June Monthly Market Update
As at end of June 2022
Bracing for Recession
Global equities were sold off in a volatile frenzy as investors contended with tighter monetary policy settings in response to high inflation plus mounting recessionary fears due to deteriorating economic indicators. After being down more than 8%, the MSCI World (NZD) Index partly recovered to finish with a return of -4.4%. There was a flight to safe-haven currencies such as the US dollar and the Swiss Franc, causing the Kiwi dollar to decline substantially, which offset some of the offshore equity market losses.
Weak economic indicators highlighted fragility across both consumer and manufacturing segments sapped sentiment in June. In the US, where consumer spending makes up almost 70% of GDP, the picture has changed dramatically. Adjusted for inflation, spending data for May saw an unexpected decline, plus gains in the prior four months were also revised down. This confirmed fears that were sown last month by several major retailers, who surprised the market by reporting unexpected weakening in consumer spending trends. For the US housing market, it has become evident the sector is coming off as home sales volumes declined to pre-pandemic levels. However, with house prices having soared some 45% since March 2020, and mortgage rates rising to levels not seen since 2008, the stability and direction of the housing market is being called into question. On the production side of the economy, manufacturing surveys showed reductions in the level of activity and a weak outlook. High raw material prices, supply chain disruptions and labour market tightness are hurting profitability, while thinning forward order books and elevated inventories are raising the spectre of a slowdown in future production.
There were not many places in the equity market to hide this month. Traditionally defensive sectors such as Health Care and Staples saw respective declines of -3.1% and -3.3%, despite being top relative performers. Recessionary fears caused commodity prices such as oil and iron ore to fall sharply, which knocked 15.6% and 15.0% off the year’s best performing sectors, Materials and Energy respectively. From a regional perspective, the US and the European markets saw significant selling pressure. The S&P 500 Index returned -8.3%, followed closely by the European STOXX 600 Index which returned -8%. Asian markets fared better, with Chinese equities in particular staging a strong rebound after this year’s under performance. The CSI 300 Index rallied 10.4% on improving investor sentiment as authorities began to ease COVID restrictions. Japanese equities also stood out, with the Nikkei 225 Index returning -3.1%. However, this needs to be taken in context of the Japanese Yen’s substantial fall over the month (-5.2% vs the US dollar). This reflects the Bank of Japan’s unorthodox commitment to pursuing yield curve control while the rest of the world embarks on an aggressive path of monetary policy tightening.
NEW ZEALAND EQUITIES
There Is No Recession in New Zealand (yet)
Whilst the shaky isles managed to avoid the worst of the international volatility, the benchmark S&P/NZX50 Index still posted a negative return to the tune of 3.9%. Contributing to the decline were markdowns in several large index constituents, notably Mainfreight (-8.0%), Fisher & Paykel Healthcare (-3.3%), and Ryman (-9.7%). The ongoing theme remains valuations recalibrating to a higher interest-rate environment and burgeoning recession risks.
Among individual companies, best performers were casinos operator SkyCity, and dairy collective Fonterra, which returned 11.1% and 6.5% respectively. SkyCity outperformed after releasing full-year earnings guidance which was slightly higher than market expectations, and Fonterra found a footing after announcing a small buyback and performance update. The co-op upgraded its 2022/23 milk price forecast, affirmed current year guidance and gave initial guidance for next year with a wide berth. At the other end, the Index’s worst performer was transport technology group Eroad, which careened 39.8% lower over the month, taking its decline to 72.5% year-to-date. Eroad’s permanent appointment of its caretaker CEO after an unsuccessful global search did little to assuage the corporate governance anxieties surrounding the surprise departure of its CEO and founder in April.
