April Market Update

Markets driven lower by tech scandal & trade wars

In the quarter ending March 2018, we have seen further volatility and uncertainty in the markets. All developed markets have produced a negative return, while the emerging markets have managed to maintain a small positive return. The S&P500 had the worst first quarter performance since 1929 according to Bloomberg, bringing the S&P500 Price to Earnings ratio back to 16.5 times. A level not seen since early 2016.

Over the last year, ending March 18, market indices have been positive. The lowest annual performance came from the UK (0.22%) and Europe (2.17%). The best performance over the past 12 months has come from the Emerging Markets (22.44%), followed the Dow Jones Industrial Index (19.39%).currency

VIX index remains high

Volatility remains high across all global markets, with the US leading the other markets for the first time since 2008. This indicates a high level of uncertainty in investors at present. This negatively impacts share prices as investors demand a higher potential return to justify the increased risk. This uncertainty has come from multiple factors such as the US Federal Reserve continuing to increase the cash rate, and the escalation of the trade war between the US and China. We have also seen the tech sector in the US sell off on the back of the recent Facebook scandal, and President Trump’s tweets attacking Amazon.

Stock Vol

Global Trade tensions

The Chinese government hit back on Monday, 2nd April at President Donald Trump’s tariffs on steel and aluminium. They acted on the threat to put tariffs, as high as 25%, on imports of 128 US-made products, including pork and seamless steel pipes. They have also placed 15% tariffs on wine, fruits and nuts. The Chinese Ministry of Commerce indicated that the tariffs were intended to pressure the Trump administration to back down from a simmering trade war.

These tariffs are seen by most market commentators as mild, and only a warning shot to the US. The tariff on products such as pork strike at America’s rural heartland (Trump country), with China being the third biggest export market for this sector.  The tariffs the US put on steel imports did not really impact China, who consume most of the steel they produce. China are the tenth largest exporter to the US of steel products.


Trump has replied to China’s trade sanctions by stating he is considering a further US$100 billion in trade tariffs from China’s “unfair retaliation” to the original US tariffs on steel.

Chinda Trade

An all-out trade war is clearly a key uncertainty and risk for markets. As discussed by many commentators, there is no winner in a trade war, hence President Trump’s comment that “Trade wars are good, and easy to win” is unsurprisingly incorrect. The most likely outcome of a trade war is lower profits for exporters & importers, and higher inflation pressures.

Will this escalate? Who knows, particularly when you have a president like Donald in the White House, surrounding himself with anti-Chinese advisers. We agree that this appears to be a negotiation tactic on the part of the US, who are trying to bully China and other trading partners into concessions. If it does escalate further, rest assured that there will be no positive outcome for anyone, and we will see a further sell off across global share markets.

US Federal Reserve continues increasing cash rates

The Federal Reserve raised the cash rate in the US again in March to 1.75%. Commentators are now split between whether there will be two or three more rate hikes this year. Either way, rates are rising in the US and globally which is leading to negative performance from bonds, and bond funds.

We continue to forecast that longer-term rates will move only a maximum of c.1.5% higher from here. We feel that the high debt levels around the world will limit the ability of the global economies to fund higher interest rates. As shown below, the US cost of funding debt is forecast to increase from c.7% of total Federal revenue to c.20+% over the next two years. This is simply unaffordable.

US debt

The US Federal Reserve continues to unwind part of their quantitative easing (QE) from the markets, and the ECB and BOJ are both now slowing their asset purchase programs. This has been one of the main reasons interest rates have started to rise globally.

We are monitoring the inflation, and growth forecasts in an effort to understand where this cycle will end.  We continue to believe inflation pressures are rising, growth is accelerating and support for the end of QE remains solid. Historically, inflation has been range bound between 1% and 2.5% in the US. We foresee this inflation band remaining through this cycle.


Local cost of bank funding forecasted to rise

New Zealand banks borrow about a third of the funds they lend to the New Zealand public from offshore markets due to the excessively high level of borrowings in this country. This opens our local markets to offshore changes in funding costs.

As shown below, the “spread”, which is the margin lenders demand for the risk of lending the funds to Australian banks, has recently increased by c.0.40%. The US 10-year bond rate has also recently risen from its low of c.2.0% to 2.77%, which again will increase the cost of borrowings for local banks. We can expect to see this translate into higher mortgage rates for both Australian and New Zealand banks in the medium term.

Aussie bank funding

Earnings growth continues to improve

The first quarter of 2018 global company reporting season is about to begin. We are anticipating that it will be positive, with some good corporate profits. The median forecast increase is around 13% growth year on year, with some forecasters anticipating a much higher result.

S&P 500

This will likely be well received by the market, and could spell an end to the recent decline we have seen in share markets. The same story is playing out around the world, with companies continuing to benefit from the easy money policies present since 2008. The question remains, how will this growth be impacted as QE is removed from the markets and interest rates move higher in the medium term?

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