During the quarter, we maintained our defensive strategy represented by an underweight to international equities and overweight positions to international and New Zealand fixed interest.
Economic data held up relatively well during the quarter which, along with AI-euphoria, saw equity markets move higher, putting the S&P 500 Index into overvalued territory based on a trailing p/e ratio. Despite this, we maintain our view that the global economy is set to face headwinds over the short to medium term.
Inflation continues to trend lower. In the US, the annual Consumer Price Index hit 4.0%, its lowest level since March 2021. However, the core Personal Consumption Expenditures (PCE) price index – the Fed’s preferred measure – remained sticky, at 4.6%. If we are to see inflation fall back to central bank target levels of around 2% it will likely require an easing of the labour market. However, if inflation remains persistent, central banks could restart or extend their monetary tightening.
In New Zealand, it appears that the cumulative effect of the interest rate hikes by the RBNZ is starting to flow through to the economy with benign growth, weak retail spending and overall weak business and consumer confidence – although both of the latter are off recent lows.
Our base case is that inflation falls slowly, but not fast enough to allow the Fed to reverse interest rate hikes. We expect the federal funds rate to move to 5.75%, but 10-year bond yields will remain below current cycle highs.
We expect PMIs (Purchasing Managers' Index) to remain in contractionary territory (below 50), which will lead to benign growth, and eventually see the economy go into a recession. This setup will be a challenging period for growth assets, underpinning our defensive position.
Finally, we expect oil to remain around $70/barrel and the unemployment rate to slowly rise as workers re-enter the workforce and immigration resumes.