PWA September Market Commentary
NZ economy slowing
We have had an incredibly positive decade of growth in New Zealand, on the back of strong demand from offshore for local assets, and globally falling interest rates. This has led to strong business growth/confidence and a reducing unemployment rate, as well as an ever more expensive New Zealand share market. Data released in the last week of August showed that business confidence in New Zealand has dropped from a high of over 60% positive in 2014 to 40% negative today. The last time business confidence was at such low levels was back in 2008-2009, during the Global Financial Crisis (GFC).
This negative view on growth is also apparent in the slowing NZ Gross Domestic Product (GDP) which has slowed from a growth rate of just under 5% per annum in late-2014 to just over 2% today. The Reserve Bank of New Zealand (RBNZ) is forecasting growth accelerating into the end of 2018, but there is more data coming in to support a further slowing in growth and local markets are now pricing in a 50% chance of the Official Cash Rate (OCR) being cut by the RBNZ in mid-2019.
Interest rates are moving higher – or are they?
NZ and Australian interest rates continue to defy the rest of the global markets and remain stubbornly low. Over the 12 months ending July 2018 the US 10-year bond rate has risen almost 35% versus the NZ 10-year bond rate which has fallen 5.22%.
This has led to the rare occurrence of the US 10-year bond rate offering a higher yield than the NZ 10-year bond rate. This is not sustainable, and we feel local debt costs will move higher into 2019.
Are all share markets expensive?
In February global markets fell c.10% and investors held their breath. Was this the start of the great share market correction we have all been expecting? What happened instead was US corporations received a great level of support from President Trump (tax cuts) and the previous Quantitative Easing (QE) which led to record high earnings growth in the US.
Given the fall in share prices, and the large increase in earnings, the Price to Earnings (PE) ratio in the US dropped from over 18X to 16.6X today. This means that whilst US share markets are still expensive, when compared to the long run average P/E ratio, they are no longer at record high P/E’s. When we compare the US share markets to both emerging markets and developed markets (ex-US) US markets are trading at a higher P/E suggesting either they are overvalued or the rest of the share markets are looking cheap.
After the share market correction in February share markets around the globe continued to slow whilst the US recovered, with the S&P500 moving to new record levels. This is turn has led to the S&P500 rally becoming the longest bull market rally in history in mid-August. The previous record bull market ended in March 2000 at a time that is now commonly referred to as the “tech wreck”.
Since the low of the GFC in March 2009 to January 2018 the market capital value of the global share markets has risen from US$25.5 trillion to $87.3 trillion. That is an increase of nearly US$62 trillion over the past nine years. In August Apple also became the first company in the world to have a market capital value of over US$1 trillion. Below is a chart that shows the MSCI All Country World Index (MSCI ACWI), which is a representation of all countries’ share market movements. There has been a strong global rally since the GFC in 2008 mainly led by the US share markets. The red line (death cross) is a representation of the percentage of share markets that have a 50-day moving average that is trading below their 200-day moving average. This shows that at present 64% of the countries in the MSCI ACWI have markets that are falling, with 48% of developed markets, and 71% of emerging markets.
Emerging Markets are in trouble
As interest rates in the US have risen we have seen a consolidated sell off across most emerging market currencies as funds have flowed from emerging debt back to safer US debt.
Emerging market investments have been under a lot of pressure with the reduction in the value of their currencies, as well as the devaluation of their debt and share markets. We have seen the MSCI emerging share index return -28%, and the JP Morgan emerging bond index -6% since January 2018.
This sort of sell off has previously been a proverbial canary in the coal mine, with contagion leading to a wider developed market sell off. Will this eventuate this time? At this stage it looks unlikely with the European Central Bank and Bank of Japan still printing unprecedented levels of Quantitative Easing and with trade across the emerging markets being supported by a strong German economy, but it has certainly been a hard year for those invested in the emerging market assets.
The volatility that we have seen in emerging markets is potentially a precursor to a more meaningful correction in the wider markets. Indeed this may already be underway, excluding the US. As inflation continues to rise, potentially above most market commentators views, interest rates will continue to rise in the US. This means that emerging economies will have further upward pressure on their interest rates, and downward pressure on their bond and share values.
One uncertainty around this view is the unknown impact of the central banks. The ECB and BoJ are able to keep printing funds to underwrite lower interest rates, and the US Fed can also slow or stop their Quantitative Tightening.