Investment Market update for the quarter ended 31st March, 2019.
The market ethos that “bad news” is “good news” has returned. The response to weaker economic data has been for central banks to again move to underwrite economies, or at least asset prices:
• the US Federal Reserve has paused hiking interest rates and is set to increase its holdings of US Treasury securities from October 2019;
• the European Central Bank has announced fresh long-term financing for Euro area banks; and
• the People’s Bank of China has injected more liquidity into China’s financial system to bolster lending growth.
Reviewing economic growth forecasts, the Central Bank action is easy to understand. Over the past three months there has been a dramatic fall-off in economic growth expectations, particularly for developed economies. Until there is evidence of growth being revised upwards, accommodative monetary policies, such as low interest rates, will continue.
Markets shrug off Quarter Four declines
In response to Central Bank policy decisions, equity markets have responded positively, largely reversing the negative returns delivered in the December 2018 quarter.
Chinese equities saw the largest reversal with New Zealand equities benefiting from the positive performance of higher yielding securities. European and Japanese equities were the laggards.
While equities have been bolstered by the return to accommodative monetary policies, the lower growth causing this has increased the risks to corporate earnings growth. For example, in the recent New Zealand company reporting season, downgrades to FY19 forecast earnings outpaced advances by two to one. This reflects the weaker economic growth outlook in Australasia and rising cost pressures for businesses.
In Australia, the weaker housing market is likely to see a similar result from companies exposed to the Australian economy. The trend of Australian companies to increase dividend payments and share buybacks at the expense of investment is likely to provide a further challenge to the achievement of their earnings growth forecasts.
Given the price-earnings-ratio (PE) expansion implicit in many share prices, we believe value-for-risk assessments will become increasingly favoured by market analysts. While higher PE multiples for companies can be supported by lower interest rates and weight of money arguments, earnings growth is still required.
For companies with defensive characteristics, the growth hurdles are low and therefore easier to attain, however companies in other sectors that are able to grow earnings will become even more valuable in a low interest environment. Overall, we see the best opportunities for “growth” in international sharemarkets, rather than in Australasia.
Monetary policy and redemptions
Global Central Bank policy responses have resulted in New Zealand interest rates falling to record low levels.
Further impetus was provided by the latest Reserve Bank of New Zealand monetary policy statement which (while leaving the Official Cash Rate unchanged) stated that the next move in interest rates would be downward. This meant New Zealand Government 10-year bonds fell by 60 basis points in the quarter and 80 basis points in the last six months. Near-term bond maturities are likely to reinforce these lower rates.
While issuance of new bonds has increased, we believe overall market supply will be limited by the Reserve Bank of New Zealand’s bank capital proposals, which will eliminate any new issuance of bank capital securities. These were previously used for regulatory capital adequacy requirements, but under the new proposals will no longer count for this purpose. The proposals (if adopted) are also likely to impact both the cost of debt and credit growth. This would add weight to expectations that New Zealand’s Official Cash Rate may be lowered.
This column is general in nature and is not personalised investment advice. This column has been prepared in good faith based on information obtained from sources believed to be reliable and accurate. Disclosure Statements for Forsyth Barr Authorised Financial Advisers are available on request and free of charge.