Positive global share market momentum carried into the second quarter of 2024 for the USA, although share market returns in other regions were variable.
The outlook for interest rates remained unchanged. However, there is growing expectation for a general reduction in interest rates around the globe. In June, the European Central Bank and the Bank of Canada became the first major banks to begin cutting rates. With local inflation heading in the right direction, it looks as though the Reserve Bank of New Zealand may soon follow suit.
In the key US market, the Federal Reserve held the federal funds rate steady at 5.25% throughout the quarter, with officials citing the need to cool persistently high inflation.
Against this backdrop, the US share market extended its bull run that began in late 2022, with the S&P 500 Index reaching all-time highs during the quarter. This performance was led, once again, by the strong performance of a handful of large capitalisation companies in the information technology sector. Unfortunately, the New Zealand share market continues to lag many of its global peers with weak economic growth, and stubborn inflationary pressures, continuing to challenge local policymakers.
On the global political stage, uncertainty and change seem to be in store in 2024. After a relatively brief campaign, the Conservatives have just relinquished Downing Street after 14 years in power in the UK. Emmanuel Macron’s snap election resulted in no clear winner, leaving France without a new prime minister or government and in political chaos just weeks before they will welcome the world for the Olympic Games. Meanwhile, the lead-up to the US presidential election has been even more volatile than pundits expected, including the shocking attack on former president Donald Trump in early July. The race between Biden and Trump will no doubt include many twists and turns before the nation votes in November.
Bigger isn’t necessarily better
Over recent months, share market news has been dominated by the strong returns of some of the largest companies in the world, including several of the technology giants based in the USA.
If we look at the leading US share market index – the S&P 500 – we can break it into ten different company groupings (or deciles) of 10% each, according to company size. In other words, we can group together the largest 10% of firms in the index all the way down to the smallest 10% of firms. If we calculate the past five year returns from each of these groups, we can see that the largest 10% of firms have beaten all other size segments. This seems consistent with the reported strong performance of many large technology companies.
However, concluding that the largest companies have performed the best would be incorrect. The analysis described above only tells us how the current largest companies have performed, looking backwards in time, not how the largest companies five years ago performed over the subsequent five years. If we use company size as it was five years ago as the starting point and then calculate the forward-looking returns of each size grouping, the analysis changes quite significantly.
The largest companies from five years ago have still performed well (+10.8% pa), but the top performer over the period, by a healthy margin, has been the smallest decile of companies (+16.0% pa).
This is because some of the big companies today were actually much smaller five years ago, and some of today’s smaller companies were much bigger.
It’s generally unusual for the largest companies in an index to continue to outperform all others, and history tells us the best time to buy these companies is before they become large, not after.
New Zealand interest rates – the wait goes on
The chart below shows the annualised inflation rate (dotted blue line) plotted against New Zealand’s Official Cash Rate (OCR), which is the short-term interest rate set by the RBNZ on a periodic basis (orange line).
New Zealand interest rates versus inflation:
The RBNZ aims to keep inflation within the range of 1% to 3% over the medium term (the area shaded in white). They have generally achieved this fairly consistently over the last 25 years. Up until 2021, there had been only occasional deviations of inflation outside this band, and most had returned to the target range within 12 months.
However, the cost-of-living crisis has been a different story. The significant ‘spike’ in inflation that commenced in 2021 has not returned to the target band. This is why the orange line is not budging yet. The length of time inflation has stayed above target (now three years and counting) has backed the RBNZ into a corner. They are highly reluctant to reduce interest rates until they see inflation back inside their target band. This caution has resulted in the OCR being stuck at 5.5% since May 2023.
The good news, as you can see from the chart, is that inflation is heading in the right direction. Many commentators consider that we could see interest rate reductions later this year (ahead of the RBNZ’s forecasts). Whenever they begin, they will mark the end of the most restrictive interest rate settings New Zealand has experienced in 15 years.
