The second quarter of 2021 again saw generally positive returns for riskier assets, and this was supported by the rollout of the Covid-19 vaccines paired with ongoing supportive fiscal and monetary policy. Many developed nations saw falling rates of infection, resulting in the loosening of restrictions which helped propel economic output and consumer spending. These, in turn, strengthened the outlook for future economic growth, which pushed markets higher.
Covid infection rates generally reduced in developed nations as mass immunisation started to yield results. Vaccination rates globally are trending upwards, and at the end of June, over 40 million Covid-19 vaccine doses were being administered daily. 50% of the US and the UK populations had been fully vaccinated.
Although the global supply chain remains stretched (e.g. new car production has been held back by a global semiconductor shortage), corporate reporting and economic indicators through the quarter were generally positive and in line with market expectations. We remain in a so-called ‘goldilocks’ environment for share markets where strong growth and accommodative monetary and fiscal policy (i.e. low interest rates and high levels of government expenditure) are very conducive to growth in company earnings.
Fears of runaway inflation dominated the headlines early in the quarter. The reopening of economies following the relaxation of lockdowns in the US, in particular, unleashed pent-up consumer demand. Coupled with a generally higher supply of money through government spending programmes, very low interest rates, and ongoing supply chain issues, this spike in demand quickly translated into higher prices. Central banks generally signalled they expect this inflationary pulse to be transitory rather than a significant and persistent issue. This message was accompanied by the clear indication that central banks remain ready and willing to use the tools at their disposal to curb unsustainable levels of inflation, most notably by increasing interest rates in the future and tapering current asset purchase programmes.
+7.6% (hedged to NZD)
The quarter was relatively plain sailing. The US’s flagship S&P 500 Index (total returns in USD) enjoyed another strong quarter, advancing +8.5% for the quarter for a remarkable +40.8% return over the past 12 months.
In Europe, share market performance was also very strong. The MSCI Europe ex UK Index (in local currency) gained +7.1% through the quarter led by Switzerland (+10.0%) and France (+8.6%). The MSCI Europe ex UK Index has gained +30.3% over the last 12 months.
British equities were also strong, although again did not increase at the same rate as their neighbours. In GBP terms, the FTSE 100 advanced +4.8% for the quarter. However, most of these gains were generated in April and May as concerns about the impact of the rapidly spreading Delta variant began to weigh on growth expectations in June.
Japanese equities lagged developed markets peers with their state of emergency continuing until late June. With the Tokyo Olympic games set to commence on 23 July, these protective measures were considered a necessity. The MSCI Japan Index increased by +0.2%.
The performance of small capitalisation companies generally lagged larger companies in the quarter, although they still held the upper hand over the last 12 months. Economically sensitive industries such as telecommunications and energy were among the best, while utilities struggled. The real estate sector enjoyed a good quarter after generally lagging since the emergence of Covid in early 2020.
In New Zealand dollar terms, the MSCI World ex Australia Index delivered a quarterly return of +7.6% on a hedged basis and +7.7% unhedged. The rolling 12-month return for the New Zealand dollar hedged index was +36.2%, while the unhedged index gained ‘just’ +28.3%.
Source: MSCI World ex-Australia Index (net div.)
Emerging markets shares
Emerging market equities generated gains as well, albeit lower than developed markets. Slower vaccine rollouts, and the Delta variant, contributed to increased infection rates, especially in India, which weighed on investor sentiment. A relatively strong US dollar and the prospect of increasing interest rates also had a negative impact, as most companies in these nations issue debt in US dollars. Both of these contribute to increasing debt servicing costs which will impact profits.
Despite these impediments, most emerging share markets delivered gains. Brazil and Russia were the best performing heavyweights. The recovering global demand for oil pushed crude prices up, enhancing profit expectations for companies (and countries) more exposed to this sector. Korea, Taiwan, and India all had middling gains, while China lagged the group as internal regulators increased scrutiny on many of the larger companies here.
