Drivers of investment performance
- Global sharemarkets staged a strong recovery in October as the wall of worry from September was undermined by strong US corporate earnings and a firmer tone to economic data.
- The wall of worry, that triggered a 3.7% decline in global sharemarkets over September, included concerns over the slowing of the global economy, central banks moving toward tightening policy positions, uncertainty over the US debt ceiling and the prospect of higher taxes in America. Other concerns included ongoing global supply constraints and rising inflation pressures, the developing energy crisis in Europe and China and the financial crisis surrounding Chinese property developer Evergrande.
- As October wore on, some of these issues faded into the background:
- With Russian gas soon to start flowing into European storage facilities, gas prices have drifted lower across Europe.
- Evergrande has so far averted default by paying overdue bond payments just in time. (Although this issue is far from over, markets have been less concerned given the situation with Evergrande appears to have been contained.)
- Progress has been made on lifting the US debt ceiling. The Democrats are moving closer to agreeing on a $1.8 trillion Build Back Better package, which includes new spending to be spent over the next seven years. Once they can agree on this package, the $500 billion infrastructure bill will be passed and the raising of the debt ceiling will be supported. In addition, the impact on corporate earnings from a higher tax rate is likely to be less than initially feared. This was a further boost for US equities.
- While concerns over the likely actions of central banks, persistent inflation, and ongoing supply constraints still linger, global sharemarkets discounted these concerns and instead focused on the strong start to the US third quarter corporate earnings results.
- As at the end of October, just over 50% of the listed companies in the US had reported their earnings and of these 80% had exceeded market expectations. This is one of the best starts to a US earnings season on record. In total, US corporate earnings have been around 9.5% higher than forecasted.
- Although Covid-19 cases have declined globally over October, continuing the trend established in September, the impact of the pickup in virus cases over July and August has been evident in recently released economic data:
- Based on initial estimates, the US economy expanded 2.0% over the third quarter of 2021, which was lower than the 2.6% growth expected. The lower outcome can be attributed to a decline in service sector activity due to the rise in covid cases earlier in the quarter. In addition, consumer spending was lower than anticipated given a 54% drop in vehicle purchases on the back of the semiconductor shortage (reflecting supply chain issues).
- Chinese economic activity was slightly weaker than expected over the September quarter. Chinese economic growth came in at 4.9% year on year, versus expectations of 5.0%. Over the quarter Chinese growth weakened on the back of adverse weather conditions, a wave of Covid-19 outbreaks and related lockdown measures, energy constraints and related production suspension, and impacts of previously enacted regulation, particularly on the property sector.
- US inflation remains elevated and has risen by 4.0% over the last twelve months. Inflation pressures have risen due to increased demand given the pickup in economic activity and global supply chains have also been disrupted by Covid-19, eg the shortage of semiconductors has resulted in an outsized gain in second-hand cars.
- Global sharemarkets have largely ignored the enduring inflation pressures in the US and higher than expected inflation outcomes across Europe. Nevertheless, it has placed upward pressure on interest rates. Unexpected inflation is a key risk for financial markets in the months ahead.
- The inflation backdrop has prompted further action by central banks. Although there is a divergence among global central banks, they are all marching towards the tightening of policy positions, some at a quicker pace than others. Examples include:
- the US Federal Reserve (the Fed) has signalled they will begin reducing the rate at which they are purchasing securities (tapering), likely to start in November or December, and are unlikely to raise interest rates until the second half of 2022,
- the Bank of England is expected to raise interest rates soon, and
- the Reserve Bank of New Zealand (RBNZ) raised the Official Cash Rate (OCR) to 0.5% from 0.25% in October.
- While central banks are beginning to tighten policy settings, they will not be tight for some time and will therefore likely remain supportive of sharemarkets in the quarters ahead.
- Nevertheless, with elevated levels of inflation there is the growing risk that central banks will be forced to act more quickly than anticipated. This is a risk in the US and Europe.
- This dynamic occurred in New Zealand with the RBNZ having abruptly changed their policy settings in recent months. Only New Zealand going into a national lockdown in August averted the increase in the OCR occurring earlier.
- The hike in the OCR comes after a period of stronger than expected economic data. The latest being the sharp rise in inflation. New Zealand’s annual inflation has accelerated to 4.9%, the fastest pace since 2011 and well above the RBNZ’s 1-3% target range. Inflation for the third quarter increased 2.2%, compared to the RBNZ’s expectations of 1.4%. The inflation pressures were broad based across the economy.
- Accordingly, the RBNZ is expected to raise the OCR further over the next 12-18 months.
- Covid cases took a backseat over October. Global virus cases continue to fall and importantly the evidence supports that the vaccines reduce the likelihood of seriousness of illness and ending up in hospital.
- Global sharemarkets rose 5.5% in October and are back near historical highs.
- The US sharemarket returned 6.9% last month, boosted by better-than-expected corporate earnings. The US S&P 500 Index has posted four consecutive weeks of positive gains, the longest winning streak since April, and ended the month at new record highs. The European markets also performed strongly, rising 5.0% over the month.
- Growth stocks outperformed value stocks by 2.1% over the month. US technology companies performed very strongly, with Microsoft and Alphabet (Google) hitting new highs during October.
- Emerging markets underperformed developed markets, rising just 0.8%, weighed down by the 0.6% decline in China, -6.2% fall in Chile and the -7.8% return in Brazil.
- The New Zealand market fell -1.3% for the month, primarily on rising interest rates, economic uncertainty given the ongoing lockdown in Auckland and weakness across several stocks following a period of outperformance.
- Commodity prices continue to move higher in October. The Bloomberg Index rose 2.6% last month, helped by the 8.0% increase in oil and 6.8% rise in the price of copper.
- It was another tough month for global fixed income markets. Longer-term interest rates continued to climb higher around the world as central banks moved toward tightening policy settings, elevated levels of inflation pressures persisted (eg ongoing global supply chain constraints and tight labour markets) and on a firmer tone to economic data.
- New Zealand’s longer-term interest rates rose dramatically in October as the RBNZ hiked the OCR. New Zealand’s 5-year government bond rate increased 83 basis points over the month. Accordingly, the domestic fixed interest market fell -2.9% over the month compared to the -0.3% decline from global fixed income markets.
- The New Zealand dollar strengthened last month, up 3.0% on a trade weighted basis, rising by 3.9% versus the US dollar and 4% against the euro. The NZ dollar was flat against the Australian dollar, highlighting commodity currencies did well last month on the back of a firmer tone to economic data around the world.
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