Insights

Market Commentary

During May, many asset sectors that comprise the components of the diversified funds performed well – both at the market level and in terms of excess returns provided by our active management. However, in aggregate it was only the Conservative fund which produced a positive return (0.44%) whilst both the Balanced and Growth funds fell slightly in value (-0.25% and -0.74% respectively). This is partly explained by the losses from our ‘alternative’ exposures to the Option Fund and the multi-strategy hedge fund, but mostly as a result of the losses suffered in the global equity markets. In fact, by the end of May 2019, global equity markets in aggregate posted a negative return for the 12 month period with only NZ dollar weakness enabling unhedged investors to generate a positive return from global equities, i.e. despite the underlying equities losing value, the value of the unhedged foreign currency increased against the NZ dollar enabling an overall positive return).

There were many reasons for the weakness in equity markets, and some of the key items are well covered – the ongoing uncertainties created by the US/China stand-off on trade, political tensions in the middle east, and uncertain growth in the Eurozone. As noted in last month’s commentary the local equity market remains remarkably strong rising another 1% in May and taking the 12 month return to 18%. This has certainly led to a number of companies here being bid up in price, but at the same time the behaviour observed is also quite rational with foreign capital searching for quality businesses that will generate strong cashflows and profit well above the yields offered by many other countries and sectors. It’s worth being mindful though of the time when some of that capital will be repatriated and the NZ market may lose some of the demand which has been creating these tailwinds for performance.

As is often the case, when equity markets suffer a loss of confidence from investors, the ‘safe-haven’ assets see a surge in demand and therefore increased prices. It was certainly true that sovereign bonds saw a strong price increase during the month as investors bid down yields, and so we observed bond markets providing returns to investors of well in excess of 1% for the month. It is this combination of the much higher than expected return from bond markets and the fall in global equities which led to the result of the more defensively positioned portfolios outperforming the more risk seeking portfolios for the month and indeed over the past 12 month period. This dynamic is to be expected from time-to-time, and those investors who have a longer term timeframe should still expect the more equity biased portfolios to outperform in the longer term, but in the meantime it’s been a period of strength for the more defensively positioned investors.

Market Commentary

In the year to date, the NZ equity market has returned a quite remarkable 14% which is well ahead of any rational expectation. Having said that, we also shouldn’t be surprised that in a world hungry for yield, then good quality companies which can offer earnings growth above 5% p.a. and sustainable dividends at similar levels are going to be sought after. In particular, the so-called ‘bond proxy’ companies (e.g utilities) are attractive holdings for those who are prepared to accept additional capital risk for the desire/expectation of cash yields which are well ahead of traditional bank deposits and bonds. Last month we observed that there was talk of the global economy has passed the peak of this rates cycle, and this perspective may have gained weight with the New Zealand central bank having just cut interest rates.

But with economic data still reasonably robust it’s a slightly surprising approach, and our Governor was left explaining the move in terms of ‘getting ahead of the curve’, which seems to be a mild acknowledgement that current data maybe didn’t demand such a cut. Global equities performed particularly strongly during April, and with the weakening NZ dollar, those investors who were unhedged saw the value of their overseas equities increase by well over 5% during the month (hedged investors still enjoyed a 3% return). All the major markets contributed to these strong returns, but Germany led the charge (7%) whilst at the other end the UK was more modest, but still very strong, at 2% (noting that on average we’d expect around 0.5-0.75% over a month from our equity holdings). The developed markets continued to outperform their emerging market counterparts for the month, quarter and year.

Fund Commentary

April provided another strong set of returns for investors in the Nikko AM diversified funds. As has been the case since the start of the year, it has been equity markets that have driven these outcomes, but a slight change in April is that the bond markets were much weaker than they had been earlier in the year. Our exposures to alternative sources of return (the Nikko AM option fund and the fund of hedge funds strategy) performed well at around 2%, and so despite the weaker bond markets, the diversified funds again provided monthly returns significantly ahead of the long-term expectations. Within the diversified funds, we remain close to our benchmark weights which has the explicit effect of locking in some of the gains from the strong equity markets and we maintain the desired allocations across sectors and geography.