Does the US election matter?
We are readying ourselves for Biden vs Trump 2.0 in November, and from afar, the view doesn’t look flattering. This time around, it is an incumbent who is facing increasing questions of his competency, including from within his party, versus an often divisive and controversial challenger whose run is likely to include significant time in the courtrooms as well as on the campaign trail. It is surely an indictment of the US political system that these are two ‘best’ candidates for leadership of the most influential nation in the free world.
Does it matter who wins?
In some ways, probably not. Both the Democrats and Republicans will aim to be expansionary and will keep issuing bonds and printing money. While the Democrats might spend more, the Republicans will aim to reduce taxes more.
In some ways, almost certainly. In matters of foreign policy, we can expect a Republican presidency to renew stronger rhetoric around Europe’s contributions to NATO, possibly not supporting efforts to arm Ukraine and likely promoting greater trade protectionism, particularly with respect to China. Conversely, President Biden has indicated he will propose extending tax breaks for those on low incomes while raising corporate tax rates, and potentially further promoting renewable energy development. Clearly, the outcome in November will have a significant impact on some sensitive corners of the economy.
How investment markets might perform is much less predictable, although history says that patient investors will be rewarded regardless of which political party controls the White House.
One of the reasons why is because the president has no direct control over the share market. While the president influences fiscal policy to varying degrees, it is Congress that ultimately creates the federal budget, and government spending is only one of many variables that affect the share market. Also, when considering events like the dot-com bubble, the Great Recession, and the COVID-19 pandemic – no president caused those events, but all three events caused share market crashes.
Since the inception of the S&P 500 share market index in 1957, the respective market performance under different presidencies is highlighted below.
S&P 500 compound annual growth rate:
Given the ability for statistics to be easily manipulated, Republicans (higher median return) and Democrats (higher average return) could both try to claim the share market has performed better when they controlled the presidency.
However, investors should ignore such comments. Share prices, determined by business fundamentals like revenue and earnings growth, are merely influenced (not controlled) by a president’s fiscal policies.
While the November winner may not have much of an impact on eventual market returns, this will nevertheless be a subject of considerable global attention over the next 4-5 months.
Tune out the noise
There is a near-constant swirl of speculative opinion, both in the general news media and in the financial press, about a range of factors or events whose outcomes are, and always will be, uncertain.
Not a day goes by without a big, scary headline professing at least some level of consternation about one or more of the following:
the timing and size of future interest rate changes
the long-term impact of AI
the consequences of a changing global political landscape
whether inflation is really back under control
whether technology companies are forming the next market ‘bubble’
when the conflict in Ukraine or the Middle East might end
the ongoing impacts of climate change
Unfortunately, reading (or watching) the guesses of different pundits about an unknown future provides no useful benefit to long term investors.
Markets, in aggregate, are aware of the prevailing uncertainties and, to the greatest extent possible, that uncertainty is already factored into asset prices today. Yes, as information changes, prices will reflect that new information. But, as the exact nature of future information is usually unguessable in advance – even by so-called experts – this speculation is nothing more than an unwelcome distraction, and investors should exclude it from their strategic decision-making.
The best response a long-term investor can have to uncertain events is to tune out the persistent noise about everything that is unknown or could go wrong and focus instead on the consistent behaviours that have been proven to add value over time.
Unlike the list of potential issues, which is always concerning and always changing, the list of great investor behaviours never changes.
These are – in no particular order:
allocate strategically (not tactically),
keep costs low, stay diversified, rebalance periodically to manage risk,
don’t engage in panic buying (or selling),
and always consult your adviser if your circumstances or requirements change.
Mastery of these relatively simple steps means you will dramatically improve your chances of achieving your long-term investment goals and objectives.
[1] Data sourced from Ritholtz Wealth Management as at 18 June 2024
Article provided by Consilium.
