We started the month with high levels of excitement, President Biden was about to pass a record stimulus package, and vaccine rollouts give hope that we will be back to normal by the end of the year. But like all good things, too much can create issues.
The strengthening economy gave way to inflation concerns, which pushed up interest rates forcing investors to question whether interest rates will stay low for as long as expected. Rising interest rates is never a good thing for stick markets. Despite all of this, we still ended the month with global markets up 2.5%, though down from their meteoric 6% rise in the middle of the month.
[1] kōura Growth Fund based on a typical 80:20 mix, NZ Equities 20%, US Equities 35.4% Emerging Markets 8.4%, Rest of World Equities 16.2%, Fixed Income 20%
During the first half of the month, markets seemed almost entirely focused on President Biden’s $1.9 Trillion stimulus package and the accelerated vaccine rollout pace. Investors became confident we would be back to normal by the end of the year, with consumers expected to spend up large their stimulus cheques to boost company revenues. The idea of stellar economic growth to drive company earnings combined with rock bottom interest rates drove the markets to record highs. At one point, global markets were up over 6.3% in February, taking the 12-month gains to 30%, a truly remarkable phenomenon given what we have been through over the past 12 months.
Unfortunately, the reality hit during the second half of the month with the realisation that strong economic growth and another record stimulus would drive inflation and cause the central banks worldwide to reverse their resolve around keeping interest rates low for a very long time. Ten year US Government bonds (the primary interest rate benchmark) are now back to where they were pre-pandemic after falling to a record low of 0.57% in July 2020. During February, US long term interest rates rose from 1.09% to 1.46%, a 35% jump. In New Zealand, the movement was even sharper, with rates rising 68%, moving from 1.13% to 1.89%. The speed of the reversal has truly shocked investors. This sharp movement in the bond market caused equity markets to fall by 2.5% last week.
Rising interest rates are typically seen as negative for stock markets. Interest rates are a core part of what investors use to value companies; typically, a higher interest rate results in a lower valuation.
- Higher growth companies (such as tech companies and Tesla) are more susceptible to higher interest rates as their profits are not expected to peak for a long time into the future. Therefore a higher interest rate results in these profits being more heavily discounted with higher interest rates.
- Smaller and lower growth companies are typically less susceptible to the moments in interest rates as investors value their earnings now, rather than expecting them to deliver significant profits in the future.
As you can see from the charts below, the Growth stocks performed exceptionally well at the start of the pandemic due to falling interest rates and their tech orientation. However, they have materially underperformed Value stocks since we started to see certainty on the economy from Q3 2020, and interest rates started to rise.
Driving the interest rate and improving the US' economic situation were several positive economic data indicators that came out, which show unemployment levels trending lower. This good economic news saw industries most exposed to the economic cycle perform very strongly during the month. While the overall S&P500 was up 2.8%, energy, financials and industrials all performed significantly better.
In Europe, markets rose by 3.6%. Like the rest of the world, nervousness about inflation saw the markets take a hit in the last week of the month as European bond markets also experienced a push upwards in yield. The European Central Bank insists it will speed up its bond-buying program if the cost of borrowing rises as it is committed to enabling favourable investing conditions.
In the UK, the lockdown shows signs of containing the outbreak; however, the lack of activity saw the FTSE deliver only 1.2%. Exports have suffered from Brexit as new trading arrangements have now come into effect.
In Japan, the economy is roaring along with real GDP growing 12.7% in Q4 2020 and an expectation that the economy will have fully recovered from the Covid impacts by the end of the year. The Nikkei was up by 4.7% and during the month crossed the 30,000 level for the first time in over 30 years. Japanese companies are expected to be significant beneficiaries of low-interest rates and significant stimulus packages around the world. The traditional Japanese manufacturing and export sector is doing well as consumers spend up (have you tried to buy a car recently, they are all sold out!). Hopefully, this continues in Japan; unemployment is low and domestic demand has risen. Japan may finally be able to shake its way out of its long term deflationary environment.
Bucking recent trends, Emerging Markets were the poorest performers in the month, growing by only 1%. This was driven by the Chinese market, falling 2.1%, mostly because of a tech and consumer stock sell-off. The Chinese Central bank has increased its constraints on lending to the property sector to cool developers from driving prices higher. Property investment increased by 7% in 2020, which has led to the government worrying about the risk of a “bubble” from people buying houses as speculative assets. There is also concern about the spill-over effects from foreign markets into China as large overseas inflows continue through Hong Kong. While capital market investment is encouraged, the volatility it potentially contributes is feared as it could lead to the tightening of monetary policy.
The New Zealand markets had a turbulent month, with the NZX50 down 6.9% in February, the worst month since March 2020. The decline was across the board. The previously safe haven Gentailers (Meridien, Contact and Mercury) all saw double-digit declines driven by increased interest rates and reduced demand. The buying from clean energy ETF’s seems to have abated. A2 Milk and Fisher Paykel Healthcare also had low months, both down c.16% each. Fisher & Paykel is a victim of the sell-off of high growth stocks, whereas A2 milk reported another set of poor results disappointing investors.
New Zealand has an enviable economic position, having come through COVID-19 with less government debt and a lower unemployment rate than initially expected; this strength resulted in the New Zealand Dollar rising to a high of 0.74 USD and New Zealand joining the coveted AAA rating club.
Newton’s third law states, “for every action; there is an equal and opposite reaction”,, which we simplify as what goes up, must come down. Have things got too good? All of the money that has flowed into global economies from fiscal and monetary stimulus meant growth would surge, driving inflation and interest rates up. We won’t know the answer to that for many months to come.
