October Monthly Market Update
As at end of October 2021
Global equity markets staged a strong rebound through October as risk sentiment lifted and investors shrugged off concerns that precipitated the previous month’s slump. Despite the kiwi dollar strengthening substantially against its peers, as reflected by the NZD Trade Weighted Index rising 3.0%, the MSCI World (NZD) Index still finished with a respectable return of 1.9%.
The US equity market led the charge with the S&P 500 Index setting new record highs and finishing up 7%. A strong start to the quarterly earnings season helped fuel the rebound, with 83% of the companies that reported in October exceeding earnings expectations. Financials delivered exceptionally strong results, in particular banks, which were driven by strong lending growth, high levels of trading and M&A activity, plus the release of capital reserves that were that were set aside for potential loan defaults during the pandemic. Results were more mixed across the mega-cap IT sector with Microsoft and Alphabet delivering robust growth from their core businesses, whilst Amazon and Apple were hampered by continuing global supply chain issues. Amongst the other regions, European equities tracked closely with their US counterparts, with the STOXX Europe 600 Index returning 4.7%, while Japanese equities underperformed with the Nikkei 225 Index falling 1.9%.
On the macroeconomic front, there were signs that economic growth and activity is slowing. Both the US and China, which together represent around 40% of total global output, saw their quarterly GDP growth rates decelerate sharply. Likewise, major industrial and manufacturing economies such as Japan and Korea, reported worsening production numbers, in part driven by global semiconductor shortages. The persistent inflationary pressure being seen around the world was another dominant theme. In the US, the headline CPI print once again came in above 5%, whilst in the Euro area inflation rose to 3.4%, the highest in 13 years. The recent surge in commodity prices, compounding ongoing issues with global supply chains, rising wages, and shelter costs have pushed long-term inflationary expectations higher. This has led markets to price in more aggressive tightening from central banks, despite central banks maintaining a view that these inflationary pressures are largely transitory.
NEW ZEALAND MARKET
Valuation Fatigue setting in
The New Zealand market underperformed, with the S&P/NZX 50 Index declining 1.3% in a month where most international markets had positive returns. The main theme locally was the underperformance of large caps. Of the top five stocks in the index only Auckland Airport managed a positive return, with the others (Fisher & Paykel Healthcare, Spark, Mainfreight and Contact Energy) all posting negative returns. In most cases, there was no significant news flow for these companies, rather the pullbacks look more like a case of valuation fatigue. With high starting valuations predicated on low rates persisting, the reality of rising rates has reduced the relative attractiveness of these stocks. With the exception of Mainfreight, which is up over 30% so far in 2021 due to strong global freight trends, these stocks have also had a lacklustre year. This is also true of the S&P/NZX 50 Index, which is essentially flat year to date, with a return of 0.6%.
One of the highly anticipated events this month was the A2 Milk (ATM) investor day, which was the first real opportunity for the relatively new CEO, David Bortolussi, to lay out the company’s strategy and set some medium-term earnings targets. ATM has been one of the most volatile stocks in the New Zealand market over the last two years, following several earnings downgrades, management changes, and unpredictable demand for its products. While there were a number of positives from the day, the trading update and medium term margin guidance led to yet another round of analyst downgrades, and saw the share price down 11.3% on the day. ATM has had a tumultuous year, and remains down 45.6% over 2021 to date. Other stocks worth a mention for October were Skellerup, Tourism Holdings, and Z Energy which were the best performing stocks in the S&P/NZX 50, all delivering positive returns greater than 5%.
Trick & Collect
The benchmark S&P/ASX200 Index returned -0.1% for October, with Industrials and Energy the two worst performing sectors, returning -3.2% and -2.7% respectively. IT and Healthcare fared best, delivering returns of 2.1% and 1.0% as market sentiment improved.
Interestingly, this month’s five best and worst stocks were all outside the top 100. Leading the list were precious metals miner Silver Lake (+26.5%) and AI training platform Appen (+20.0%). At the other end were gift card platform EML payments (-24.2%) and Codan (-21.3%), best known for its prospecting and communication equipment. Among the larger household names, notable movers were JB HiFi (+10.9%), Domino’s Pizza (-15.6%) and Rio Tinto (-9.9%).
Hot on the heels of Australia’s largest ever quarter for M&A volume, deal frenzy continued in October. Activity this month included Korean steelmaker POSCO bidding for energy junior Senex, Aussie Broadband’s proposal to acquire Over The Wire, and Origin Energy selling down 10% of its stake in the Australia Pacific LNG terminal. A string of sizeable acquisitions by the likes of Aristocrat, Reliance Worldwide, and Aurizon also featured. The recent urgency to deal likely has to do with expensive equity and cheap debt, which has historically led to large write-downs on some transactions further down the track.
In macroeconomic news, the RBA spooked markets with an early Halloween trick when it abruptly stopped buying the April 2024 government bond. Markets took this as a signal it was abandoning its yield curve control (YCC) policy, and quickly priced in expectations of interest rate lift-off much sooner than the bank’s 2024 guidance. This was affirmed at the RBA’s November meeting on Melbourne Cup day, with YCC formally abandoned, and the 2024 pledge disappearing from the Monetary Policy Statement. These ructions drew uncharacteristic attention globally as a cautionary example of the risks inherent in placing too much faith in central bank guidance.
Inflation is everywhere, except for bond prices
It was a rough month for local bond markets following hotter than expected inflation data for both New Zealand and Australia. This led to sharply higher bond yields and negative returns for both corporate and government bonds on both sides of the Tasman. Interestingly, the largest moves in bond yields were for shorter dated securities. For example, the yield on 2024 government bonds rose from 1.2% to 2.0% during October, while the yield for 2032 government bonds ‘only’ rose from 2.1% to 2.6%. Notwithstanding, negative returns were unavoidable this month, and all local market indices recorded significant declines. In New Zealand, the S&P/ NZX Investment Grade Corporate Bond Index recorded its worst month since March 2009 with a decline of 2.3%. The S&P/NZX Government Bond Index fared even worse with a drop of 3.2%, and has now declined in value by 10% over the last 12 months. It was a similar story in Australia with the Bloomberg Australian Corporate Bond Index declining by 3.1% and the Bloomberg Australian Government Index by 3.9%.
These rapid and significant increases in bond yields illustrate the concern over the level of inflation, and expectations of tighter monetary policy in response. The RBNZ has been one of the first central banks to react, with the OCR being increased to 0.5% in early October. Current market pricing now implies an OCR of 2% in less than 12 months. The question is whether this will be enough, and this comes back to the debate on the persistence of inflation which has been raging all year. In its August Monetary Policy Statement, the RBNZ was expecting inflation to peak this December, before rapidly declining back to 2% in early 2023. This forecast is already looking outdated, and the risk is on the side of inflation peaking higher and later, and then maybe not declining as quickly as anticipated.