Disclaimer: Information as of 18 July 2024. This article is general information, does not consider your financial situation or goals, and does not constitute personalised advice. Please get in touch with your financial adviser for advice specific to your situation. There are no warranties, expressed or implied, regarding the accuracy or completeness of any information included in this article.
Economic Commentary Winter 2024
Positive global share market momentum carried into the second quarter of 2024 for the USA, although share market returns in other regions were variable.
The outlook for interest rates remained unchanged. However, there is growing expectation for a general reduction in interest rates around the globe. In June, the European Central Bank and the Bank of Canada became the first major banks to begin cutting rates. With local inflation heading in the right direction, it looks as though the Reserve Bank of New Zealand may soon follow suit.
In the key US market, the Federal Reserve held the federal funds rate steady at 5.25% throughout the quarter, with officials citing the need to cool persistently high inflation.
Against this backdrop, the US share market extended its bull run that began in late 2022, with the S&P 500 Index reaching all-time highs during the quarter. This performance was led, once again, by the strong performance of a handful of large capitalisation companies in the information technology sector. Unfortunately, the New Zealand share market continues to lag many of its global peers with weak economic growth, and stubborn inflationary pressures, continuing to challenge local policymakers.
On the global political stage, uncertainty and change seem to be in store in 2024. After a relatively brief campaign, the Conservatives have just relinquished Downing Street after 14 years in power in the UK. Emmanuel Macron’s snap election resulted in no clear winner, leaving France without a new prime minister or government and in political chaos just weeks before they will welcome the world for the Olympic Games. Meanwhile, the lead-up to the US presidential election has been even more volatile than pundits expected, including the shocking attack on former president Donald Trump in early July. The race between Biden and Trump will no doubt include many twists and turns before the nation votes in November.
Bigger isn’t necessarily better
Over recent months, share market news has been dominated by the strong returns of some of the largest companies in the world, including several of the technology giants based in the USA.
If we look at the leading US share market index – the S&P 500 – we can break it into ten different company groupings (or deciles) of 10% each, according to company size. In other words, we can group together the largest 10% of firms in the index all the way down to the smallest 10% of firms. If we calculate the past five year returns from each of these groups, we can see that the largest 10% of firms have beaten all other size segments. This seems consistent with the reported strong performance of many large technology companies.
However, concluding that the largest companies have performed the best would be incorrect. The analysis described above only tells us how the current largest companies have performed, looking backwards in time, not how the largest companies five years ago performed over the subsequent five years. If we use company size as it was five years ago as the starting point and then calculate the forward-looking returns of each size grouping, the analysis changes quite significantly.
The largest companies from five years ago have still performed well (+10.8% pa), but the top performer over the period, by a healthy margin, has been the smallest decile of companies (+16.0% pa).
This is because some of the big companies today were actually much smaller five years ago, and some of today’s smaller companies were much bigger.
It’s generally unusual for the largest companies in an index to continue to outperform all others, and history tells us the best time to buy these companies is before they become large, not after.
New Zealand interest rates – the wait goes on
The chart below shows the annualised inflation rate (dotted blue line) plotted against New Zealand’s Official Cash Rate (OCR), which is the short-term interest rate set by the RBNZ on a periodic basis (orange line).
New Zealand interest rates versus inflation:
The RBNZ aims to keep inflation within the range of 1% to 3% over the medium term (the area shaded in white). They have generally achieved this fairly consistently over the last 25 years. Up until 2021, there had been only occasional deviations of inflation outside this band, and most had returned to the target range within 12 months.
However, the cost-of-living crisis has been a different story. The significant ‘spike’ in inflation that commenced in 2021 has not returned to the target band. This is why the orange line is not budging yet. The length of time inflation has stayed above target (now three years and counting) has backed the RBNZ into a corner. They are highly reluctant to reduce interest rates until they see inflation back inside their target band. This caution has resulted in the OCR being stuck at 5.5% since May 2023.
