Pre-emptive stimulus supports expansion

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Investment Market update for the quarter ended 31 July, 2019

The US economic expansion is now 121 months long, twice as long as any expansion post-World War II. Consumer strength boosted US GDP growth higher than expected in the June quarter, while unemployment levels are at 50 year lows. 

This backdrop remains supportive for financial markets, but is being further underwritten by US Federal Reserve interest rate cuts. 

These are serving as a further vaccination against the impacts of the ongoing trade dispute with China, weaker sentiment for global growth and potential issues as the UK and Europe contemplate divorce. 

The flow-on impacts of US actions should benefit developing economies given these countries tend to borrow in US dollars. 

In addition, supportive monetary policies are being adopted in Europe, China, Australia and even in New Zealand.

In China and Australia, fiscal stimulus is also being utilised. In the case of Australia, this is aimed at stabilising house prices and bolstering household disposable incomes. 

In China, reserve requirement ratio reductions should improve access for small to medium sized companies to borrow. Chinese tax cuts are supporting profitability, while direct infrastructure investment should allow the Chinese to manage the current slowdown. 

In New Zealand, with the domestic economy slowing and changes to bank capital requirements potentially another handbrake, we expect the Reserve Bank of New Zealand to cut the overnight cash rates at least one or two more times in this cycle.

Collectively, these initiatives are expected to result in global growth expectations rebounding, but expect low interest rates to remain in place until all the various economic overhangs are resolved.

Financial market impacts

The strength of asset prices in 2019 has been beyond most expectations and has more than recovered from the “taper-tantrum” slump late last year.

That slump was triggered by the US and other Central Banks beginning to tighten monetary policy. 

With monetary policy settings now reversing, asset prices are being bolstered and likely to be supported by continued low interest rate settings.

New Zealand equities continue to lead global sharemarket return tables (including in 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 strong performances within the Resource and Healthcare sectors and from the interest rate sensitive Industrials sector. 

Similar performance was seen in US companies, with the strongest contributions from the Financial and Technology sectors. 

In contrast, Consumer Discretionary companies led returns in European equity markets.

In terms of growth stocks, earnings results from the Technology sector indicate ongoing investment in business solutions to boost productivity. In a low-growth, low-inflation world, those investing to improve productivity are seen as better able to maintain earnings growth. 

In the case of Defensive Yield stocks, these are likely to continue to be supported by low interest rates but will require further interest rate declines to maintain their current positive momentum.

Domestically we are also cautious around economic growth given the current government policy mix, but also 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. 

Australia in contrast is adopting more positive policies with tax cuts, lower interest rates and infrastructure investment. 

With these yet to be reflected in company earnings (and adding in the current level of the New Zealand dollar versus the Australian dollar), Australian investments look the most attractive from a New Zealand perspective for some time.

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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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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