Monthly Market Update
As at end May 2019
Geopolitics fray markets
Global equity markets broadly fell in May, giving back some of April’s stellar performance. The MSCI World Index (NZD) dropped 3.6% over the month, however a weakening Kiwi dollar helped soften the impact in NZD terms. Positive returns in Brazil and India bucked the trend, helping emerging markets indices to outperform developed markets, something that has not happened for a while.
The weakness in markets accelerated at month-end as the US President made an unexpected announcement stating he would impose tariffs on Mexico if it did not stop the flow of illegal immigrants crossing the border into the US. This added further uncertainty concerning global trade, just as investors were evaluating the reescalation of the US-China trade war.
Another contributor to the renewed anxiety in markets was the deteriorating political landscape in Europe. The recent EU election showed populist politics is still on the rise across the continent, while at the individual country level, Italy has made it known it is about to flout EU fiscal rules around its budget. Across the channel, there are now heightened prospects of a no-deal Brexit, coupled with a leadership vacuum after Prime Minister Theresa May announced she will resign in June.
In stark contrast to European politics, India’s Prime Minister Narendra Modi won a strong mandate for his second five-year term. The question being asked by investors is to what extent he re-engages with the significant reforms he was planning to undertake in his first term, such as overhauling the labour and agricultural sectors, that did not materialise. Notwithstanding, with its economy still among the fastest growing in the world (GDP is running at 7%), India is likely to remain a favourite in the emerging market universe.
NEW ZEALAND MARKETS
New Zealand keeps on truckin’
New Zealand equities continued their unbroken run of positive monthly returns for the year, with the S&P/ NZX 50 Index’s monthly return of 1.0% bringing the total to 14.8% year to date.
Vista Group International (VGL) was the top performing company in the Index, returning 14.5% for the month. VGL has seen solid returns this year, helped by good growth in its Movio business, returning 54.8% year to date. It was a good month for NZ industrials, among them Skellerup, Auckland Airport, and Mainfreight all returning more than 9%, with the latter advancing 4% in a single day after reporting a 28% rise in full year net profit.
Synlait Milk (SML) was the worst performer in the index, returning -16.1%. SML faced multiple setbacks starting with the reversal of a High Court decision which had previously given it the green light to build a new factory in Pokeno. Later in the month, SML also received a cease-and-desist notice regarding the Pokeno land. The company believes it will be able to find a solution, however the timing and total cost of the near-complete project remains unclear. Another bump in the road came when the U.S. FDA put the registration process for SML’s infant formula product “Munchkin”, on hold.
The NZ Government’s annual budget was announced on 30th May and was touted as the “Wellbeing” budget. As expected, keynote funding allocations to mental health and child wellbeing constituted part of the $15.2b of net new operating expenditure, and the establishment of a new $300 million fund to support start-ups was a welcome boost for potential entrepreneurs.
The Bill Australia Couldn’t Afford
The benchmark S&P/ASX 200 Index made a return of 1.7% for May, performing resiliently in what was a notable down month across many developed markets. Despite intensifying rhetoric and action on the USChina trade-war front, Australia’s saving grace was the unexpected re-election of the Liberal-National coalition. Banks and Financials (approximately 30% of the index) chalked up a strong relief rally on the back of this, as prospects of Bill Shorten’s (Labour Party) negative gearing and franking credit reforms faded into the background.
Rare earths producer Lynas was the top performer, returning 54.0% in the wake of its investor day update, signing of a US development MOU, and talk that China could restrict rare earths supply. Fortescue was second, returning 24.3% on expectations protracted delays for Vale in Brazil will see iron ore prices stronger for longer. The two worst performers both gave profit warnings. Produce grower Costa (-30.3%) watered down EBITDA guidance to >10% below consensus, citing deteriorating conditions on several fronts; whilst lack of an expected freeze event in the US led plumbing fitting manufacturer Reliance Worldwide (-24.8%) to downgrade its EBITDA guidance by 7%.
April’s labour force data came in weaker than expected, as participation slipped and the unemployment rate edged up to 5.2% (vs 5.0% expected). Prior to this release, the RBA left rates on hold in May, but flagged it would be keeping a close eye on labour market developments. By late May, assisted by the RBA’s commentary, the market-implied probability of a cut increased to a near-certainty, which has now been effected at the June meeting.
One and done or more to come?
May was a strong month for bond markets across the globe. Government bond yields have fallen significantly, with 10 year yields plummeting to new 12 month lows for US, UK, Japan and Germany; and all-time lows for New Zealand and Australia. Investors are becoming increasingly nervous on the outlook for global growth and are seeking out the relative safety of government bonds, pushing prices up and yields down. There has been a growing expectation of looser monetary policy from the central banks with interest rate cuts seen as being increasingly likely.
This expectation became reality for New Zealand with the RBNZ cutting the OCR from 1.75% to 1.5% this month. This was the first change in the OCR since October 2016 and was deemed necessary to support the outlook for inflation and employment. Domestic economic data has been on the soft side in recent months, with weaker than expected GDP, lower inflation, and a slowdown in residential property markets. However, there does not appear to have been a ‘smoking gun’ that prompted the cut. It looks more like a pre-emptive move to counter potential downside risks that may eventuate. There certainly is potential for further cuts to occur if such a scenario unfolds and this is being reflected in current market pricing. For example, the closest to maturity government bond in April 2020 is currently priced at a yield of 1.31%, versus 1.84% this time last year.
With the backdrop of falling government bond yields and the OCR cut, New Zealand fixed interest markets have performed well. The S&P/NZX Investment Grade Corporate Bond Index and the S&P NZX Government Bond Index both rose by 1.2% this month.