Central banks drive markets

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Investment Market update for the quarter ended 31 August, 2019

Investors should be very satisfied with returns over the last quarter. As central banks around the world continued to cut official cash rates and increase monetary stimulus, global interest rates fell. Lower rates lifted the capital value of income generating assets.

Central banks drove markets with an almost seemingly coordinated response to deteriorating global economic conditions. 

Concerns have been heightened by the trade war between China and the US. 

Global growth forecasts for the next 12 months have been lowered by the International Monetary Fund.

The US Federal Reserve made an about-turn from tightening monetary policy to cutting the Federal Funds Rate for the first time in more than a decade. 

Australia cut its official cash rate (OCR) twice in quick succession to 1.0 percent, and this was eventually followed by an aggressive 50 basis point cut by our own Reserve Bank of New Zealand (RBNZ), also to an historical 1.0 percent low. 

In Europe, where official cash rates are already negative, the European Central Bank is considering further alternative stimulus measures, and policymakers in China and Japan are also considering monetary and fiscal responses to support economic activity.

Globally, cash rates are now straddling zero. There is an estimated US$15 trillion in negative yielding bonds issued; many investors are paying borrowers for the privilege of lending them money. 

Probably unsurprisingly, high dividend paying equities have continued to find support, despite the softer economic outlook. 

The equities of defensive dividend-paying companies with reliable cash flows such as listed property, infrastructure and utilities, performed particularly well over the quarter. Bonds with longer maturities produced some of the highest returns as falling interest rates pushed their prices up.

Financial Markets – softer economic growth can be a positive 
Over the past six to 12 months, interest rates have been heading towards zero across much of the developed world, with Japanese and many European bonds already providing negative yields. 

Yield curves, which reflect the difference between short-term rates (two years) and long-term rates (10 years) have also narrowed. On some measures in the US, long-term rates have fallen below short-term rates. 

Historically, these “inverted” yield curves have always preceded recessions by six to 24 months. Importantly, recessions have not always followed these inversions. 

The current state of interest rates reflects the ongoing sluggish economic recovery since the Global Financial Crisis (GFC), and the preference of major central banks to keep stimulating financial markets with even lower rates and more money printing. 

Investing in a low-rate environment
While ever lower interest rates should generally be interpreted with caution, due to the soft underlying economic environment that central banks are trying to stimulate, we make some broad observations:

• Historically, low rates are positive for assets with reliable cash flows. This includes high quality investment grade bonds and bond-like equities (utilities, electricity generators, listed property and infrastructure).

• While holding cash becomes less appealing, some global currencies tend to perform well in times of uncertainty. These include the Swiss Franc (CHF), Japanese Yen (JPY) and US dollars (USD). New Zealand cash rates are now well below those in the US, which is a key cause of the softer New Zealand dollar.

• Property should do well in a very low interest rate environment. This includes listed property that generates reliable income streams via rents, as well as traditional bricks and mortar.

• Alternative assets can also do well in a very low rate environment and at times of increasing uncertainty.

As always, diversification remains the key investment strategy to mitigate market risks and volatility. 

While a global recession is not our central expectation for the rest of 2019, the current business cycle is mature and a market pullback wouldn’t be a huge surprise. 

As in the past, any significant correction in markets will present good buying opportunities for those with a medium to long-term outlook.

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.

Snapshot of the quarter
• Returns were strong over the past quarter – supported by the relentless march lower in interest rates.

• Falling bond yields relative to cash can be a warning sign of recession – though we don’t anticipate this in 2019.

• Reliable dividend paying equities, bonds, property and alternatives can thrive in a low interest rate environment.

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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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