Rates returning to zero

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Investment market update for the quarter ending 30 June, 2019

Global economic growth, and in particular growth in developed economies, has been pared back significantly since December 2018. Despite this, global employment growth continues to underpin household incomes and a more robust service sector, relative to the weak manufacturing sector.

The lower growth outlook has put Central Banks on the defensive. Since the equity market pullback in the fourth quarter of 2018, the various regulators have back-pedalled on what had been tighter monetary policy measures. 

Short-term interest rates have been cut and further cuts have been signalled. This has led to 10-year New Zealand and Australian government bonds trading at record lows (1.57 percent and 1.32 percent respectively), while United States bonds are back at 2016 levels (2.01 percent) and European benchmark bonds are negative (-0.33 percent).

To change this backdrop, GDP growth expectations will need to improve. Expectations are still for positive growth, but the US-China trade dispute continues to be an obstacle. The parties are now back at the negotiating table and the probability of escalation in tensions, if now not reduced, has at least been pushed out. 

In terms of growth stocks, assuming no deterioration in trade, the accommodative interest rate settings around the world should allow for some improvement in the next six months.

Could a speedy outcome occur? Yes, as the build-up to the 2020 US Presidential race is nearing and improving growth would help Trump’s re-election. However, equally possible is a tougher stance by the US on Europe or Japan. Until we have clarity on these scenarios, low interest rates, which dis-incentivise saving, will prevail.

Financial market impacts

Economic growth concerns first hit equity markets in the fourth quarter of 2018. However, stimulatory activity by Central Banks has boosted equity markets this year. An escalation in US-China trade tensions saw market declines during May. But, the continuing downward trend in interest rates alongside the US and China renewing talks at the G20 summit, allowed equity markets to rally over June and end the quarter with positive returns. 

New Zealand equities continue to lead global sharemarket return tables year-to-date, (including the fourth quarter of 2018). This reflects investor preference for Defensive Yield stocks in New Zealand, a sector that has benefited as investors have focused on companies with high sustainable free cash flow yields. 

Australian equities benefited from a recovery in Banks and strong performances within the Healthcare sector and interest rate sensitive Industrials. Similar performance was seen in US companies, with the strongest contributions from Financial and Technology sectors. In contrast, Consumer Discretionary companies led returns in European equity markets.

Looking forward, interest rate-sensitive stocks appear to require further declines in interest rates to maintain their current momentum. In terms of growth stocks, assuming no deterioration in trade, the accommodative interest rate settings around the world should allow for some improvement in the next six months. 

However, some caution around economic growth in New Zealand would be prudent given the potential impact of proposed increases in Bank capital requirements. The level of required capital is expected to be finalised by November 2019, with implementation to commence from April 2020. 

Outside of this, we also have to consider proposals affecting the Australian parents of New Zealand banks. Australian regulators are reviewing subsidiary support levels and are proposing significantly lower settings. This may further impact credit availability in New Zealand, with finalised proposals on this due to be implemented on 1 January 2020.

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.

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About Author

Brett Bell-Booth

Investment Advisor with Forsyth Barr Limited in Tauranga. Phone: (07) 577 5725 or email brett.bell-booth@forsythbarr.co.nz

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