Central Banks soothe nerves

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Investment Market Update, quarter ended 30 September 2019

Investors could understandably be nervous given geopolitical noise, and the resulting volatility they’ve seen in markets over the last quarter. But when they look at their portfolios, they will generally continue to be satisfied with returns.

Central Banks around the world cut official cash rates and increased monetary stimulus, and globally interest rates have fallen. Lower interest rates lifted the capital value of most asset classes.

The geopolitical and economic influences on markets are currently at an extreme level.

Investor returns over the quarter more than offset the plethora of risks and uncertainties which include the China-US trade war, the impact of Brexit, attacks on Saudi oil infrastructure, Hong Kong protests, the build-up to the US election (still 13 months away), and softening international and domestic economic data.

In particular, economic concerns are rising in China, with the world’s second-largest economy now growing at its slowest pace since the early 1990s. China’s economic influence is broad, impacting global demand for everything from commodities, to machinery to tourism.

In response the US Federal Reserve cut the Federal Funds Rate by 50 basis points, the first reduction since 2008 when in the heart of the Global Financial Crisis (GFC).

The Reserve Bank of New Zealand also dropped its official cash rate by 50 basis points on 7 August to a historic one percent low.

The Reserve Bank of Australia went one step further with a further 25 basis point cut on 1 October to 0.75 percent.

Europe is particularly exposed to global trade. Around half of Germany’s GDP is reliant on exports. The European Central Bank (ECB) announced its largest stimulus package in three years, pushing interest rates further into negative territory.

The ECB has also restarted buying bonds (quantitative easing), and called for European governments to provide fiscal stimulus (increased spending and/or tax cuts) to counter economic weakness.

In a sign of the unique times, a Danish bank is offering a 10-year mortgage at a fixed rate of -0.5 percent (yes, negative 0.5 percent).

Focus on investing basics

Investing against this backdrop can feel uncomfortable. But investors who maintain the core disciplines of a long-term focus and a diversified portfolio are rewarded with the “market risk premium”, which means that higher long-term returns will compensate investors for bearing additional investment risk.

Unsurprisingly in the face of falling interest rates, equities with reliable cash flows (and attractive dividend payments) such as listed property, infrastructure and utilities, performed well over the quarter.

Bonds with longer maturities produced some of the highest returns, as falling interest rates pushed prices up.

More surprisingly, the best-performing sector in the New Zealand market over the past quarter was the typically economically sensitive consumer discretionary sector.

New Zealand investors with international assets benefited from the weaker New Zealand Dollar (NZD) against some key peers, with our local currency falling seven percent against the US Dollar and three percent against the Australian Dollar over the quarter.

Portfolio diversification reduces risk in an uncertain world. 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 6 to 24 months, although importantly recessions have not always followed these inversions.

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

Investors with a long-term focus know the economic pendulum always swings back and forth, with companies continuing to meet the needs of consumers across all economic cycles.

While any significant correction in financial markets will present good buying opportunities for those with a medium to long-term outlook, investors with shorter-term investment objectives may adopt a more cautious stance in the current environment.

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
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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