Emerging markets (EM) slid from February through the year-end on the back of a stronger dollar, an escalating trade war and notably weaker growth in China. However, we see evidence that these previous headwinds may now be turning into tailwinds.

The Japanese equity market fell in December, with the TOPIX (w/dividends) dropping 10.21% on-month and the Nikkei 225 (w/dividends) declining 10.28%.

It is a design fault amongst perhaps the majority of economists that, when things don’t quite go according to their forecasts, they will either ‘blame the data’ and stick to their previous view for too long, or attempt to finesse a ‘U-turn’ in such a way that it does not look like one so as not to undermine their short-term credibility….

Global growth is expected to grind lower in 2019, with continued monetary policy normalization in developed markets being the key headwind for the world economy. Financial conditions will tighten further as the Fed continues its gradual increase in interest rates.

In December, US Treasury (UST) yields fell as risk assets came under pressure from various factors, triggering ‘safe-haven’ buying.

The return of negative bond/equity correlations was a rare silver lining for multi-asset investors in 2018.

The MSCI AC Asia ex Japan (AxJ) Index fell by 2.6% in USD terms in December, as concerns about slowing global growth, tightening monetary policy and rising geopolitical tensions continued to drive sentiment.

The S&P/ASX 200 Accumulation Index returned -0.1% during December.

The Australian bond market (as measured by the Bloomberg AusBond Composite 0+ Yr Index) was up 1.50% over the month, outperforming Australian equities which fell 0.12%.

At present, our working hypothesis for 2019 is that, following a potentially quite bright start to the year as the US approaches its ‘peak fiscal stimulus’ and the Administration runs down some of its savings deposit holdings at the Federal Reserve (for reasons connected with the Debt Ceiling), global liquidity conditions and in particular dollar liquidity conditions are likely to tighten quite significantly – and possibly severely – during the second quarter.

The word “volatility” crops up a lot when commentators try to explain price movements in financial markets. More often the word is used to explain a sudden drop in prices, whereas if prices rise investors compliment themselves on their astute insights rather than the vagaries of the markets. Psychologically, losses are felt more intensely than the pleasure of a gain.

While New Zealand markets have had a rather interesting and more volatile time, the main drivers of the economy remain sound.

The Japanese equity market rose in November, with the TOPIX (w/dividends) climbing 1.30% on-month and the Nikkei 225 (w/dividends) rising 1.98%. Equities rose in the early part of the month on strong US economic indicators and easing political uncertainty after the US midterm election results largely matched expectations.

As we wrap up the final weeks of 2018 and look ahead to whatever challenges lay ahead next year, we can’t help but reflect on what has been a testing and frustrating year for investors.

US Treasuries (USTs) registered gains in November, while yields fell along with faltering US equities.

While it is true that the Fed will be criticized no matter what it does tomorrow, it could limit criticism to mild levels if it hikes only 10 bps.

John Vail, Chief Global Strategist for Nikko Asset Management, contributes a regular column to Forbes.com

Today’s release of the 3Q CY18 data on aggregate Japanese corporate profits showed interesting trends regarding our long-term theme about improving corporate governance.

John Vail, Chief Global Strategist for Nikko Asset Management, contributes a regular column to Forbes.com

The macroeconomic backdrop for Asian countries should remain broadly neutral for credit performance in 2019. GDP growth is expected to moderate across the key economies, although we don’t expect any hard landing scenarios to materialize.

One thing is for sure, 2019 will not be a dull year. We expect more headlines and drama on trade but would pay more attention to underlying policy direction at both the Federal Reserve and Chinese authorities, as bigger markers for improved fortunes across Asian markets.

Shakespeare once said, “present fears are less than horrible imaginings.” As we come to the close of 2018, we have observed equity markets turn double-digit returns to losses, an aggressive rise in interest rates and a modest increase on the perception of escalating tensions surrounding the world’s two largest economies.

In addition, we have to consider the eventuality of a prolonged trade war. But China would be able to mitigate its impact initially via a combination of monetary and fiscal stimulus, helping offset the impact of tariffs to a certain extent.

Credit markets didn’t perform in line with the expectations we set at the beginning of the year and disappointed most investors.

