The quarter started on a positive note for most markets but gains generally eased in September amid concerns of rising inflation, worries about China, and energy shortages in Europe.
The New Zealand share market performed better than most developed markets with the economic growth rate (2.8% in the second quarter) reported to be much stronger than expected. Before heading into a new lockdown in the third quarter, New Zealand’s economy was enjoying high employment, relatively strong household and business balance sheets, and the expectation of ongoing fiscal support from the New Zealand government.
Key interest rates changed little internationally although, as inflation fears strengthened, the focus returned to the likely size and timing of future interest rate hikes around the globe. Rising yields on US Treasuries in September underlined the market view that rate hikes could be brought forward in addition to an earlier tapering in their asset purchase programme.
In August, New Zealand was poised to be one of the first developed nations to commence raising interest rates; its first hike in seven years. This was only stymied at the eleventh hour as New Zealand went into another Covid-related lockdown, with the highly anticipated first move upwards in rates being deferred until early October.
+0.5% (hedged to NZD)
International developed share markets generally delivered low positive returns during the third quarter of 2021.
In the USA, the flagship S&P 500 Index (total returns in USD) was in line with the broad market, gaining +0.6% for the quarter. Strong company earnings supported the index through July and August, but growth and inflation concerns late in the quarter saw US shares retrace their steps in September.
European markets followed a similar pattern, with weakness later in the period due to rising energy prices and concerns that supply-chain bottlenecks would drive inflation higher.
Although the headline returns for USA and Europe were similar, the drivers of returns varied quite markedly. In the USA, leading performers were in the large capitalisation space, with financials and utilities sectors leading the way. In Europe it was small capitalisation companies that generally outperformed, with the energy sector in particular recording strong gains.
After generally lagging over the last couple of years, the UK market performed a little better than its European peers over the quarter with the MSCI UK Index gaining +2.2%. Increased merger and acquisition activity helped drive market sentiment overall, while weakening economic indicators were otherwise reflected in a wide dispersion in company returns across sectors.
All of these results paled next to the Japanese market where the MSCI Japan Index increased by +5.3% with corporate profit results, purchase orders and capital expenditure plans all looking relatively strong. The quarter also saw the surprise resignation of Prime Minister Yoshihide Suga who was replaced by Fumio Kishida, an establishment politician considered to be a safe, if unexciting, choice to guide Japan through the next stage of its post-Covid recovery.
In New Zealand dollar terms, the MSCI World ex-Australia Index delivered a quarterly return of +0.5% on a hedged basis and +1.3% unhedged. The rolling 12 month return for the New Zealand dollar hedged index was +28.4% while the unhedged index gained +23.4%.
Source: MSCI World ex-Australia Index (net div.)
Emerging markets shares
Emerging market equities struggled in the third quarter which saw a sell-off in Chinese shares, concerns over continued supply chain disruptions, and worries over the implications of higher food and energy prices in some markets.
Regulatory actions in China were the initial trigger for market weakness. These were compounded by the re-imposition of some Covid-19 restrictions, power shortages, and worries about possible systemic financial system risks stemming from the potential collapse of Chinese property developer Evergrande.
Brazil was also weak as above-target inflation continued to rise and the central bank there responded with further interest rate hikes, while the South Korean market was impacted by falling prices for dynamic random access memory chips (DRAM) as well as general supply chain concerns.
In stark contrast, net energy exporters generally outperformed, most notably Colombia, Russia, Kuwait, Saudi Arabia, Qatar and the UAE. India also delivered a strong gain, with investor sentiment boosted by a recent stream of initial public offerings.
In unhedged New Zealand dollar terms, the MSCI Emerging Markets Index produced a quarterly return of -6.8%, for a +13.6% return over the last 12 months.
Source: MSCI Emerging Markets Index (gross div.)
New Zealand shares
New Zealand was one of the better performing global developed share markets through the quarter with the S&P/NXZ 50 Index returning +5.2%.
With underlying economic conditions still broadly favourable and the market ‘looking through’ the ongoing Covid uncertainties, it was generally the larger companies within the index which performed better than the smaller capitalisation firms. The most significant contributions came from firms in the Healthcare and Industrials sectors.
In the Healthcare sector, it was Pacific Edge leading the charge with a gain of 24.4% following strong interest in a retail placement to help support their US growth strategy. Ryman Healthcare also performed strongly, up 15.0% after announcing record first quarter sales and continued expansion in Melbourne.
