03 April 2019

    It was the best of times

    Thoughts on how markets performed in March

    Well that was quite a month. Solid gains for every asset class, in almost every market around the globe. It really was, with a little Dickensian licence, the best of times[1].

    The numbers make for impressive reading. The global share market rose 1.2% for the month, New Zealand shares leapt 5.9% and fixed income posted strong gains. New Zealand government bonds, for instance, delivered a return of 1.85% based on the S&P/NZX New Zealand government stock index.

    Rising asset prices will certainly make quarter end statements look healthy and are a welcome recovery from the challenging markets at the end of last year.

    Falling interest rates were a standout

    For me the standout feature of the month was the dramatic fall in long term interest rates around the globe. New Zealand led the charge with ten-year government bond yields falling from 2.2% to end the month yielding a paltry 1.8%.

    This is where the duality of Dicken’s quote seems eerily appropriate. March, in many ways, was the best of times. Falling bond yields point to something quite different.

    The level of long term interest rates is a function of a number of influences. Yields reflect investor’s outlook for economic growth, where they expect inflation to head and how much compensation they demand for locking money up on a fixed rate for long time periods.

    This month’s falling long term interest rates provide a clear indication that investors expect either economic growth or inflation to be lower in the next ten years than they have been.

    Lower economic growth or lower inflation, particularly given that inflation is already very low, is unlikely to be a great backdrop for asset returns.  The “best of times” that we have enjoyed over the past three months may well be followed by a less attractive investing environment.

    Cautious positioning is warranted

    There is little doubt, in our view, that the global economic growth is slowing and that the impact of this will be felt not only in interest rate markets but will also slow company earnings growth potentially pressuring share prices. 

    As a result of this view we have adopted, where we have discretion, a cautious posture having a lower exposure to shares than normal. This is certainly not an extremely nervous or bearish posture but reflects a healthy dose of caution.

    Low interest rates pose additional challenges

    We Kiwis have been a lucky bunch. Since the Global Financial Crisis we have enjoyed a healthy economy, a vibrant share market and yet still been able to generate good returns on lower risk investments like government bonds and bank term deposits. This is changing.

    New Zealand Government bonds now yield a paltry 1.8%. This is lower than the average 2% inflation rate targeted by the Reserve Bank of New Zealand. Buying ten-year Government bonds and holding them to maturity is likely to lock in a real, after inflation, loss. For investors living off interest income this represents a massive challenge.  

    The capital gains from falling interest rates have delivered what we will look back on as the best of times. The low yields now in place from falling interest rates may mean, for many investors, the worst of times is yet to come. Expect to hear more from us on this topic over the coming months.

    [1] With apologies to Charles Dickens from “A Tale of Two cities.”  The full quote is that “It was the best of times. It was the worst of times.”