US President Donald Trump. Photo / AP
COMMENT:
The six months ended May 31 was a particularly volatile period on global sharemarkets, as demonstrated by the figures in the accompanying table.
The good news is that Australasian markets performed particularly well during this period, but the bad news is that this stellar performance will be difficult to maintain in the long run.
The first point to note is that major markets suffered huge losses in December and May but the NZX and ASX avoided most of the carnage.
Consequently, the New Zealand and Australian markets both appreciated by 12.9 per cent, in capital terms, in the six months ended May 31, while the NZX50 Gross Index expanded by 14.7 per cent.
Gross indices perform better than capital indices because the former include dividends while the latter exclude them. This column uses the NZX capital index because most of the world's major sharemarket indices are capital-only indices.
The Tokyo market, which declined by 7.8 per cent in the six-month period, was the world's worst performing major market while the Shanghai market appreciated by 12.0 per cent, slightly less than the NZX and ASX.
The two major factors impacting global markets in recent months have been interest rates and trade disputes.
The big issues at the end of 2018 were the strength of the US economy and the prospect of further interest rate rises. On November 8 the US Federal Reserve Board's Open Market Committee noted that "the labour market has continued to strengthen, and that economic activity has been rising at a strong rate. Job gains have been strong, on average, in recent months, and the unemployment rate has declined".
The committee went on to note that "further gradual increases in the target range for the federal funds rate will be consistent with sustained expansion of economic activity, strong labour market conditions, and inflation near the committee's symmetric 2 per cent objective over the medium term".
The clear impression from this release, and other Fed announcements at the time, was that interest rates would continue to rise, and this was spooking sharemarket investors.
Interest rates had already risen by the fourth quarter of 2018, with US government 10-year rates at 3.1 per cent at the end of October 2018, compared with just 2.4 per cent 10 months earlier.
But in early January Fed chairman Jerome Powell responded to market concerns, and possible pressure from President Trump, with the following comment: "As always, there is no pre-set path for policy, and particularly with muted inflation readings that we've seen coming in, we will be patient as we watch to see how the economy evolves."
Investors immediately concluded that Powell's use of the word "patient" meant there would be no further US interest rate increases. Consequently, global sharemarkets took off faster than Usain Bolt in an Olympic 100m final.
January was an extremely positive month and global markets have continued to benefit from the following interest rate declines:
• United States 10-year government interest rates have fallen from 3.1 per cent at the end of October to 2.1 per cent at the end of May
• United Kingdom 10-year gilts have gone from 1.3 per cent to 0.9 per cent over the same period
• German 10-year bund interest rates have gone from a positive 0.4 per cent to a negative 0.2 per cent
• The yield on Australian government 10-year bonds has declined from 2.6 per cent to 1.5 per cent
• Ten-year New Zealand government bond yields have fallen from 2.6 per cent to 1.8 per cent over the same six-month period.
The NZX received a huge boost from the decline in global interest rates because our sharemarket is a high-dividend-yield market, which is particularly attractive to overseas investors when global interest rates are low and declining.
Our relative attractiveness is reflected in the 17.0 per cent rise in the NZX10 Index in the six months ended May 31. This index contains the top 10 companies that most overseas funds invest in.
Meanwhile, the more widely spread NZX50 Index appreciated by 12.9 per cent over the same period, the NZX Mid-Cap Index by 7.8 per cent, while the NZX Small-Cap Index declined by 2.4 per cent in the six months to May 31.
Companies in the latter two indices receive relatively little buying interest from offshore investors.
It is also worth noting that the seven NZ companies included in the MSCI Index — a2 Milk, Meridian Energy, Auckland International Airport, Spark, Fisher & Paykel Healthcare, Fletcher Building and Ryman Healthcare — have also performed relatively well as they have attracted investment from global passive funds.
In recent months the focus on global markets has changed from interest rates to trade issues, particularly Trump's disputes with China, Mexico and other countries. As these disputes have escalated, global investors have shifted from companies that are trade-reliant to companies with a domestic focus, particularly property and utilities. This also benefits the NZX because our market is dominated by these sectors.
The interesting point is that investors haven't abandoned sharemarkets altogether; they have just shifted to more defensive stocks because banks, bonds and fixed interest yields are relatively unattractive following the sharp declines in interest rates.
But two events have rocked investor confidence in the past 10 days. These have been President Trump's announcement of tariffs on Mexican imports and moves to take antitrust action against several large tech companies.
The US stock market was hammered last Friday after Trump announced he would impose a 5 per cent tariff on Mexican imports on June 10, quickly rising to 25 per cent by October 1 in 5 per cent steps.
Ford and General Motors, which have manufacturing plants in Mexico, experienced sharp share price falls and shares in Constellation Brands, the company that owns the Mexican Corona and Modelo beer brands, plunged 5.8 per cent.
Kansas City Southern, which operates the main US/Mexico cross-border rail network, was off 4.5 per cent.
Markets received some relief this week when Fed chairman Powell signalled that the central bank was ready to cut interest rates and the Fed vice-chair Richard Clarida said the bank was "very attuned" to growth risks and would remain "nimble" as far as interest rates are concerned.
The use of the word "patient" in January was especially important when investors were concerned about interest rate rises, as is the use of the word "nimble" this week when rate cuts could act as a counterbalance to Trump's tariff announcements.
Trump is obsessed with immigration and trade issues, and these obsessions are likely to increase as he begins his re-election campaign in the next month or so.
His focus is extremely narrow, as demonstrated by his removal of India's special trade status last week, an agreement that removed tariffs on a small range of Indian exports to the US.
Trump seems to be obsessed with the high Indian tariffs on imported Harley-Davidson motorcycles, yet Facebook and Google are more dominant in India than they are in their home country.
Increased tariffs are negative for the world economy because importers either stop importing, which slows growth, or they continue to trade, which leads to higher prices.
Central banks can't continue to reduce interest rates if higher tariffs boost prices and inflation.
The NZX is in a sweet spot at present, and could remain in that position for some time, but when economic growth declines or interest rates increase it will lose its current attractiveness.
The lessons of history are that no sharemarket or asset class continues to be a top performer year after year and, with Trump in the White House and shortly commencing his re-election campaign, we can expect further market volatility in the months ahead.
- Brian Gaynor is a director of Milford Asset Management.
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