Macroeconomic news centred around recessionary signals, with March quarter GDP contracting 0.2% versus expectations of a 0.6% expansion. Coupled with a key consumer confidence measure cratering to the lowest level since the GFC, there is a prevailing consensus that the effects of rising interest rates, cost of living pressures, and falling house prices may soon bring about a recession in New Zealand. The last one, coinciding with the GFC, saw unemployment increase from 3.7% to 6.1%, despite the OCR being slashed from 8.25% to 2.5%. Though unemployment is now much stronger at 3.2%, a key worry is that the RBNZ may still be hiking into a prospective recession and may be limited in how much it could ease in response.
The S&P/ASX200 index returned -8.8% for June, led by the heavyweight Materials and Financials sectors, which fell 12.4% and 11.9% respectively. Consumer Staples and Energy, were the only sectors escaping relatively unscathed, both ending broadly flat. Energy continues to benefit from an environment of high prices driven by supply uncertainty and geopolitics, with four of the top five performers year-to-date being involved in fossil fuel extraction.
Best performing companies this month were Tabcorp 14.5% and Atlas Arteria 12.1%. After demerging the lottery operations it acquired less than five years ago, bookmaker Tabcorp lifted on wagering tax changes which would even the playing field versus online bookmakers. Toll road operator Atlas rose after infrastructure fund IFM conducted a raid on its share register, accumulating a 15% holding. A stalemate ensued, with IFM seeking more information to decide whether to make a formal offer, and Atlas rebuffing the request. On the other side, buy-now pay-later operator Zip, was the index’s worst performer, in palindromic fashion over both the month (-51.9%) and year-to-date (-91.5%). The broader consumer finance space has been among the worst casualties as rates rise and bad debt concerns mount.
Aside from a larger than expected 0.50% hike and a rare television interview of RBA Governor Lowe, the macroeconomic limelight was mostly trained on the dysfunction in Australia’s domestic energy markets. The fiasco culminated in AEMO (the regulator) suspending the national electricity market, after a price cap it imposed caused some generators to withdraw capacity. This resulted in further intervention being required to avoid blackouts. As record gas and coal prices feed through to power bills and put further strain on budgets, the RBA remains in an unenviable position of needing to rein in inflation whilst treading carefully around rate sensitivity given the high level of household debt.
Joining the dots
As the first half drew to a close rates volatility was back in the ascendency, proving May’s slight reprieve for bond markets short lived. New Zealand bonds remained relatively sheltered and fared better than their Australian counterparts, with the S&P/NZX Investment Grade Corporate Bond Index returning -0.2%, versus -1.6% for the S&P/ASX Australian Corporate Bond Index. June ended up being somewhat of a round trip for bonds as yields retraced from their intra-month highs to finish only marginally higher than where they started.
The major market-moving event in June was the response to a higher than expected US headline CPI print of 8.6% y/y. The spike in yields was exacerbated by commentary hinting that US inflation may have peaked with the April data release. US bond markets were initially concerned with a re-accelerating monthly trend for CPI and started to price more aggressive moves for short term rates. The Fed did not disappoint and delivered a 0.75% hike mid-month to 1.5%, demonstrating the central bank’s resolve on tackling inflation. Forward guidance at the June meeting was aided by the release of the FOMC’s dot plot of future Fed Funds rates. The median of the ‘dots’ representing committee members now reflects a peak of 3.8% in 2023 for the Fed Funds rate, which is incidentally not too far off the RBNZ’s peak estimate of 3.9% for the OCR. The RBNZ arguably retains some advantage from being further down the track on executing its monetary policy tightening.
Earlier in the month, Australia’s cash target rate was stepped-up to 0.85%, with the market reaction overshadowed by attention being monopolised by the US. RBA Governor Lowe belatedly hopped onto the “stitch in time” bandwagon, citing higher inflation estimates of 7% as a key reason for an outsized move of 0.5%. Across in Australia, there were no new central bank announcements. New Zealand Q1 GDP printed 1.2% y/y (-0.2% q/q) which was softer than expected with forecasts obviously muddied by the Omicron outbreak. Whilst the peak inflation question remains open, movements in bond yields during late June suggest that delivering on the level of further rate hikes flagged over second half of 2022 may prove challenging.