The potential hangover from the monetary binge of QE continues to weigh on global equity markets as we head towards 2019. The turning of the calendar will do little to change this.

Once again, the Federal Reserve (Fed) policy has proven itself to be the key determinant of global liquidity, and 2018 was clearly tight.

As we reflect on 2018, we would all agree that Trump and his trade policies dominated the conversations and dictated some of the major moves in the financial markets around the world.

We believe 2019 will be an important year for active selection or alpha and our focus will be on delivering on stock selection returns by picking quality companies who are resilient in growth amid a rising risk environment.

So many developments have occurred since we last met in September, but the major ones were the surprising collapse in oil prices mostly due to geopolitical factors, the U.S.-China trade and BREXIT conflicts becoming increasingly intractable, and that aspects of the global economy showed occasional signs of moderation.

Global growth remains desynchronized, with China, the Eurozone and Japan continuing to show further signs of moderation, while the US remains relatively robust.

The MSCI AC Asia ex Japan (AxJ) Index gained 5.3% in USD terms in November, despite persistent concerns over global growth and a slide in technology stocks.

The S&P/ASX 200 Accumulation Index returned -2.2% during November.

The Australian bond market (as measured by the Bloomberg AusBond Composite 0+ Yr Index) was up 0.24% over the month, outperforming Australian equities which fell over 2%.

Global growth remains desynchronized, with China, the Eurozone and Japan showing a further moderation in growth, while the US remains robust.

The late 1990s and mid 2000s were periods that appeared characterised by above trend growth in much of the OECD and ‘unexpectedly’ low rates of inflation, a combination that was blithely described as the ‘Goldilocks Economy’.

Earth’s largest single geographic region, Asia represents approximately 60% of the planet’s population and is one of its fastest growing economic areas. The region had more billionaires in 2017 than anywhere else and it will represent 57% of middle-class consumption by 2030.

Over the past year Australian house prices have seen 12 consecutive months of decline, the longest streak of persistent falls in over 20 years.

Volatility is back in a big way in 2018. A large increase in the VIX is showing an annual level not witnessed since 2007. The sell-off that started in October appears to have been triggered by a number of negative technical forces in the USA coming into effect at the same time, which impacted global markets.

One of the pleasures of getting older is that you start to have proper grown-up conversations with your children.

The US economy is enjoying its second-longest growth cycle in history and is on the way to becoming the longest on record.

How do you react when you see blood; do you swoon or just observe with intrigue? Perhaps conditioned by a recent overdose in crime related dramas (favourites include: ‘Killing Eve’, ‘Peaky Blinders’ & ‘Better Call Saul’), it was the latter outcome for me after a recent DIY debacle with a saw.

The MSCI AC Asia ex Japan (AxJ) Index fell by 10.85% in USD terms, on the back of concerns about rising interest rates, slower economic growth, and persistent US-China trade tensions. Large technology stocks were particularly hard hit.

US Treasury (UST) yields spiked at the start of October as the market responded to stronger US data and Federal Reserve (Fed) Chairman Jerome Powell's hawkish comments.

The Japanese equity market dropped in October, with the TOPIX (w/dividends) falling 9.41% and the Nikkei 225 (w/dividends) declining 9.04% on-month.

Global equities corrected downwards by 7.5% in USD terms in October. Stocks in the US ended the month down 6.5% after an intra-month peak-to-trough drawdown exceeding -10%.

On the back of unrelenting USD strength, 2018 has been a tumultuous period for Asian currencies. Countries in the region with current account deficits have been facing more currency pressure, prompting their central banks to engage in series of rate hikes to defend their currencies.

Clearly, the U.S. Administration has tried to protect the steel and other industries considered important for defense and economic security. The intent is to have them invest in new capacity due to the recently higher product prices.

John Vail, Chief Global Strategist for Nikko Asset Management, contributes a regular column to Forbes.com

The S&P/ASX 200 Accumulation Index returned -6.1% during the month.

The Australian bond market (as measured by the Bloomberg AusBond Composite 0+ Yr Index) was up 0.48% over the month, outperforming Australian equities which tumbled over 6%.

As the world experiences more extreme weather patterns and climate-related incidents, pressure is mounting to curb greenhouse gas emissions.