Investment Update

It was another strong quarter for US share markets with most indices trading to record highs, while European markets faced pressure amid geopolitical uncertainty. The gains in the US were helped in part by the ongoing AI-boom, while progress on inflation also boosted sentiment. The MSCI All Country World Index rose 2.8%, in local currency terms.

Technology companies continued their outperformance during the quarter, largely driven by the ‘Magnificent 7’, with all but Tesla ending the quarter with double-digit gains. The strong showing of this sector was twofold: Firstly, optimism around artificial intelligence (AI) continued as many of the mega-caps raced to stay ahead of their competitors, while secondly, many delivered better than expected Q1 earnings, proving that they have been able to navigate higher borrowing costs.

After a challenging start to the year, the US saw progress on inflation, with the annual rate dipping to 3.3% in May, down from 3.4% in April, and 3.5% in March. However, despite the drop in inflation, the US Federal Reserve (the Fed) decreased its expectation of interest rate cuts for 2024 from the three it signaled in March, to just one when it met in June.

The European Central Bank (ECB) and the Bank of Canada (BoC) both cut interest rates by 25 basis points, with the BoC offering the most dovish tone, saying if inflation continues to moderate, “it is reasonable to expect further cuts to our policy interest rate”.

The BoC and ECB joined the Swiss National Bank (SNB) and Sweden's Riksbank in being among the first major central banks to cut interest rates to ease pressure on households and businesses.

Facing mounting pressure, French President Emanuel Macron, and UK Prime Minister Rishi Sunak, called snap elections. Macron was trying to fend off the growing support from right-wing parties, while Sunak, whose approval rating continued to decline, was hoping to capitalise on the recent drop in inflation and economic rebound.

It was a tough quarter, with economic data highlighting the ongoing challenges the New Zealand economy is facing. The unemployment rate rose to 4.3%, the highest level since mid-2021, business and consumer sentiment remained downbeat, and retail spending data suggested New Zealanders were tightening the screws as the cost-of-living crisis continued. GDP (Gross Domestic Product) figures showed that the New Zealand economy came out of a recession, but on a per capita basis it continues to contract at a material pace.

Despite ongoing challenges, businesses and households got no relief from the Reserve Bank of New Zealand (RBNZ), as it maintained its hawkish bias, raising its OCR track (the rate it expects the OCR to peak) by 10 basis points to 5.65%, implying a 60% chance of another interest rate hike. The RBNZ said that despite a slowing economy, its number one goal is to get inflation back to its 1-3% target range.

Finally, Budget 2024 didn’t offer up any surprises with the Government reiterating the challenging economic outlook ahead, while forecasting a return to surplus by 2027-2028.

International equity markets delivered mixed performances, despite some reaching record highs. Driving sentiment were signs of a continued easing in inflationary pressures and the strong performance of the information technology sector. A notable performer was Nvidia (+36.7%), which briefly surpassed both Apple and Microsoft to become the largest company in the world by market capitalization.

In the US, the S&P 500 Index rose 4.3%, while the NASDAQ 100 Index was up 8.5%. The Dow Jones Index finished in the red however (-1.7%), such was the outperformance of various sectors of the market. Communication services and information technology were the standouts, while materials, industrials and energy were lower.

European equity markets were generally lower, as politics took centre stage. France’s CAC 40 Index fell 6.6%, as President Emanuel Macron called a snap election. The UK equity market however climbed to a new high, on hopes of interest rates cuts by its central bank. Its gains were despite the prospect of Rishi Sunak’s Conservative Party losing power in its own elections (which is how things played out early in July). The FTSE 100 Index finished the quarter up 2.7%.

Asian markets were also down. Japan’s Nikkei 225 Index fell 1.8% amid concerns about economic growth after the Bank of Japan (BoJ) ended its zero interest rate policy. A standout was Hong Kong’s Hang Seng Index, which rose 9.0% given an improving economic landscape in China (albeit off a low base).

