February Monthly Market Update
As at end of February 2023
After a strong start to the year, the rally in global equities stalled during February. While headline returns for February across most major country-based indices were in negative territory, unhedged kiwi investors were still able to see positive returns due to the kiwi dollar weakness - notably versus the USD, where it fell 4.1%. The MSCI World (NZD) Index rose 1.8%, whilst the local currency variant, which excludes the impact of foreign currency shifts was down 1.6%.
In terms of regional performance, Eurozone and UK equities were the best performers, eking out small gains as risks of an energy shortage induced squeezing dissipated, largely thanks to an unseasonably warmer winter. By contrast, Chinese equities were among the worst regional performers. The MSCI China Index fell 10.2% as increasing geopolitical tensions drove some profit taking following the recent re-opening surge which saw the market rally 50% over the course of a few months.
The shift in risk sentiment was another case of ‘good news is bad news’ for equities - whereby resilient and improving macroeconomic data adding further weight to the narrative that central banks will need to be more restrictive for longer, negatively impacting equity valuations.
The positive news-flow was predominantly around very strong labour market data, with unemployment rates across many parts of the world continuing to edge below pre-pandemic levels, and wage growth continuing to run at a historically high pace, albeit somewhat below the rate of inflation. Despite rising fears of a global economic slowdown, manufacturing data was also surprisingly strong, indicating the economic backdrop remains healthy. Purchasing Manager Index (‘PMI’) surveys from major regions such as US and Europe exceeded expectations, showing recovery in levels of output, whilst in China activity picked up sharply after the recent relaxation of tough Covid-19 restrictions. Meanwhile, the pivotal inflation data which has been on a downward trend since last year’s highs, didn’t slow as much as expected by the market this month. This stubbornness played into fears that high inflationary expectations may be embedded in the economy, and hence more aggressive tightening by central banks will be required get inflation back under control.
NEW ZEALAND EQUITIES
Scaling down margins
Mirroring New Zealand’s weather in February, the local market had a volatile month, but still managed to outperform most global peers, with the S&P/NZX 50 Index returning -0.6%. One noticeable trend coming out of the recent reporting season was margin pressure caused by cost inflation and higher interest burdens.
A major theme this month was the shock from cyclone Gabrielle, with many companies directly and indirectly impacted by the storm. The biggest direct impact was felt by Scales, which fell 18.6% after reporting damage to multiple orchards and an uncertain long-term impact on crop yields. The company flagged a significant financial impact on its horticulture division in FY23 and withdrew prior earnings guidance. Fletcher Building, which ended down 6.3% also noted adverse weather impacts over January-February when the company lowered its fullyear earnings guidance this month.
The overall worst performer in the Index was Ryman Healthcare, returning -19.0% following a material $900m capital raise at a significant discount. After some hefty USPP exit costs, RYM was left with circa $750m to improve its balance sheet. The capital call caused some consternation for the rest of the sector, with Arvida and Oceania returning -12.9% and -12.4% respectively, while Summerset was a bit more resilient, ending down 5.8%.
At the top of the Index, things were less exciting with only 16 companies managing a positive return, with the top performer being KMD brands. KMD returned 6.6% following a well-received trading update, highlighting sales growth ahead of analyst estimates. Close behind was Precinct properties, with a 6.0% return despite persistent macro headwinds for the sector and revaluation losses. The company noted strong portfolio metrics and reiterated its full-year dividend guidance.
The S&P/ASX 200 Index sustained a negative return of –2.4% for February, dragged down by the heavyweight Materials (-6.6%) and Financials (-3.1%) sectors. Utilities and IT were the top outperforming sectors, delivering returns of 3.4% and 2.7% respectively.
Among individual companies, several of the outsized moves were driven by interim results announcements and accompanying outlook statements. Domino’s Pizza was the month’s worst performer, returning -32.9% after margin pressure clipped its half-year earnings by over 20%. Casino operator Star Entertainment was another poor performer, returning –17.5% as its very public downfall continued. February saw Star announce an earnings downgrade, billion-dollar asset write-down, two shareholder class actions, and culminated with an $800m capital raise ahead of anticipated regulatory penalties.
The two best performers were both in the automotive space. Component manufacturer G.U.D. returned 26.2% after reporting strong earnings momentum driven by acquisitions, and car dealer A. P. Eagers returned 19.9% on the back of a much stronger than expected revenue outlook.
Whilst corporate results stole the show, there were also a couple of surprises on the macroeconomic front. Most notably, the unemployment rate ticked up from 3.5% to 3.7%, with declines in workforce participation and fulltime jobs a worrisome composition. Building approvals for December were also unexpectedly strong, climbing 18.5% from November. The RBA took another baby step, hiking the cash rate 0.25% to 3.35% amidst louder noises about rising mortgage stress; and Treasurer Chalmers foreshadowed plans to tinker with Australia’s circa A$3 trillion superannuation system.
Back to Reality
Much of January’s optimism faded quickly into February as bond yields reversed course to finish higher for the month. Slow progress towards disinflation and robust labour markets left bond investors fearful that central bankers would revert to a “higher rates for longer” narrative to combat sticky inflation. Returns turned negative for the month, with the Bloomberg GlobalAgg (NZD) Index finishing 1.7% lower. Corporate bonds in both New Zealand and Australia outperforming expectations following a reporting season which saw many companies report continued recovery in consumer activity toward pre-Covid levels. The S&P/NZX Government Bond Index, closed down 1.9%, behind the S&P/ASX Australian Corporate Bond Index which fared better finishing -0.7% for the period, supported by credit spreads which did not follow moves wider in the US.
February’s FOMC meeting saw the Fed Funds rate move higher by 0.25% to 4.75%, with Chair Powell reiterating that ongoing rate hikes remain appropriate. While the downshift in size of hike was anticipated, market expectations for the Fed Funds peak rate shifted higher over the month towards 5.4%, corresponding with concerns that higher rates may be necessary to tame inflation.
Here in New Zealand, the RBNZ hiked by 0.5% to 4.75% at its first meeting of the year. Though the RBNZ anticipates a short-term domestic inflationary impulse in response to the recent floods and Cyclone Gabrielle, the bank is also cognisant of an increasing correlation between tradables and non-tradables inflation. The implication is that global disinflationary effects need to play their part to get CPI back to target levels. This will be no easy feat, as New Zealand’s labour market continues to remain historically tight. The latest unemployment reading came in at 3.4%, completing a 5th quarter of sub-3.5% unemployment. For now, the RBNZ’s outlook for the OCR track remains unchanged, forecast to peak at 5.5% with unemployment data expected to soften in coming quarters.
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