Last month I wrote of the parallels between financial markets and the recent extreme weather hitting the country. While driving through Northland earlier this month, I witnessed some of the aftermath of these storms – with significant damage to many roads. While the outlook for long-term returns continues to improve, like the start of this year in markets, these potholes and sunken roads make for a bumpy journey.
Inflationary pressures are easing across much of the world which gives hope that a peak in interest rates may be near. This should be positive for financial markets as expected long-term returns for both bonds and equities continue to improve from the low levels of recent years. But while the destination has improved, we can expect a bumpy journey to get there, and the journey may take a little longer than we originally expected.
Road back to target inflation could be longer than hoped
After a strong start in January, markets gave back some gains this month, although they are still up from the start of the year. Both New Zealand’s NZX50 and the S&P500 have increased by 3.7% in the year-to-date, although the NZX50 fell 0.6%, and the S&P 500 was down 2.4% in February. Despite small declines over the month, our portfolios are performing well year-to-date.
Having fallen in January, interest rates for 10-year NZ government bonds increased rapidly during the month and are approaching peak levels seen in October last year.
While overall inflation appears to have peaked – the market is increasingly coming to the view that central banks have more work ahead in getting inflation back under control. Global economic data has also begun to surprise to the upside – tempering expectations of a softening stance from central banks.
Job markets continue to be resilient with unemployment rates moving below their pre-pandemic levels across many economies. The US posted an unemployment rate of 3.4%, the lowest level since 1953 as half a million new jobs were added in January. Perhaps supported by high employment, US consumer spending was also strong with retail sales continuing to rise.
Plenty of potholes for economies to navigate
While negative for those hoping for a decline in interest rates, the resilience of the economic data suggests that a recession may not be as imminent as feared. While you might expect the prospect of a delayed recession would be positively received by markets, this was outweighed by the disappointment at the prospect of less monetary easing in the near future.
Investors also seem to be looking past strong data today to potential economic challenges ahead. Rising mortgage rates, falling house prices, and shrinking savings balances continue to weigh on sentiment. On the other hand, a reopening Chinese economy should provide a boost to global demand. All this means we should expect a few bumps ahead as economies and markets navigate these challenging times.
We are driving towards a better destination
The near-term path for economies and markets remains uncertain, but trying to predict or time these moves is a near impossible task. Investors should instead block out the noise and focus on the longer-term fundamentals.
Higher interest rates and lower equity valuations than a year ago both provide better expected returns for long-term investors in bonds and equities. Within these markets we are seeing attractive investment opportunities and continue to take advantage of these as they arise. The fundamentals of our portfolio companies remain strong despite the challenging economic backdrop.
As this month has shown, the road ahead may be a bumpy one, but the destination for long-term investors is looking increasingly attractive.