New Zealand equities finished the quarter lower, with the NZX 50 Index down 3.2%. The local market retreated given the challenging economic backdrop. At a company level, Fisher & Paykel Healthcare (+18.5%) and Gentrack Group (+15.2%) were standout performers, both benefiting from having increased their earnings forecasts, the former getting a boost from a weaker kiwi dollar. In contrast Tourism Holdings (-43.7%) suffered, after cutting its earnings forecasts citing weaker economic conditions, while retailers Warehouse Group (-32.4%) and Kathmandu Brands (-36.4%) were also down sharply.

In Australia, the ASX 200 Index declined 1.1%. Its underperformance was largely due to stronger-than-expected inflation, which raised the possibility of the Reserve Bank of Australia (RBA) hiking interest rates, when markets had come to expect the next move to be lower.

US government bonds came under pressure early on. Many expected the first rate cut from the Fed to come in June, however sticky inflation and resilient economic data meant this was pushed to later in the year. The idea of interest rates staying higher for longer meant bonds sold-off. They later reversed direction, allowing them to regain most of their losses. This was on the back of the latest CPI data and an acknowledgment by Fed Chairman, Jerome Powell, that “there has been modest further progress” on inflation.

Bond markets elsewhere finished the quarter lower. The weakness was most pronounced in Europe, despite the ECB delivering a rate cut – which ordinarily would be good for bonds. The region was hampered by the poor performance of French bonds, which fell as investors worried that campaign pledges by political parties for July’s elections could blow out already-high levels of government debt. Japanese bonds were also weak, as the BoJ raised interest rates for the first time in 17 years, and Australian bonds were also down as inflation put the prospect of rate hikes back on the table.

While government bonds fell, corporate bonds did a bit better. As a result, the Barclays Global Aggregate Index (100% hedged to NZD) was broadly unchanged over the quarter, up 0.1%.

New Zealand bonds largely took their direction from the US market but ended the quarter modestly higher. Initial weakness was driven by domestic inflation data, which was on the strong side, and as the RBNZ left interest rates unchanged, saying they may need to remain “at a restrictive level for longer than anticipated… to ensure the inflation target is met”. They later recovered ground as overseas central banks began cutting interest rates, and given continued weakness in local economic data.

New Zealand listed property struggled as bond yields edged back towards the 5% level. The sector fell 8.6%, underperforming the broader equity market. Of the ten companies that make up the property index, nine delivered negative returns, with Kiwi Property Group the only one to post a modest gain. The worst performer was Vital Healthcare Property.

It was a similar story in Australia, with the listed property index down 5.6%, as stronger than expected inflation meant rate cuts there were taken off the table.

Meanwhile, listed infrastructure stocks gained over the quarter, with the FTSE Global Core Infrastructure 50/50 Net Index (100% hedged to NZD) delivering a 1.4% return.

We saw some divergence in financial markets during the second quarter, with US equities continuing to outperform, while several other global share markets ended the quarter lower. The divergence highlights the ongoing strength of the US economy, which continues to run at a faster pace than its peers. As we assess the outlook for the global economy, the key themes we are following include:

Rhetoric from the Fed shifted during the quarter, as its rate-setting Committee scaled back its forecast of three interest rate cuts in 2024, to just one. Policymakers highlighted that getting inflation back to target is taking longer than they had hoped, largely driven by the stubbornly high shelter component of the inflation basket.

On a more positive note, the Fed’s preferred measure of inflation – the personal consumption expenditures (PCE) price index – is running below 3% and is trending down.

After a prolonged period of record-low unemployment in many countries, labour markets have loosened to some degree over the past few months, which has helped bring down inflation.

In the US, we have seen a rise in the number of people filing for unemployment benefits, and while headline job growth in the nonfarm payrolls remains robust, there is some divergence with the household labour force survey, which could point to some potential weakness.

The New Zealand economy continues to underperform many of its peers with retail spending, confidence numbers and per capita growth all uncomfortably low.

Nevertheless, the RBNZ has remained steadfast in its focus on bringing inflation back to its target range. Despite this hawkish bias, we still see a relatively high chance the RBNZ will be forced to cut interest rates later this year as the economy continues to deteriorate.