It still seems extraordinary that something we knew virtually nothing about just 18 months ago has so utterly dominated global news, our feelings of economic and personal wellbeing, and the normal functioning of our daily lives ever since.
Of course, we are talking about Covid-19.
Given the highly unusual circumstances surrounding the pandemic, the evolution of our collective response to it has conformed quite closely to the five stages of grief outlined in the Kübler-Ross Grief Cycle1:
- Denial: This virus won’t affect us.
- Anger: You’re restricting our freedom by making us stay at home.
- Bargaining: If we wear a mask and social distance everything will be fine, right?
- Sadness: In spite of everything, there is still no end in sight.
- Acceptance: Ok, this isn’t going away; we have to figure out how to carry on.
While individual countries have been wrestling with various approaches to Covid-19 suppression or elimination, an emerging international theme in recent weeks has been a move towards Stage 5 – Acceptance. This theme, propelled by rapidly advancing vaccination programmes internationally, marks another important step on the global road to recovery.
Living with Covid-19
In the UK, newly installed Health Secretary Sajid Javid said the country would “have to learn to live with” community transmission in order to restore freedoms and that “no date we choose comes with a zero risk from Covid”.
Similarly, in Australia, Prime Minister Scott Morrison recently outlined a four-phase plan for the country to move from trying to suppress Covid-19 to living with the virus once enough of its population is vaccinated.
Widespread adoption of this mindset would inevitably mean that our current ‘blunt instruments’ of rolling lockdowns and blanket travel bans would eventually be replaced by measured pragmatism. As vaccination rates continue to grow and the global economy continues to turn its attention towards living more effectively with Covid-19, it also reinforces the likelihood that the global recovery currently underway may have more upside to come.
The strong global economic growth evident in recent quarters is not difficult to understand. Fiscal policy (government spending) and monetary policy (interest rate management) are still highly stimulatory. Households in many countries have also had access to increased cash reserves resulting from lower spending due to lockdowns and reduced travel. These factors, in conjunction with supply side constraints, due to shipping issues and raw material bottlenecks, have, in recent months, seen demand comfortably outstripping supply. This has resulted in sharp price increases around the globe, with average inflation in May across the 37 OECD2countries reported to be growing at its fastest pace since October 2008.
This has had some market observers buzzing about the potential for the world economy to move towards more persistent higher inflation. As we reported last quarter, there are plausible arguments both for and against this.
The inflation question
Even as we write this, the debate continues between central bankers and the general market about whether these recent price hikes are likely to be transitory or something more permanent. At the moment, at least, the argument is being won by the central bankers who maintain that today’s inflation spurt is due to nothing more than the unleashing of considerable pent-up demand, which is likely to be temporary and will gradually revert back to a more reasonable level.
This is also the view of our own Reserve Bank of New Zealand, who noted in their 26 May Monetary Policy Statement that “a range of domestic and international factors are expected to lift headline inflation above 2% for a period, but these factors are expected to be temporary”.
Over the most recent quarter, what’s been conspicuous is that equity investors don’t appear to have been remotely distracted by this debate. Even if there may be a little more inflation on the horizon, it generally means the prices most businesses are charging for their goods and services are going up. That’s not necessarily a bad thing for future business profitability! Of course, it’s not quite that simple. Cost pressures, supply constraints, and other factors will all have a role to play in influencing corporate profitability, but a small uptick in prices does not, in itself, mark the death-knell for equities.
Global share markets were again generally very strong over the second quarter. The main US3 market recorded another impressive gain of 8.5%, and positive investor sentiment was also observed, in different measures, around the globe. Across other notable international developed markets, Europe (excluding the UK)4 gained 7.1%, and the UK4 itself delivered a solid 5.8%. Japan4 was something of an outlier returning just 0.2%,with the nation appearing divided about whether or not they could (or should) continue with their scheduled hosting of the Olympic Games in July (the decision was made to proceed).
Emerging market returns painted a broadly similar picture. Of the four largest emerging market constituents, China4 returned 2.1%, while South Korea4, Taiwan4, and India4 posted quarterly results of 4.4%, 4.6%, and 8.8%, respectively. Higher crude oil prices helped drive strong gains in both Russia and Brazil, with these markets jumping 11.1% and 9.3%, respectively. In aggregate, the emerging markets asset class delivered 5.0%5 over the three months from April to June.
