06 December 2022

    Has the Grinch stolen Christmas?

    Ashley Gardyne

    Chief Investment Officer

    Ashley Gardyne

    Chief Investment Officer

    Although markets have started to rebound in recent weeks, no one can deny it’s been a very tough year for investors. Central banks have been playing the Grinch by hiking interest rates, which has implications for investors, retirees and borrowers. While 2023 could be a challenging year economically, share markets and bond prices have fallen to an extent that returns in the years ahead are likely to be much more attractive. The Boxing Day sales look good this year.

    Some Christmas lights at the end of the investing tunnel

    The outlook for investment returns next year looks to be improving. Investment bank JP Morgan has been publishing long term market return assumptions for the last 27 years. These return forecasts are their best guess at the return each asset class will deliver over the next 10-15 years. One conclusion from JP Morgan’s latest 120-page report is that “markets today offer the best long-term return potential in more than a decade.”

    After the 2022 market downturn, return projections have increased meaningfully
    Source: JP Morgan

    Although projections for investment returns are looking better, there are still challenges ahead for the economy, with the central banks around the world trying hard to rein in inflation.

    Central bankers playing the Grinch

    The Christmas Grinch award this year well and truly goes to central bank governors. Most global central banks have hiked interest rates significantly this year, with no let-up coming into Christmas. The increased cost-of-living, combined with rising mortgage servicing costs, has households questioning just how much they should splash out this Christmas.

    After years of their policies contributing to soaring asset prices, central banks have well and truly taken away the punch bowl and called an end to the party. As shown in the charts below, the result has been falling asset prices and one of the most difficult years for investors in decades.

    While investors in equity markets are more accustomed to the volatility we have experienced this year, conservative investors have been surprised by falls in their conservative and balanced funds. Bond prices fell by a record amount this year which led to a c.7-8% fall in conservative fund values. This is a very rare event and not something we would expect a repeat of in the years ahead.

    Are the Official Cash Rate (OCR) hikes hitting the mark?

    The Reserve Bank of New Zealand (RBNZ) recently lifted the OCR by 0.75% to 4.25% - the sharpest hike in over 20 years. They also lifted their expectation for the peak OCR from 4.1% to 5.5%. These moves have seen fixed mortgage rates rise above 7%.

    We are of the view that the RBNZ is in the process of making a policy mistake – and will do more harm than is needed to get inflation back under control. Current inflation has been caused much more by supply-side shocks (energy shortages, shipping bottlenecks, labour shortages etc.) than out-of-control consumer spending. But the RBNZ is caught between a rock and a hard place. They only have one tool in their tool kit, and they need to show they are serious about getting inflation under control. In doing so they will put many New Zealand households under significant strain.

    Play the game in front of you, not the one you hope for

    Regardless of your view on what the RBNZ should be doing, we all need to respond to what they are doing, and there are some positives amongst the gloom.

    For those with a mortgage – this means some belt tightening. Not only do borrowers need to find room in their budget for higher mortgage payments, but if possible, they should also be building up a cash buffer, so they have reserves as the economy slows.

    For those entering retirement –after years of low interest rates and retirees struggling to make their money work for them, they can finally get attractive prospective returns on lower risk investments like bonds. The running yield on our Income Fund has increased to over 7% in recent months.

    For first home buyers – the rising cost of mortgage servicing makes it harder to get and service a mortgage, but on the flip side, house prices are falling and likely to fall further. By the end of next year house prices may be significantly lower, and if the economy enters recession the RBNZ may need to start cutting interest rates, finally bringing the prospect of more affordable housing.

    The Boxing Day sales are looking better this year

    There are also some positive signs for those saving for retirement. The flipside of falling share markets and rising interest rates is better future returns. The Boxing Day sales in the market this year are as good as they’ve been in over a decade. The valuations of many high-quality businesses like Amazon, Alphabet and Xero are almost as low as they’ve ever been. As history has taught us, investors that continued contributing to KiwiSaver during the global financial crisis and other major market downturns, benefitted significantly as markets rebounded.

    With asset prices having fallen back down to earth, there are richer pickings for investors in both equity and fixed interest markets.

    If you would like to talk to someone about your investment strategy, the team at Fisher Funds are here to help. Please contact us or get in touch with your adviser.