Investment Update

It was a volatile first quarter of the year in financial markets, highlighted by the failure of two banks in the US and the takeover of a major European bank. Despite these concerns, and lingering fears of a global recession, most equity markets ended the quarter higher, with the MSCI All Country World Index rising 6.5% in local currency terms.

Significant events from the first quarter of 2023 included:

In March, the failure of Silicon Valley Bank (SVB) rattled financial markets. The California-based lender collapsed at an alarming speed after a failed capital raise to cover a shortfall in deposits saw a run on the bank. Following SVB’s collapse, New York-based Signature Bank suffered a similar fate given its niche client base.

To shore up confidence, US regulators pledged to make all deposits whole (under current FDIC legislation, only deposits up to $250,000 are insured).

A few days after the collapse of the two US banks, Credit Suisse ran into troubles when its annual report showed it was experiencing an outflow of funds. This prompted the bank’s largest lender to say it would not provide any further funding, raising fears that it could also have difficulty raising equity to strengthen its balance sheet.

As concerns mounted, it was agreed, with support from the Swiss government, that its competitor, UBS, would buy Credit Suisse for about US$3 billion.

In March, the US Federal Reserve (the Fed) raised the fed funds rate by 25 basis points, and signalled that the end of the current tightening cycle is near, with participants expecting one more interest rate hike in 2023.

In its summary of economic projections, the Fed reduced its growth outlook (but does not foresee a recession), revised down its unemployment rate forecast and said inflation will stay above normal levels throughout 2023.

In New Zealand, the quarter was dominated by Cyclone Gabrielle and the economic and social fallout. The devastating floods are likely to have a long-lasting impact on our primary industries, especially food production and dairy.

The Reserve Bank of New Zealand (RBNZ) raised the Official Cash Rate (OCR) by a further 50 basis points in February, signaling its fight against inflation is far from over. It added that the rebuild post Gabrielle will likely be inflationary.

“In time, the infrastructure and community rebuild will add to activity and inflationary pressures, especially given existing capacity constraints in the economy,” the RBNZ statement read.

Economic data showed the New Zealand economy contracted in the fourth quarter of 2022 by 0.6%, a bigger contraction than expected. 

International equity markets shrugged off the banking concerns in the US and Europe, and ongoing fears the global economy could be headed for a recession, to finish the quarter mostly higher.

After underperforming in 2022, US equity markets were some of the best performing over the quarter, led by the technology sector that benefited from falling bond yields. The tech sector’s outperformance saw the NASDAQ 100 TR Index rise by 17%.

Meanwhile, lower oil prices saw energy stocks out of favour, while the banking worries weighed on financials. In spite of this, the broader S&P 500 TR Index recorded a 7.5% gain.

Continental European share markets had a good quarter, helped in part by a warmer winter that meant the energy crisis did not materialise as feared. Despite a late-quarter sell-off, the Euro Stoxx 50 Index still recorded a 13.7% gain.

Finally, the Chinese re-opening boosted activity there and saw its share market, the Shanghai Composite TR Index, hit an eight-month high, finishing the quarter up 5.9%.

The New Zealand equity market finished the quarter higher, but underperformed most global counterparts, with a further interest rate hike and uncertainty surrounding the economic impact of Cyclone Gabrielle tempering investor sentiment. Furthermore, consumer and business sentiment continued to wane as inflation pressures persisted.

Over the quarter, the NZX 50 Index rose 3.6%, with energy the strongest sector, while consumer staples shares lagged.

At a company level, Push Pay Holdings (+8.6%) benefited from an improved takeover offer, up from $1.34 per share, to $1.42 per share. Fisher & Paykel Healthcare (+17.6%) was the best-performing company.

In Australia, falling commodity prices saw the energy-heavy index underperform, while bank stocks also struggled with the “big four banks” all ending the quarter lower.

Nevertheless, the ASX 200 TR Index still ended the quarter with a 3.5% gain.

Global bonds had a strong quarter as the bank failures in the US saw safe haven assets, notably government bonds, in demand.

Although we saw further interest rate hikes from the Fed and some persistent inflation data, most US bond yields fell to their lowest levels since 2022. By the end of the quarter, the yield on the US 10-year government bond was at 3.47%, down 40 basis points.

It was the same story in Europe with bonds in demand as worries around Credit Suisse and potential market contagion persisted.

At one point, the yield on the German 10-year government bond dipped below 2%, having traded above 2.7% in early March.

Japanese bonds also delivered strong returns, but their gains came mostly from policy decisions. In March, the Bank of Japan (BOJ) maintained its ultra-low interest rate policy, and made no changes to its contentious yield curve control (YCC) policy where it does not let its key 10-year yield trade outside a certain band.

New Zealand bonds also had a good quarter, but a hawkish central bank and worries that Cyclone Gabrielle could add to inflation concerns meant gains were more limited than offshore markets.

At the RBNZ’s February meeting, the Committee stressed that inflation is “too high” and it must “continue to increase the Official Cash Rate” to bring inflation down.

Over the quarter, the 10-year government bond yield fell 27 basis point, ending at 4.20%.

The New Zealand listed property index finished the quarter with a more modest 2.0% gain. The property sector continues to underperform against the backdrop of higher interest rates.

Across the Tasman, the listed property sector underperformed, finishing with a 0.5% gain.

Meanwhile, infrastructure stocks were mixed over the quarter. Some strong performances from European utilities and transport that benefited from inflation tailwinds were offset by US weakness as investors preferred growth assets.

It was pleasing to see most equity and bond markets finish the quarter higher, but we remain relatively cautious as we are starting to see the cumulative effect of the interest rate hikes over the past 12 months or so.

Firstly, the failure of two US banks was part due to higher interest rates, and part due to poor risk management in dealing with the move higher in interest rates.

And in New Zealand, borrowers are starting to roll off ultra-low mortgage rates. This is going to slow household spending further, as disposable incomes fall. It appears to have already started, with GDP growth data showing that the local economy contracted in the final quarter of 2022.

Looking ahead, sticky inflation and robust labour markets continue to pose challenges for policymakers to bring inflation back to target levels.

Meanwhile, the biggest risk in the wake of the bank failures is to what extent it will tighten financial conditions. A tightening of conditions will make borrowing more challenging which would likely weigh on growth and potentially be detrimental to labour markets and inflation.

Finally, given the risks discussed, our base case now leans towards a mild recession that is more likely to begin in the second half of this year, rather than early in 2024, as the market had previously expected.