For the second quarter in a row, the ‘battle of the Tasman’ was decisively won by Australia6, with our near neighbour returning an impressive 8.3% return while the New Zealand7 market delivered just 0.9%. Following an extended period where New Zealand shares have generally outperformed their Australian counterparts, investor optimism about the global recovery, and the broad-based strength evident in commodities and metals prices, may be creating a stronger tailwind for the Australian market.
Fixed interest markets experienced a slight hiatus following the previous quarter’s inflation-hyped yield spike, as investor expectations moderated. The Federal Reserve policy meeting in June was keenly anticipated and ultimately delivered a slight shift in tone, with the committee indicating that US interest rates were likely to rise earlier than initially expected. While seemingly an endorsement of the previous quarter’s yield spike, it more pertinently reinforced the Federal Reserve’s likely intolerance of an inflation overshoot by removing the assurance of infinite policy support.
In the end, far from spurring further increases in longer term Treasury yields, market participants were comfortable allowing these yields to slowly drift lower. As a result, the US 10-year Treasury yield declined from 1.74% to 1.47% over the quarter, which had a positive impact on quarterly returns from the international fixed interest asset class.
Around the rest of the world, government yield curves were relatively less affected than in the US, with most other global Treasuries trading within fairly narrow ranges. With minimal price action outside the US, the World Government Bond Index8 was essentially flat for the quarter, gaining 0.1%, while the Global Aggregate Bond Index9, containing more credit and duration exposure, was up 1.0%.
On 26 May, the Reserve Bank of New Zealand (RBNZ) once again held New Zealand’s overnight cash rate (OCR) at 0.25% and signaled very little change in their expectations. Embedded in their review was the continued projection that our OCR will begin to increase in New Zealand from around the middle of 2022.
However, after the end of the quarter in early July, the bank adjusted its stance and signalled an expectation of hikes in the Official Cash Rate (OCR) commencing as soon as this year and continuing through to a level of around 2% in 2024.
Over the quarter, New Zealand’s 10-year government bond yield was almost unchanged, and the New Zealand Corporate A Grade Bond Index10 advanced 0.3%.
Conditions remain favourable for growth assets
Overall, it continues to be an excellent time to be a diversified investor, and particularly so if you have a reasonable exposure to growth assets. The significant fiscal and monetary support that has helped propel asset markets over the last 15 months will evolve as circumstances dictate, but any change will only be incremental. This should mean the supportive share market environment we have enjoyed of late looks set to remain broadly in place for a little longer yet.
While residential property prices seem to have dominated local headlines recently, those keeping an eye on other traditional (and more liquid) asset classes, like shares, will have noticed some stunning returns coming from these markets as well. For example, in local currency terms, the highly influential US sharemarket3 has delivered 40.8% in the last 12 months alone; by any measure, a very significant return.
What’s perhaps more surprising than the strength of these returns is that they have occurred in a global environment, which is still very much focused on waging war against Covid-19. As nations progressively turn their energies towards constructively managing the ongoing threat of Covid-19 whilst getting on with life, it will be interesting to see how this may further influence investment market returns in the months ahead.
1 The Kübler-Ross Grief Cycle model was originally used to describe the common stages of grief that applied to terminally ill patients.
2 Organisation for Economic Co-operation and Development.
3 S&P 500 Index (total return in USD)
4 MSCI Country and regional indices (gross dividend in local currency)
5 MSCI Emerging Markets Index (gross dividend in USD)
6 S&P/ASX 200 Index (total return in AUD)
7 S&P/NZX 50 Index (gross with imputation)
8 FTSE World Government Bond Index 1-5 Years, hedged to NZD
9 Bloomberg Barclays Global Aggregate Bond Index, hedged to NZD
10 S&P/NZX A-Grade Corporate Bond Index
This information has been furnished to you by Cambridge Partners Ltd, a fee-only Independent Financial Adviser registered in New Zealand. Copies of our advisers’ disclosure statements are available on request and free of charge. Disclaimer: there are no warranties, expressed or implied, as to accuracy or completeness of any information included in this document. Use of any information obtained from such addresses is voluntary, and reliance on it should only be undertaken after an independent review of its accuracy, completeness, efficiency, and timeliness.