The good news, as you can see from the chart, is that inflation is heading in the right direction. Many commentators consider that we could see interest rate reductions later this year (ahead of the RBNZ’s forecasts). Whenever they begin, they will mark the end of the most restrictive interest rate settings New Zealand has experienced in 15 years.
Does the US election matter?
We are readying ourselves for Biden vs Trump 2.0 in November, and from afar, the view doesn’t look flattering. This time around, it is an incumbent who is facing increasing questions of his competency, including from within his party, versus an often divisive and controversial challenger whose run is likely to include significant time in the courtrooms as well as on the campaign trail. It is surely an indictment of the US political system that these are two ‘best’ candidates for leadership of the most influential nation in the free world.
Does it matter who wins?
In some ways, probably not. Both the Democrats and Republicans will aim to be expansionary and will keep issuing bonds and printing money. While the Democrats might spend more, the Republicans will aim to reduce taxes more.
In some ways, almost certainly. In matters of foreign policy, we can expect a Republican presidency to renew stronger rhetoric around Europe’s contributions to NATO, possibly not supporting efforts to arm Ukraine and likely promoting greater trade protectionism, particularly with respect to China. Conversely, President Biden has indicated he will propose extending tax breaks for those on low incomes while raising corporate tax rates, and potentially further promoting renewable energy development. Clearly, the outcome in November will have a significant impact on some sensitive corners of the economy.
How investment markets might perform is much less predictable, although history says that patient investors will be rewarded regardless of which political party controls the White House.
One of the reasons why is because the president has no direct control over the share market. While the president influences fiscal policy to varying degrees, it is Congress that ultimately creates the federal budget, and government spending is only one of many variables that affect the share market. Also, when considering events like the dot-com bubble, the Great Recession, and the COVID-19 pandemic – no president caused those events, but all three events caused share market crashes.
Since the inception of the S&P 500 share market index in 1957, the respective market performance under different presidencies is highlighted below.
S&P 500 compound annual growth rate:
Given the ability for statistics to be easily manipulated, Republicans (higher median return) and Democrats (higher average return) could both try to claim the share market has performed better when they controlled the presidency.
However, investors should ignore such comments. Share prices, determined by business fundamentals like revenue and earnings growth, are merely influenced (not controlled) by a president’s fiscal policies.
While the November winner may not have much of an impact on eventual market returns, this will nevertheless be a subject of considerable global attention over the next 4-5 months.
Tune out the noise
There is a near-constant swirl of speculative opinion, both in the general news media and in the financial press, about a range of factors or events whose outcomes are, and always will be, uncertain.
Not a day goes by without a big, scary headline professing at least some level of consternation about one or more of the following:
Unfortunately, reading (or watching) the guesses of different pundits about an unknown future provides no useful benefit to long term investors.
Markets, in aggregate, are aware of the prevailing uncertainties and, to the greatest extent possible, that uncertainty is already factored into asset prices today. Yes, as information changes, prices will reflect that new information. But, as the exact nature of future information is usually unguessable in advance – even by so-called experts – this speculation is nothing more than an unwelcome distraction, and investors should exclude it from their strategic decision-making.
The best response a long-term investor can have to uncertain events is to tune out the persistent noise about everything that is unknown or could go wrong and focus instead on the consistent behaviours that have been proven to add value over time.
Unlike the list of potential issues, which is always concerning and always changing, the list of great investor behaviours never changes.
These are – in no particular order:
Mastery of these relatively simple steps means you will dramatically improve your chances of achieving your long-term investment goals and objectives.
[1] Data sourced from Ritholtz Wealth Management as at 18 June 2024
Article provided by Consilium.
Disclaimer: Information as of 18 July 2024. This article is general information, does not consider your financial situation or goals, and does not constitute personalised advice. Please get in touch with your financial adviser for advice specific to your situation. There are no warranties, expressed or implied, regarding the accuracy or completeness of any information included in this article.
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