After a strong start to the year, equity markets declined modestly in August as investors weighed up contrasting economic data. This year has also seen widely divergent performance across different sectors and asset classes, but these divergences create opportunities in markets and our team has been busy repositioning portfolios accordingly.
Markets cool in August as investors weigh up contrasting data
Global share markets fell 2.6% in August, with US equities outperforming (down just 1.8%), while European equities fell 2.8% and emerging markets declined 6.4% – primarily due to concerns surrounding the Chinese economy.
The primary driver of this market weakness was the rise in bond yields, which in some markets reached fresh 10-year highs. Strong US GDP growth (growing at 2.6%), retail sales growth, and a rebound in consumer confidence in recent months has highlighted underlying resilience in the US economy. This strong economic data drove yields higher and raised concerns that central banks may need to keep interest rates higher for longer to offset inflation pressures.
Later in August, however, some of the concerns around too much heat in the economy subsided as US labour market data pointed to a cooling job market (with payroll job gains in July coming in at 187,000 – below the market expectation of 200,000). Commentary by US Federal Reserve Chair Jerome Powell late in the month also indicated that they weren’t wedded to further rate hikes, which was well received by the market.
Globally, consumer spending is still strong, but interest rates are starting to bite
While it was strong economic data and the prospect of more interest rate hikes that spooked markets, there are also increasing questions about the longer-term impact of interest rates on consumers if rates don’t start to subside next year.
On one hand, most countries have so far avoided the recession that many expected. Unemployment is very low globally (3.8% in the US and 3.6% in New Zealand), and global consumer spending has been supported by economic reopening and the large cash balances that consumers built up during Covid.
On the other hand, the impact of rising interest rates is slowly starting to be seen. As we know from history, central bank interest rate hikes take several quarters (often up to 18 months) to have their full effect, as consumers re-fix mortgages and adjust their spending accordingly. We have already seen some of the effects, with a slight increase in loan arrears in a number of markets. Lower housing turnover and low mortgage applications will also have an impact on economic activity, as will the wealth effect of the significant fall in house prices witnessed in many markets.
The chances of an economic soft landing have increased compared to last year, but we are not yet out of the woods. This economic uncertainty will impact different companies and economic sectors differently.
Market dispersion creates opportunities
The uncertain economic backdrop can also create opportunities, as different markets and asset classes see their performance and valuations diverge. While international equity markets have rallied this year, bond markets have gone sideways. The New Zealand and Australian equity markets have materially lagged their global counterparts. Sectors like technology have outperformed, while defensive sectors like healthcare and consumer staples have underperformed. These divergences create opportunities for investors, and our team has been busy repositioning portfolios to take advantage of these.
We have been adding new investments to our International and Australian equity portfolios in recent months. In a number of portfolios we have been moderately reducing our exposure to technology companies (which have rebounded strongly this year) and adding to more defensive investments in areas like healthcare. At the margin we have also reduced our exposure to selected cyclical companies in areas like transport and homebuilding. In our Fixed Income portfolios, we have generally been increasing duration to take advantage of the most recent spike in longer term interest rates.