In unhedged New Zealand dollar terms, the MSCI Emerging Markets Index produced a quarterly return of +5.0%, for a +30.5% return over the last 12 months.
Source: MSCI Emerging Markets Index (gross div.)
New Zealand shares
Domestic equities again lagged other markets through the quarter, with the broad S&P/NXZ 50 Index returning +0.9%. This result was directly due to a relative underperformance of the larger companies on the exchange.
a2 Milk continued its recent slide, down -25% for the quarter and now a phenomenal -70% lower than its share price high of only 12 months ago. Other large companies, Ryman (-13.3%), Auckland Airport (-7.1%), and Air New Zealand (-7.2%), struggled with their corporate earnings announcements generally falling short of market expectations. Air New Zealand continues to battle in this challenging environment – it is clearly hampered by the lack of clarity about the prospects for a general reopening in the border anytime soon.
At the other end of the spectrum, Contact Energy (+18.2%) saw positive price action as their clean energy solutions stimulated investment inflows from foreign investors and, along with Mainfreight (+10.9%) and Infratil (+10.1%), managed to keep the index in the black.
Source: S&P/NZX 50 Index (gross with imputation credits)
Australian share market returns were strong over the quarter. The S&P/ASX 100 (the largest 100 companies in the Australian market) and the S&P/ASX Small Ordinaries Index (the companies ranked 101 to 300 in the Australian share market) both returned +8.5% in Australian dollar terms. Over the last 12 months, small capitalisation companies have been a bit stronger, with the S&P/ASX Small Ordinaries Index up +33.2% versus +27.9% for the top 100 companies.
Among the top performers were Rio Tinto (+14.4%), who benefited from continued increases in global demand for the industrial metals they mine, and Commonwealth Bank (+16.0%), who are set to write more (and larger) loans due to strong rebound in the Australian residential property market.
A small depreciation slightly reduced returns to unhedged New Zealand investors in the Australian dollar over the quarter.
Source: S&P/ASX 200 Index (total return)
International fixed interest
The main event for market observers in international fixed interest markets was how the US Federal Reserve would react to increasing inflationary pressures. The US consumer price index, which measures the average increase in the price of goods for American consumers, had been persistently low following the global financial crisis in 2008. However, this year, due to the economic resurgence brought about by the reduction in many Covid restrictions, prices have been trending upwards. The index clocked in at +5% for the year ended May 2021, the largest 12-month increase since 2008. Contributors to this surge in prices have been the very things that bridged the gap through the lockdowns 12 months ago; accommodative monetary and fiscal policy and a gradual unwind of the social restrictions put in place to limit the spreading of the virus. The fiscal stimulus pumped into the economy (relief packages) and record low interest rates have resulted in consumers having access to more money and – with restrictions relaxing – a greater inclination to spend it. Add in some supply side constraints (raw material shortages, shipping delays etc), and prices for many goods have been squeezed higher.
In the short term, central banks have sought to stimulate an economy wounded by Covid, but the management of inflation risks will increasingly be their focus in the long term. With inflation pressures becoming more evident, the central banks will be reviewing the tools at their disposal to manage this. The fiscal support they have been offering through the crisis can be pared back, and monetary policy changes can also deliver higher short term interest rates – if considered necessary – as another mechanism to dampen inflationary pressures. This is precisely what the US federal reserve signalled late in the quarter. They elected to keep their official interest rate at the current record low but signalled an expectation to raise interest rates sooner than previously expected. This was a clear signal to the market of their likely intolerance of allowing sustained levels of inflation above their long term target level.
This announcement caused shorter term yields to spike – the US 2-year yield rose to 0.25% from 0.16%, where it has stubbornly been sitting since the crisis began. The longer term US 10-year yield actually declined from 1.74% to 1.47% as the notion that above target inflation in the future might be tolerated was quashed in the Federal Reserve’s June update. The UK and Australia followed a broadly similar path to that of the US, and both had relatively stable quarters, as did Japan.
