbour team | Posted on Mar 8, 2019

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.

Key points

  • Share markets continued their new year rally, aided by positive noises from trade negotiations and further dovish rhetoric from the US Federal Reserve (the Fed)
  • Economic data released during the month continue to portray lower economic activity, especially in Europe and China, though China has looked to combat this through a range of stimulatory measures
  • Domestically, the economic outlook is continuing to soften, though at this point, the transition appears to be from strong to moderate growth, with risks to the downside

Key developments

Global equity markets continued to strengthen in February with the MSCI World index (in local currency) rising by 3%. Stocks benefited from improving market sentiment which was largely driven by further evidence that the Fed remains on pause and positive news flow surrounding the US and China trade negotiations. US earnings season was in full swing during the month and, while we saw some strong earnings results, negative outlook statements outnumbered positive statements three to one, putting a dent in otherwise buoyant investor confidence.

The New Zealand share market benefited from the improving sentiment, moving higher with the global trend. Our domestic index was given a further boost by its largest constituent, a2 Milk, which rallied by over 13% during the month following a strong earnings result. While the New Zealand earnings season delivered some success stories, the reading from the latest outlook statements remained cautious. Revenue trends are moderate, and costs, especially labour costs, are gradually rising.

Australian shares also performed strongly during the month, driven by strong returns from the banks. Bank share prices rallied following the release of the final Royal Commission Report that was greeted positively by the market, which in a sense means a significant high point in expectations of regulatory change, fines and costs has now been reached.

While the recovery in equity markets has led to a repricing of credit risk, particularly globally, bond yields have not retraced their earlier moves. New Zealand bond and swap yields have reached record lows for some maturities. This is something we would expect to see during periods of recession, as opposed to periods of strong (but moderating) economic growth.

What to watch

Looking forward, we see three main things to watch:

  • While equity markets have recovered strongly, earnings growth trends, both domestically and globally are softer. We will be looking for evidence of corporate strength before taking a more bullish stance in markets.


Source: Bloomberg, Harbour

  • We’ve clearly seen a softening in economic activity, but we are encouraged by the announcement of stimulus in China, which will provide a boost to both consumers (through tax cuts) and manufacturing (through infrastructure projects). While these stimulus measures will have a lagged impact on markets, we will be monitoring confidence and business intentions surveys to gain early insight into the efficacy of these measures.
  • Locally, we had two important policy discussion papers published in February which could have wide-reaching implications for investors:
    • Firstly, the Tax Working Group (TWG) provided their final report which recommends a capital gains tax on non-owner-occupied housing, local businesses and Australasian shares. While we believe some of the recommendations in the report could have potentially undesirable effects on New Zealand capital markets, it seems improbable that all the recommendations made within the report will be proposed to the electorate. We will know more when the Coalition Government responds to the TWG’s report in April.
    • Finally, the Reserve Bank of New Zealand (RBNZ) continued to outline their case for much higher bank capital. If this is implemented it is likely to result in a combination of higher lending rates, lower deposit rates and low returns on equity. It is also likely that Australian banks will become more discerning about the volume of lending to low return sectors. While these measures will undoubtedly make banks safer, which is a good thing, it has the potential to do so at the expense of economic growth.

Market outlook and positioning

Our broad economic view is one of moderately slower growth and moderately higher inflation. The RBNZ has a similar view, projecting that the Official Cash Rate (OCR) will stay at 1.75% for the next two years. Looking ahead, the debate will be focused on how rapidly the economy slows and to what extent inflation pressures exert themselves. We acknowledge a case can be made for rate cuts if the economy slows significantly, but we still see this as a risk scenario, not a base case. Assuming no rate cut, pricing across the yield curve looks expensive.

Within domestic credit markets, spreads have been increasing steadily, but not aggressively. Offshore, credit spreads widened during the sell-off in November and December, but there has been a strong rebound since then. In New Zealand, we have lagged global moves and are moving from expensive to neutral levels. We expect to reduce our underweight credit position as the year progresses.

In the equity growth portfolio, we have taken some profits in some strongly-performing positions and, while it can be tempting to become more defensive in positioning following a large recovery in prices like we have just had, we think growth stocks will continue to deliver. Defensive yield stocks have benefited from the fall in bond yields and we think yields are set to remain unchanged or edge slightly higher. Moreover, we think cyclical and value stocks which bore the brunt of earnings downgrades (Fletcher Building, Sky TV and Air New Zealand) appear more challenged by the possibility of even weaker demand conditions.

In multi-asset portfolios, we have removed our overweight position to equities, reflecting the more cautious outlook and increased valuation levels.

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