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Regular readers of our monthly market commentary will know that we hold a relatively positive outlook for shares, whilst noting that short-term price corrections are likely. While share markets face many challenges with the potential for some of these to become more enduring, we invest for the long-term, choosing to look past market fluctuations. The ups and downs are part of investing.
Share markets performed strongly over December, with investors using November’s dip as a buying opportunity. While the domestic market rose over the month, it continues to underperform overseas markets as interest rates rise with the Reserve Bank of NZ (RBNZ) continuing its fight against inflation.
Share markets rebounded strongly following November’s short-term sell-off, rewarding those investors that remained focused on the hill (long-term investing), rather than the yoyo (short-term market noise). Financial news headlines over the month included:
1. A spike in market volatility following the discovery of the Omicron Covid-19 variant. This placed selling-pressure on shares, especially Covid-impacted sectors; and
2. Central bankers turning into the Grinch with interest rate hikes and reduced stimulus.
In December global share markets rebounded from an Omicron dip and took tightening actions of central banks, including reduced stimulus in the US and interest rate hikes by the Bank of England, in their stride. Global shares (as represented by the MSCI World Index) gained 4%. US shares recorded a gain of 4.5%, European shares were up 5.6%, while the UK market rose 4.6%. This capped off a banner year for global shares, up 24.7%. US shares led the way over the year, fuelled by low interest rates and economies reopening; the S&P 500 Index rallied 28.7%, recording 70 new highs along the way.
All sectors posted gains in 2021, led by energy, up a dramatic 54.6% in the US, a stunning turnaround after its 34% loss in 2020. The sector’s significant price volatility did little for investors over the past two-years, with the energy sector recording a relatively flat return over this time period. While energy rallied strongly over 2021, its relatively low weight in the Index means its contribution to the total S&P 500 Index return was relatively small. Market heavy weight, information technology on the other hand, gained 34.5% over the year and was the largest contributor to the return of the S&P 500 Index.
Source: S&P Dow Jones Indices
NZ shares gained 2.5% over December but failed to produce the same level of returns as global peers for the year as sentiment soured for domestic investments; the S&P/NZX 50 Index fell 0.4% over the 2021 calendar year. Emerging markets (as measured by the MSCI Emerging Markets Index) gained 1.5% in December, pulling the index slightly into positive territory for the year. This is an impressive feat given that heavyweight China plummeted 22%, impacted by new government regulations and property developer issues; the two next largest markets, Taiwan and India, rallied 23.7% and 30.1% respectively.
Record levels of inflation, the removal of monetary stimulus and eventual rate hikes saw interest rates rise over the year. Domestic short-term government bond yields lifted from 0.26% at the end of 2020, to sit just under 2.0% 12-months later, while the equivalent US yield moved from 0.12% to 0.73%. The NZ dollar peaked at a shade below US$0.75c early in the year, but trended lower from there, accelerating its decline on the back of a relatively hawkish RBNZ to sit at US$0.68 at the end of the year.
December saw the domestic share market underperform its global peers, the S&P/NZX 50 Index gained 2.5%, while global shares returned 4%. This occurrence, however, is not isolated to the past month, it has actually been a persistent theme over 2021. The return difference between the local and overseas markets over the year is eye watering. The S&P/NZX 50 Index slipped 0.4% over the calendar year, while overseas markets rallied strongly.
The S&P 500 Index in the US returned 28.7%, European stocks recorded their second-best year since 2009 with a gain of 22.5% and Australian shares jumped 17.2%. The negative return for the local market breaks a nine-year streak of positive calendar year returns.
So why has the local share market suddenly hit the wall in 2021?
1. A strong run leading up to the pandemic;
2. A relatively high weight to defensive securities; and
3. Expectations of rising interest rates.
At the end of 2020, the S&P/NZX 50 Index had produced an annual return of 17% for domestic investors, far superior to overseas markets. This is partly due to NZ’s high allocation to defensive stocks, such as utilities and property, as their bond-like qualities are sought after in a low interest rate environment. The steady stream of dividend payments acts as a bond proxy for investors wanting regular income.
The appeal of NZ’s defensive stocks, however, quickly changed in 2021 due to the expectations of rising interest rates to fight high levels of inflation. Utilities, like Contact Energy and Meridian Energy, represent just under 20% of the local market, and listed property another 9%. These are the bond proxy type of stocks that come under selling pressure when interest rates rise. By way of contrast, the percent allocation to these sectors in the domestic market is five times larger than the global market.
The latest significant Covid-19 variant, Omicron, caused a temporary panicked sell down in share markets around the world. Investors became concerned that current vaccines may be less effective against the new variant, meaning the potential for border closures and tighter restrictions were back on the cards.
Indeed, this has started to play out in European countries while the Chinese government has placed extensive restrictions in specific regions. China’s ‘Covid-zero’ policy is causing investors some unease as an escalation in restrictions could see factory shutdowns further increase supply constraints. An end to China’s ‘Covid-zero’ strategy is unlikely in the short-term as the country prepares to host the Winter Olympics next month.
Pandemic-impacted sectors temporarily sold-off with Omicron’s discovery, with WTI crude oil tumbling 16% and pulling energy stocks lower. Energy is a volatile sector, as listed companies can experience rapid price swings. AMP’s sustainable investment philosophy prohibits investment in fossil fuel related securities, meaning that AMP-branded funds avoid the volatility of the stocks in the energy sector. The AMP branded funds instead focus on the long-term low carbon economy and those businesses that will benefit from the changing structural environment. This sees AMP branded funds overweight sectors such as technology.
Around 50% of the global population are now fully vaccinated against Covid-19, with NZ sitting at the higher end of the spectrum. In terms of impacts on market volatility, the less wealthy countries with much lower vaccination rates are a cause for concern. The World Health Organization has warned that the unequal distribution of vaccines around the world has contributed to the emergence of new Covid-19 variants, with new variants likely to develop in these lower vaccinated countries. Any significant new variant is likely to cause investors concern, resulting in heightened market fluctuations and significant share price volatility, especially for the pandemic-impacted sectors.
Our view remains relatively unchanged, share markets will trend higher but continue to experience short-term bouts of volatility and selling pressure. These pullbacks are to be expected and are part of investing. Omicron (and other variants which may follow) will cause headlines for some time and may result in increased sell downs until the full extent of its impact is known.
Omicron and China’s ‘Covid-zero’ strategy has increased the risk to both growth and global supply constraints. However, we remain focused on the hill (long-term). Omicron may disrupt growth, but it will only delay the global restart. In our view, less growth now means more growth later.
Looking through the short-term noise, even with rate hikes, interest rates are likely to remain low for the medium term. This, alongside strong company profits and a successful vaccine rollout leading to more sustained re-openings of economies, should ultimately prove supportive over the next 12-months for shares.
We expect bond yields to rise, as the market becomes more confident that the longer-term recovery in the global economy remains on track. Hence our outlook for fixed interest investments continues to remain less positive.
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