Recently we held a virtual roundtable event, hosted by Rebekah Swan, Managing Director/Head of Clients and Michael Gray, Head of Investments NZ. Although it would have been nice to meet in person, the roundtable covered several topics based on feedback provided by participants prior to the meeting.
The scene for the roundtable session was set with the presentation of the Goldman Sachs Effective Lockdown Index (see graph below). In this one slide the story of 2021 can be highlighted. This story is the opening of the global economy due to the successful roll out of the vaccines across the world, particularly Europe and the US.
The Goldman Sachs Effective Lockdown Index is a combination of official restrictions and actual mobility data from 46 countries. The solid blue line is the global index, and it shows a steady opening of the global economy as lockdown measures have been eased around the world over the last 10 months. New Zealand’s Goldman Sachs Effective Lockdown Index value is currently near 50.
The easing of lockdown measures this year is most dramatic across Western Europe (grey line) and reflects the rolling out of their vaccine programme. For similar reasons, the US has also made steady progress in opening their economy over 2021.
The upshot of this is that the global economy has witnessed a sharp rebound in economic activity this year, led by the US and Europe. The global economy is expected to grow around 6.0% in 2021 based on forecasts by the International Monetary Fund.
Goldman Sachs Effective Lockdown Index
Accordingly, global sharemarkets have performed strongly this year buoyed by stronger than expected economic data and robust earnings results. Global equities have risen 13.3% over the first nine months of 2021, pushed higher by the US (+14.7%) and Europe (+14.0%).
However, with robust economic activity and uncertainty around the virus, it gives rise to several investment risks.
The key risks identified by the roundtable participants are presented in the table below, in order of most mentioned by the contributors.
In addition to some discussion around the above risks, current developments in China were also covered. In relation to China, the recent collapse of the large Chinese property developer Evergrande was highlighted. It was concluded that the company was likely to be restructured and that the Chinese officials would contain the financial and economic impact from the demise of Evergrande. Nevertheless, it was highlighted that the Chinese economy was slowing and that China was a key risk for markets in the months ahead.
On the number one risk of inflation, it was noted that inflation in the US appears to have peaked. Although elevated, inflation in the US, and around the world, is expected to be transitory. High inflation has been driven by a combination of excess demand and disruptions to supply chains. Inflation is most prevalent in the ‘delta sensitive’ areas of the economy, eg hotels, used cars, airfares, car rental and event ticket prices. Although inflation pressures are expected to fade, there is the risk that inflation remains elevated relative to market expectations.
The discussion on risks prompted a question around what investors should consider doing given capital losses from rising interest rates on defensive assets?
Although it goes without saying investors should take a longer-term view, in response to this question it was noted we are in a rising interest rate environment. To manage through this environment, we highlighted some of actions AMP Capital is implementing for their portfolios, including being overweight equities and maintaining shorter duration within the fixed income assets.
Broad diversification was another means to manage portfolios in the current environment. This not only included diversification within the defensive assets, such as an allocation to inflation linked securities, which are outperforming currently, but also within the growth assets. Diversification should not only be seen as way to dampen portfolio volatility, but also to provide multi-sources of income across the market and economic cycle.
The concept of financial repression was also touched upon. A key characteristic of financial repression is that interest rates are lower than the rate of inflation, and this is a distinguishing feature of global fixed income markets presently. In a recent post Generating income in an environment of financial repression Michael discussed the re emergence of financial repression and its impact on income generation.
Active management can also play a part in enhancing outcomes in a rising interest rate environment – not just from the perspective of managing assets within asset classes, but also in being able to dynamically adjust asset allocations within the overall fund.
The chart below outlines participants’ positioning of client portfolios’ relative strategic allocations. 78% of participants’ client portfolios are overweight to growth assets.
This led to the question, can equity markets keep moving higher?
Although AMP Capital expect returns from equities to moderate from the current strong pace, the outlook for global equity markets remains constructive.
As highlighted in the graph below, equity markets generally do not have large falls unless there is a recession. The likelihood of a global recession is low over the next 12 – 18 months. Therefore, we think it is potentially too soon to consider reducing growth assets allocations.
Global equity markets are likely to remain well supported by the economic backdrop. Although the pace of global economic activity is beginning to moderate, the outlook remains promising and above trend growth is expected for next year. The outlook for the global economy is positive based on the ongoing opening of economies due to the continued vaccines roll-out (particularly across the emerging countries), inventory rebuilding, excess consumer savings, and although central banks are tightening policy settings, they are not tight. From a market valuation perspective, although there are concerns in relation to the US market, sharemarket valuations overall are not excessive. Furthermore, valuations continue to be attractive relative to cash and fixed income.
The session finished with Rebekah Swan answering the question:
How do we see the responsible investing sector evolving in the coming years?
What Covid has done in some respects is take the spotlight off longer-term environmental trends, which is not to say that people are not doing the work and that they’ve forgotten about them. But what it has done is highlight or signal the importance of crisis planning – not just around the pandemic but also around climate change. There are some parallels that we can draw there, as investors and businesses need to understand their resilience in the face of climate change as well as in a pandemic.
While the world and New Zealand work out how to operate in the new environment as borders open and business activity returns to normal (although with supply chain issues, that is a topic for another day!), a united effort can strengthen environmental sustainability and help reduce our carbon footprint and carbon emissions. Many of you will be aware that TCFD reporting is to become a mandatory requirement for many types of investors in New Zealand. The External Reporting Board (XRB) is currently firming up reporting standards and scenario analysis requirements going forward and is looking at the first financial reporting period starting from 1 January 2023, which is not that far away.
More and more investors are beginning to use financial related disclosure when analysing companies as it enables them to better understand the risks that a company is facing. For companies, it enables them to have a better strategic planning focus and to assess risk over the short, medium and longer term. They are also able to assess climate related risks with regards to their operations, supplies and assets and look for climate-related opportunities. For both the investor and company, it allows them to decide how to allocate their capital to be more effective going forward. Increased investor and consumer demand for climate related disclosure means companies that don’t manage these risks well will struggle to find capital going forward. Disclosure also allows companies and investors to mitigate any reputational issues that might occur, along with their social licence to operate.
One of the biggest trends we are going to see, as we navigate this change in disclosure and businesses start to implement new processes, is for the industry and market participants to work what is going to be meaningful for investors. There is an annual reporting requirement but it’s really a question of what the investor is going to get out it and whether it’s going to allow them to make better informed investment decisions going forward. While it is a ‘comply and explain’ regime (so not optional), it is a good move in the right direction.
Overall, I think we‘re going to see better disclosure, better transparency, and better reporting around key metrics, at a company and fund level. We should also see a real improvement in the availability of options out there, with a wider range of funds for investors that are easier to compare.
Even if only virtually, it was great to be able to connect with clients and have a different format to discuss today’s current investment environment. Hopefully, next time it will be in person.
This blog post has been prepared to provide general information and does not constitute financial advice in accordance with the Financial Markets Conduct Act 2013. An individual investor should, before making any investment decisions, consider the information available in the relevant Product Disclosure Statement and seek professional advice. While every care has been taken in the preparation of this document, AMP Capital Investors (New Zealand) Limited and the AMP Group (together, 'AMP') make no guarantee that the information supplied is accurate, complete or timely and do not make any warranties or representations in respect of results gained from its use. The information is not intended to infer that current or past returns are indicative of future returns. The views expressed are those of the author and do not necessarily reflect those of AMP. These views are subject to change depending on market conditions and other factors.