After bucking the trend in the March quarter, European yields picked up through April and May in particular. The German 10-year bond yield increased 0.09%, the French by 0.18% and the Italian by 0.16%
Broadly, this meant longer duration bonds outperformed shorter duration bonds. Credit spreads narrowed and are now, on average, tighter than pre-Covid levels, helping corporate bonds outperform government bonds.
The FTSE World Government Bond Index 1-5 Years (hedged to NZD) made +0.1% for the quarter and the same return over 12 months. The broader Bloomberg Barclays Global Aggregate Bond Index (hedged to NZD) returned +1.0% for the quarter but is flat over the 12 months to end June.
Source: FTSE World Government Bond Index 1-5 Years (hedged to NZD)
New Zealand fixed interest
With an eye to their dual mandate of stable 2% inflation and maximum sustainable employment, the Reserve Bank of New Zealand (RBNZ) again elected to leave the official cash rate at 0.25%. With inflation nearing the mid-point of the target 1% – 3% range and the unemployment rate has pulled back to 4.7% (very near to pre-lockdown levels), it is easy to conclude the existing policy settings are fulfilling those objectives. In its most recent announcements, the bank 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. The market is broadly in consensus with these projections.
With no real catalyst – endogenous or exogenous – yields in New Zealand were relatively unchanged through the quarter. The NZ 10-year yield closed the quarter at 1.80%, 0.04% below its starting point, which meant very small gains for this asset class this quarter.
Government bonds underperformed corporate bonds, while longer maturity bonds outperformed shorter maturity bonds, but generally, all parts of this asset class posted negligible returns through the quarter.
The S&P/NZX A-Grade Corporate Bond Index rose +0.3% for the quarter and is the only asset class with a negative 12-month return at -1.2%. Longer term performance remains robust, with both the 3 and 5 year annualised average returns coming in at +3.7%, and the 10-year return is +4.9% per annum.
The longer duration but higher quality S&P/NZX NZ Government Bond Index rose +0.2% for the quarter and has retreated -3.6% over the preceding 12 months.
Source: S&P/NZX A Grade Corporate Bond Index
Table 1: Asset class returns to 30 June 2021
|Asset Class||Index Name||3 months||1 |
|3 years||5 years||10 years|
|New Zealand shares||S&P/NZX 50 Index, (gross with imputation credits)||+0.9%||+11.2%||+13.2%||+14.0%||+15.2%|
|Australian shares||S&P/ASX 200 Index (total return)||+6.8%||+28.2%||+8.9%||+11.8%||+7.2%|
|International shares||MSCI World ex Australia Index (net div., hedged to NZD)||+7.6%||+36.2%||+13.8%||+14.9%||+12.8%|
|International shares||MSCI World ex Australia Index (net div.)||+7.7%||+28.3%||+13.9%||+15.4%||+12.7%|
|Emerging Markets shares||MSCI Emerging Markets Index (gross div.)||+5.0%||+30.5%||+10.5%||+13.9%||+6.4%|
|New Zealand fixed interest||S&P/NZX A-Grade Corporate Bond Index||+0.3%||-1.2%||+3.7%||+3.7%||+4.9%|
|International fixed interest||FTSE World Government Bond Index 1-5 Years (hedged to NZD)||+0.1%||+0.1%||+2.5%||+2.1%||+3.4%|
|New Zealand cash||New Zealand One-Month Bank Bill Yields Index||+0.1%||+0.3%||+1.0%||+1.4%||+2.1%|
Unless otherwise specified, all returns are expressed in NZD. We assume Australian shares and emerging market shares are invested on an unhedged basis, and therefore returns from these asset classes are susceptible to movement in the value of the NZD. Index returns are before all costs and tax. Returns are annualised for time periods greater than one year.
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