In the Industrials sector, the continuation of a stellar year for Mainfreight saw their share price advance another 26.6%. On 1 September they announced significantly improved revenue and profitability figures compared with the same 22-week period last year.
All sectors made a positive contribution over the quarter with the exception of the Consumer Discretionary sector, where the increased lockdown restrictions likely had a more immediate impact. SkyCity Entertainment, down -6.8% for the quarter, was the worst affected in this sector.
Source: S&P/NZX 50 Index (gross with imputation credits)
In spite of a September sell-off, the Australian share market also returned a positive quarter in local currency terms, with the S&P/ASX 200 Index (total return) in Australian dollars gaining 1.7%. In direct contrast to the New Zealand market, the largest capitalisation firms generally struggled over the quarter, while good returns were delivered by the mid and small capitalisation end of the market.
Within the large capitalisation space, it was the Materials sector that caused the largest drag on performance, with market heavyweights BHP (-17.0%) and Fortescue Metals (-26.9%) delivering disappointing returns on the back of weakening iron ore prices and, in BHPs case, an underperforming energy business.
Offsetting this was a positive contribution from all other sectors, and in particular, a good performance from the important (i.e. sizable) Financials sector, where a number of firms recorded strong double digit returns, including Clearview Wealth (+38.0%), Challenger (+18.0%), Suncorp Group (+17.4%) and Macquarie Group (+16.4%).
Returns to unhedged New Zealand investors were slightly negative due to a depreciation in the Australian dollar over the quarter.
Source: S&P/ASX 200 Index (total return)
International fixed interest
While the US 10-year Treasury Bond yield finished the quarter at 1.49%, only one basis point higher than it closed in June, it was the pathway to get there that interested markets. Yields fell initially, as the rapid economic recovery appeared to be moderating. However, as the market focus turned to rising inflation and the prospect of the withdrawal of monetary policy support, yields rose back to the levels seen at the start of the quarter. The Federal Reserve also recalibrated expectations regarding their ongoing asset purchase programme, suggesting they could commence a tapering of asset purchases as early as November 2021 and completed by mid-2022, earlier than originally expected.
The UK 10-year yield increased from 0.72% to 1.02%, with the move occurring in September. As with the Federal Reserve, there was clear signalling from Bank of England policymakers that rate rises might be warranted before the end of the year. Recent economic indicators came out worse than expected, while year-on-year consumer price inflation rose to 3.2% in August, the highest since 2012.
The German 10-year yield was one basis point lower at -0.19%, while Italy’s 10-year yield finished 0.04% higher at 0.86%. In spite of worries about inflation and higher energy prices, economic activity continued at a robust pace across Europe. Having come out of lockdowns relatively late, the region appeared to benefit from a similar release of pent-up demand that had been witnessed elsewhere. In August, Eurozone inflation recorded a decade high 3.4% p.a.
With little overall movement in international yield curves over the quarter, returns for high quality, low duration bonds were largely flat, while investment grade and higher yielding credit securities generally outperformed government bonds.
The FTSE World Government Bond Index 1-5 Years (hedged to NZD) made +0.0% for the quarter, while the broader Bloomberg Global Aggregate Bond Index (hedged to NZD) returned +0.1%.
Source: FTSE World Government Bond Index 1-5 Years (hedged to NZD)
New Zealand fixed interest
At their 18 August 2021 meeting, the Reserve Bank of New Zealand (RBNZ) once again elected to leave the official cash rate at 0.25% however, it was only the recent return to Level 4 lockdown that deferred the anticipated increase in interest rates. The Monetary Policy Committee advised this was only a delay due to the sudden increase in health uncertainties, not a change in their planned approach. This was subsequently verified on 6 October when they announced an increase in New Zealand’s official cash rate from 0.25% to 0.50%.
Faced with clear signalling about inflation concerns and higher interest rates, the NZ 10-year yield, after bottoming out at 1.49% in late July, rose steadily throughout August and September to close the quarter at 2.01%. This led to negative quarterly returns for both the corporate and government bond indexes.
Over the quarter, the movement up in yields was slightly larger for shorter duration bonds, resulting in a ‘flattening’ of the New Zealand yield curve. This culminated in shorter duration bonds performing a little worse than longer duration bonds.
The S&P/NZX A-Grade Corporate Bond Index fell -1.3% for the quarter, while the longer duration but higher quality S&P/NZX NZ Government Bond Index fell -1.2% for the quarter.
Source: S&P/NZX A Grade Corporate Bond Index
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