Pay attention – we are in the middle of a historically significant event
There is an old proverb, “May you live in interesting times”. This is falsely attributed to an English translation of a Chinese curse. The closest Chinese comparison to this saying is, “Better to be a dog in times of tranquillity, than a human in times of chaos“. Either way, there is no arguing that we do indeed live in interesting times.
Since the start of the year, the world has changed in meaningful ways. We will focus below on the market related changes. Firstly, global share markets dropped 30% in March from their previous highs, wiping off US$30 trillion (30%) in value. Markets have since recovered to be only c.9% down from the previous high, as at the end of August 2020.
World vs. US share markets
Source: The Daily Shot
In the US, we have seen share markets recover all their losses, now trading back at their historically record high valuations. Indeed, the US
sharemarkets have now priced in the very unlikely “V-shaped” economic recovery, suggesting that the US is already out of the recent recession. Other asset class pricing suggests a continued recession in the US and vary from a 38% chance (US High Yield) to a 100% chance (5-year US government bonds).
Market pricing change of US recession
Source: Sun Trust Private Wealth Management
The world is awash with money
Central Banks around the world have produced unprecedented levels of stimulus through Quantitative Easing (QE) to support the global economy through the damage caused by the ongoing Covid-19 pandemic. Central banks are purchasing bonds at record levels, providing much needed liquidity to the global debt markets. This was absolutely necessary in March to sustain any semblance of liquidity in the global debt market, which in a debt heavy world is essential to our survival.
The Reserve Bank of New Zealand has even started our very own printing press, with $100 billion being printed over the next year to support our markets. To put some perspective around the level of cash being pumped into the system globally, we have highlighted the “massive” level of NZ stimulus in the table below.
Global Central Bank Balance sheets
Source: Deutsche Bank Research, The Daily Shot
When we consider the sum of QE the RBNZ is printing as a percentage of GDP however, we see a very different picture with the RBNZ leading the way. This “sugar rush” is providing New Zealand’s economy with much needed breathing room to try and support struggling local businesses through a slowing economy. The only question now is what will the world look like when this support finally stops?
Central Banks Covid-19 related support as percentage of GDP
Source: Westpac NZ
Global Gross Domestic Product (GDP) growth
Most economies are forecast to produce a negative GDP result for the year of 2020, with the obvious exception being China who has recovered very quickly from the impact of their Covid-19 lockdown.
Economists continue to forecast a recovery in global GDP growth in 2021, with GDP moving back to positive quarterly growth by the middle of next year. New Zealand’s ability to close our borders and better control the virus, as well as the speedy recovery of our major trading partner China (29% of total NZ exports in 2019), suggests we may have a lower GDP contraction than most other countries this year, before one of the larger recoveries in GDP growth in 2021.
Global GDP forecasts
Source: Westpac NZ
New Zealand’s second biggest trading partner, Australia (13.5% of total NZ exports in 2019), is seeing a similar drop and recovery in their GDP. However, recent secondary waves of Covid-19 infections in Australia (mainly Victoria) has led to a lowering in the speed of their recovery.
New Zealand’s economic recovery appears to be sustainable at present with consumer demand returning to close to normal levels across several different sectors, including the arts and recreation sector as Kiwi’s spend their global travel dollars at home this year. This positive data has led local Westpac economist, Dominick Stevens, to upgrade the bank’s forecast for the New Zealand recovery, which is a much-needed ray of hope in these challenging times. Let’s hope that we don’t see any more short-term lockdowns in NZ, as each time this occurs the chance of a longer contraction in NZ’s economy increases.
NZ electronic card spending
Source: Westpac NZ
Property bubble continues to grow
As Central Banks continue to run their printing presses at record speeds (QE), the newly minted cash is being used to push down interest rates. On the back of falling bond yields, New Zealand’s term deposit and mortgage rates have also moved lower. Mortgage rates are down c.24% since the start of 2020 and forecast to move lower into 2021.
NZ Residential Mortgage Rates
Source: RBNZ, ANZ Research
This reduction in mortgage interest rates has made borrowing more affordable, with the average debt servicing costs being c.44% of the average net disposable incomes and forecast to drop to 35% in 2021. The average house price to income ratio in NZ has risen from 6.2 times at the start of 2019 to 6.7 times today.
NZ National House Prices
Source: Westpac NZ
NZ National Debt Serviceability
Source: ANZ Research, Statistics NZ, REINZ
As shown above, Westpac has upgraded their NZ property forecast to show a much smaller drop in house prices in 2021 (-1% now vs. -7%) as well as a fast recovery in annual growth in 2022.
It is incredible to think that borrowers are still so comfortable to leverage up their balance sheets to buy a record low yielding property in a country where we had:
61,063 borrowers with $20.9 billion in loans who took up the first mortgage deferral in March (now 25% less),
A record high level of economic uncertainty, and
A record high level of government support, which is required to prop up the economy.
If the funding costs remain at these record low levels for the next 5-years however, the majority may just manage to stay solvent and keep their homes. When will the Kiwis’ fanatical love of the unproductive investment in residential property finally stop? Likely rather quickly when borrowing costs finally start to rise again, but we don’t see this happening within the next two years.
Where to from here?
We have now hopefully seen the worst of the global GDP contraction this year. Economies are still reeling from this shock, but the economic data coming out of most economies shows a rapid improvement from the second quarter GDP lows. To assist in this recovery, we have witnessed a level of government and central bank stimulus not seen since the end of World War 2.
At the end of August, central bankers from around the world met virtually and the US Federal Reserve Bank (the Fed) announced it will be changing the way it runs its monetary policy with a change to “average inflation targeting”. So what, I hear you say. Why should we be caring about this wording?
This is the clearest indication yet that the Fed is positioning itself to allow inflation to run higher for longer than they previously would have. Does this mean we will be seeing inflation move higher in the next 12-months? Most likely not, but this move will allow the Fed to keep its foot on the economic stimulus gas pedal longer than they previously could.
On the back of this news we saw yield curves around the world reprice for a higher risk of inflation with government longer term funding costs rising. It is a very fine balancing act that the central banks will have to run between pushing QE into the markets to keep interest rates lower, while also stimulating inflation which in turn would normally push interest rates higher.
UK Yield Curve
Source: The Daily Shot
US Yield Curve
Source: Bloomberg, ANZ Research
Share markets could well double from here. This is not a typo. When interest rates are 0% or negative around the world, investors have subscribed to the “TINA” theory (There Is No Alternative) and are investing into anything that has a high yield. Shares are therefore attractive if interest rates stay low.
This is obviously not PWA’s primary view, but it is absolutely a possibility. Now more than ever we feel investors should be investing with an eye on the downside risks.
Interest rates should stay low for the next two-years on the back of central bank controls but if the risk of inflation rises, we could see interest rates unexpectedly move higher as shown above.
The global economy is also currently fuelled by unprecedented levels of support from governments and central banks. To date, this has allowed for a speedy recovery from the negative impacts of Covid-19. This support will end, likely in 2021. We will then start to see what real damage has been done to economies by shutting them down for months at a time.
In conclusion, we do live in uncertain times, but at present, the economic indicators are improving, and some data is coming in ahead of economists’ expectations, leading to them having to upgrade their forecasts. This is great news and we truly hope this continues, but we will continue to manage our clients’ portfolios cautiously until we have a clearer view on how markets and economies will manage post government stimulus.