Investment Update

September Quarter 2023

Global markets 

Global equities were mostly lower over the third quarter as rising bond yields and the prospect that interest rates would stay higher for longer weighed on most growth assets. Against the backdrop of a challenging quarter, the MSCI All Country World Index fell 2.9%, in local currency terms.

US bond yields rise to pre-GFC levels

US bond yields rose sharply over the quarter with some hitting their highest levels since before the Global Financial Crisis. The rise in bond yields came in part as the US Federal Reserve (the Fed) reiterated it would be keeping interest rates higher for longer, raising its most recent ‘dot plot’ projection for the fed funds rate in 2024. The dot plot indicated the Fed will raise interest rates one more time this year, but only projected two interest rate cuts in 2024, which is two fewer than it forecasted in June.

Furthermore, bond markets had to adjust to a pickup in issuance, especially as one of the historically biggest buyers of US bonds, China, scaled back its demand.

Oil prices surge after production cuts

The price of oil surged by as much as 30% over the quarter after Saudi Arabia and Russia said they would be extending their voluntary production cuts through to the end of the year.

The decision raised concerns of significant shortages heading into the final quarter of the year, which could weigh on global growth and add to already elevated energy prices.

During the quarter, most Western economies have seen the price of petrol at the pump increase.

ECB hikes, Bank of England pauses

The European Central Bank (ECB) lifted its key deposit rate 25 basis points to 4%, the highest level since the introduction of the euro in 1999.

Ahead of the meeting, there had been division over whether the central bank would lift interest rates, but, as with many other central banks, inflation concerns won out – and interest rates were hiked again. "Inflation continues to decline but is still expected to remain too high for too long”, the ECB said in its statement.

Meanwhile, the Bank of England (BoE) hit pause on its historic interest rate hiking programme. However, it was a close call with the nine-panel committee voting 5-4 in favour of a pause.

New Zealand market

In August, the Reserve Bank of New Zealand (RBNZ) left the Official Cash Rate (OCR) unchanged at 5.50%, however, projections released alongside the decision showed the chance of another interest rate hike was increasing. The terminal rate, which is the rate where the Committee believes the OCR will peak, rose 10 basis points to 5.60%.

In economic data, it was a mixed quarter. At one point, dairy prices fell to their lowest level in nearly five years at the Global Dairy Trade auction, driven in part by softening of demand out of China.

Meanwhile, retail sales figures also undershot expectations, while on a positive note, the economy grew in the second quarter at a faster-than-expected pace and a revision of Q1 data meant the economy avoided a technical recession.

Markets at a glance

International equities

The MSCI All Country World Index fell 2.9% over the quarter as share markets were in retreat as resilient economic data suggested that interest rates may need to stay higher for longer. In New Zealand dollar terms, the declines were contained to a 1.6% fall, as the kiwi dollar lost ground against most other major currencies.

In the US, the S&P 500 TR Index was down 3.3%, whilst the tech-heavy NASDAQ 100 TR Index fell 3.9%. At a sector level, energy was the best-performing thanks in part to rising oil prices.

One of the worst performing regions was Europe, where the Euro Stoxx 50 Index fell 4.9%. Economic data has shown a significant downturn, particularly in Germany – ordinarily the region’s economic powerhouse. While interest rates there continued to be raised, the European Central Bank has indicated that the peak may have been reached, as it also lowered its growth projections for the region for the coming years. The UK share market however was the only major market to deliver a gain over the quarter, rising 1.0%. 

Asian markets also fell, but China’s market proved surprisingly resilient despite a raft of weak economic data. The Shanghai Composite TR Index fell only 1.4%, although Japan’s Nikkei 225 TR Index was down a bigger 3.3%.

Australasian equities

Taking their lead from their international counterparts, the NZX 50 Index was down 5.2% over the quarter. While recent company earnings updates were broadly in line with expectations, companies’ forward guidance was somewhat disappointing, which contributed to the index’s falls. Weak business and consumer confidence also didn’t help. 

At a sector level, energy was the standout performer as it delivered solid gains, while consumer staples was the main loser, followed by consumer discretionary and healthcare. Out of the 50 companies that make up the index, only 16 delivered positive gains. Pacific Edge, Fonterra Shareholders Fund and Serko were the big winners, while Vista Group, A2 Milk and Synlait Milk were the big losers. 

In Australia, the ASX 200 TR Index proved surprisingly resilient despite the raft of negative news flow out of China. It finished the quarter down only 0.8%, supported mainly by the strong performance of the energy sector on the back of surging global oil prices.

International fixed interest

It was another tough quarter for global bond markets. Despite signs central banks were winning in their battle against inflation, resilient economic growth in some of the major economies meant sentiment shifted towards the prospect of interest rates staying ‘higher for longer’. What’s more, expectations remained for further potential rate hikes before a peak in rates is reached. This was certainly the case in the US, where market pricing suggests one more quarter per cent move higher later this year. 

Over the quarter, the yield on the US 10-year government bond rose 73 basis points, to finish at 4.57%.

Bond markets in Europe, Japan and Australia took their lead from the US, but did not deliver as big losses. Inflation readings in most of these regions suggest that higher interest rates are starting to bite, with the European Central Bank saying that rates there may have peaked.

New Zealand fixed interest

New Zealand bonds were also lower over the quarter, which pushed bond yields to multi-year highs. Bonds came under pressure after the RBNZ raised its terminal rate, which suggests there may be one more interest rate hike later this year. Meanwhile, stronger than expected growth data reaffirmed that the central bank would need to hold interest rates at a restrictive level for a prolonged period.

Over the quarter, the yield on the New Zealand 10-year government bond rose 69 basis points, closing at 5.31%.

Listed property and infrastructure

The property sector continued to face headwinds over the quarter due to higher bond yields. Rising bond yields weigh on property valuations and make raising capital more expensive. Moreover, property companies are dealing with higher expenses as they roll over debt to much higher interest rates. The New Zealand and Australian property sectors were down 5.5% and 2.9% respectively, both underperforming their broader share markets.

Finally, listed infrastructure stocks were some of the better performing over the quarter. Infrastructure remains a sensible allocation to hedge longer term inflation risks because it can pass through some of the inflation costs. Still, the sector is sensitive to higher interest rates.

Market outlook

Global bond yields continued to move higher over the third quarter as central banks reiterated that interest rates would need to stay higher for longer to bring inflation back to manageable levels.

The move in bond yields put pressure on equity markets, which had, earlier in the quarter, risen as the probability of a soft landing grew. However, the hawkish central bank rhetoric saw equities close the quarter mostly lower.

Inflation remains front and centre, and while progress continues to be made, the recent rise in energy prices has caused some headline inflation readings to turn higher over the last month. Core inflation, which strips out the more volatile food and energy components, is still trending lower but remains well above levels where central banks are comfortable. This has put most central banks in wait-and-see mode, with risks skewed to the upside for further hikes from the Fed and the RBNZ.

In New Zealand, the outlook remains challenging, with the RBNZ likely to move in line with global central banks unless we see a sharp rise in unemployment. Any moves to ease monetary policy domestically before other central banks ease policy runs the risk of inflation turning higher. Households remain under pressure from higher mortgage rates which is weighing on retail spending, and although the housing market has stabilised it still faces downside risks if unemployment rises. 

Our base case is that growth continues to slow but remains positive over the short term. Labour market demand continues to soften, partly due to easing consumption in the face of new headwinds, bringing it more in line with labour supply. Core inflation makes slow progress towards target, with central banks holding rates in restrictive territory. An extended period of tight monetary policy eventually weighs on growth enough to tip it into negative territory consistent with a mild recession.

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