The flattening of global yield curves (a smaller difference between short-term and long-term interest rates), has investors concerned about an impending economic recession. Yet the current global economic expansion is about to become the longest in recent history.
Central Banks responded to last year’s asset price volatility by reversing asset sales and their bias toward higher official cash rates; they are now renewing monetary stimulus. Asset prices have responded positively to this significant policy reversal.
However, macro-economic indicators continue to cause concern. Global manufacturing has slumped, capital expenditure has slowed, unemployment has hit cyclical lows (it is unlikely to go lower), and there are signs of fatigue in the credit cycle, with wider interest rate spreads and stricter lending standards.
Service sector activity, aided by robust labour markets, has offset some of this weakness. However, global consumers are becoming more cautious, as evidenced by slowing housing markets and a reluctance to take on more debt. Further monetary support may therefore be needed, particularly if the expected growth surge later this year fails to materialise.
Markets reverse Quarter Four declines
In response to Central Bank policy decisions, equity markets have responded positively, broadly reversing the negative returns experienced in the December 2018 quarter. Chinese equities saw the largest reversal, helped by lower interest rates as well as tax cuts and targeted lending.
New Zealand equities performed well over the combined period but this was largely due to the market comprising a greater weighting to companies with defensive earnings streams. This dampened the extent of market losses during the December quarter. Elsewhere, returns year to date have been strong, with European and US equities topping developed market returns, in local currency terms. Japanese equities were the laggard.
While the positive year-to-date returns are normally what we would expect to get over a year (with much of this offsetting the fourth quarter sell-off), markets are not necessarily over-bought. Unfortunately while equities have been bolstered by the return to accommodative monetary policies (low interest rates), the lower economic growth causing this has increased risks to future corporate earnings growth.
In New Zealand, the last reporting season saw downgrades to FY19 forecast earnings out-pace increases by 2 to 1 and in the upcoming reporting season, earnings growth expectations are minimal. We expect inflows from corporate activity to help underpin equity prices over the next three months, however finding value for risk has become more difficult.
Australia appears likely to fare better. Even excluding commodities, earnings growth is still expected to be positive. Global earnings growth expectations are also higher and are generally being priced on lower Price to Earnings (PE) multiples. The likelihood of New Zealand’s continued market outperformance therefore appears lower, meaning that we see the best opportunities for “growth” in international share markets.
Interest rates capped
Global Central Bank policy actions have resulted in New Zealand interest rates consolidating near 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 has meant New Zealand Government 10-year bonds have fallen 70 basis points (0.70 percent) since September 2018, most of which has occurred this year.
This is unlikely to change even should the Reserve Bank of New Zealand’s proposals to increase bank capital proceed. These proposals are expected to increase the cost of debt and reduce credit growth, adding weight to expectations that New Zealand’s Official Cash Rate, currently 1.75 percent, may be lowered further.
Reduced availability of bank credit could see an increase in corporate credit issuance. But while the number of issuers may increase, we don’t believe this would be sufficient to replace the issuance that would have arisen from Banks. Accordingly, we don’t expect credit spreads and underlying interest rates to move higher.
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.