February Monthly Market Update
As at end of February 2021
When the chips are down
The MSCI World sharemarket Index (NZ$) gained 1.7% despite the headwind of sharply rising bond yields. The Japanese and European markets were the best performers of the major developed economies, although returns were reduced when translated back into New Zealand dollars due to the resurgent Kiwi dollar. Commodities were the standout performer this month, as reflected in the commodities CRB Index rising 7.0%. This spike in interest came from the accelerating inflation narrative that has taken hold, as investors focus on the likely effect of pent-up services demand coupled with further stimulus from the likes of the US. This inflationary view was also on display in bond markets, where yields pushing higher triggered rotation out of interest rate sensitive large cap growth stocks such as Apple, Amazon, and Walmart.
The strength in the European and Japanese sharemarkets reflected a series of generally positive announcements around manufacturing. Both economies have been significant beneficiaries of exporting into China, where consumers have been spending up. However, both regions have contracting service sectors - for three consecutive months in Japan’s case. The game-changer for the service sector is the speed of the vaccine rollout that unfortunately for Europe has got off to a very slow start.
Another country benefitting from China’s healthy demand picture is South Korea. Overall exports in February were up a solid 9.5% year-on-year, within that exports to China were up a stunning 26.5%. South Korea is the home of several of the world’s largest chipmakers, who are clearly benefitting from the global shortage of chips coupled with China’s aggressive inventory rebuilding.
NEW ZEALAND MARKET
Strong earnings, weak market
In an unusually large divergence from global markets, the S&P/NZX 50 Index returned -6.9% for the month versus positive returns for many global peers. Despite a relatively good reporting season thus far, the index was dragged down by rising bond yields, as well as some notable stock-specific impacts.
Among the worst performers, index heavyweight Fisher & Paykel Healthcare (FPH: -15.6%) was the major casualty of interest rate sensitive stocks falling out of favour due to rising bond yields. Meridian Energy (MEL: -20.3%) and Contact Energy (CEN: -16.3%) fell sharply after S&P proposed changes to its Global Clean Energy Index which would likely instigate ETF selling in these companies. a2 Milk (ATM: -16.0%) announced its third FY21 guidance downgrade in six months. Continued weakness and lack of transparency around the significant daigou (informal reseller) channel continues to be a source of consternation for the company.
On a more optimistic note, cinema software company Vista Group International was the top performer in the Index, returning 14.1% on the expectation that the vaccine rollout could lead to cinema attendance normalising in the near future. Other outperformers were the dual-listed banks, with results for both ANZ (ANZ: +10.6%) and Westpac (WBC: +13.5%) ahead of expectations. Both benefited from tailwinds, including improving net interest margins and more benign credit losses, which allowed them to write loss provisions made earlier back to profit. The banking sector is also one of the few that could stand to benefit from recent rising bond yields.
RBA Reverse Bond Vigilante
The S&P/ASX200 Index returned 1.5% in February, after bond market ructions wiped away more than half the month’s gains on the final trading day. Unsurprisingly, interest-rate sensitivity was a key theme behind sector performance. The two worst returning sectors, IT (-8.9%) and Utilities (-8.0%), are both casualties of rising rates. On the other side, Materials (7.3%) performed best, followed by Financials (5.2%). Resources were buoyed by rising industrial commodity prices, most notably Brent Oil and Copper, which were both up over 15% in USD terms.
Interim reporting season provided a litmus test for earning expectations, with more companies surprising on the upside versus the downside. However, lack of visibility added a cautionary tone to outlook statements amidst the supply chain disruptions and abnormal demand which are still impacting many sectors.
Buy-now pay-later operator Zip was again the index’s top performer, returning 35.4%. The wooden spoon went to utility services provider Service Stream (-39.6%) after a weak result revealed a large drop in revenue from their core telco segment.
February’s macroeconomic data releases were overshadowed by the sharp rise in Australia’s 10- year bond yield from 1.13% to 1.92%. Such a rise is a double-edged sword, on the one hand it can reflect the economy running hotter as the recovery gathers steam, but it can also indicate rising inflation expectations due to excessive stimulus. Second order impacts of too brisk a rise in bond yields, particularly Australian dollar strength, induced the RBA to intervene more forcefully. Its more aggressive bondbuying on March 1st helped push the 10-year below 1.70%.
Central Banks are playing defence
It was a turbulent month for bond markets with a sharp spike in bond yields resulting in negative returns for most global fixed interest indices. The S&P/NZX Investment Grade Corporate Bond Index was no exception, declining by 1.9%, while the S&P/NZX Government Bond Index was down 3.6%. New Zealand, Australia, and the US have all seen their 10 year government bond yields increase by more than 0.5% since the start of the year, and this move accelerated towards the end of February. Despite causing unhelpful market volatility, it is actually a positive sign, with increases in both inflation expectations and real interest rates signalling that monetary policy objectives are closer to being met. The dilemma facing central banks is assessing the speed and magnitude of these market movements. If they think that bond yields are rising too quickly it could be perceived as a premature tightening of monetary conditions.
The RBNZ is in a particularly awkward spot because the local economic data has been much stronger than expected, making it more difficult to justify its aggressive asset purchasing and bank funding programs. The governor continues to talk about being ready to add more stimulus (including a negative OCR), but at the same time the RBNZ is being forced to upgrade its economic forecasts and is also dealing with political pressure stemming from an overheated property market. This month the Minister of Finance announced that the RBNZ is now required to consider government policy on housing in relation to its financial policy functions. The actual targets (inflation and employment) have not changed, but we think it will result in the RBNZ paying more attention to house price inflation. Market pricing is now implying a 50% chance of an OCR hike in the next 12 months.