Investment Update

Global equity markets had a strong start to the year, driven in part by the ongoing artificial intelligence boom, which saw indices in most major markets reach new highs. Against this backdrop, the MSCI All Country World Index rose 9.1% over the quarter, in local currency terms.

Bond markets had a more challenging time as expectations for early interest rate cuts were delayed to later in the year given generally upbeat economic data. The Barclays Global Aggregate Index (100% hedged to NZD) was unchanged over the quarter.

While inflation has fallen over the past 12 months, progress stalled in the US, with the annual Consumer Price Index at 3.1% in January and 3.2% in February. Both were ahead of consensus, raising concerns that bringing inflation back to its 2% target rate may be more challenging than expected.

It was a better story in Europe. Year-on-year inflation in the Eurozone fell to 2.6% in February, while in the UK it dropped to a two-year low of 3.4% for the same period.

Heading into the year, investors appeared confident interest rate cuts could be seen as early as March. However, these expectations were pushed out as growth data and the employment situations in many economies remained resilient. 

Given this, most of the major central banks pushed back on the idea of rate cuts anytime soon, saying they wanted to be confident that inflation was heading back to target levels before cutting. It meant that most left interest rates unchanged, including those in the US, Europe, UK and Australia.

The outliers were Japan and Switzerland. The Bank of Japan raised its lending rate 10 basis points, becoming the last country in the world to end a policy of negative interest rates, while, the Swiss National Bank cut interest rates, saying it’s confident inflation there would return to target.

Economic data during the quarter highlighted some of the challenges facing the New Zealand economy at present. Inflation showed that consumer prices rose at an annual pace of 4.7% in the fourth quarter of 2023. While it was the smallest annual rise in over two years, non-tradeable inflation (domestically generated) remained worryingly high, at 5.9%.

Perhaps the biggest news however was confirmation that the New Zealand economy entered a recession in the final quarter of 2023 contracting 0.1% , and marking the second consecutive quarter of negative economic growth. On a per capita basis the economy fared even worse, shrinking 0.7% over the quarter.

Also on the weak side were retail sales figures, which fell 1.9% during the final quarter of last year. It’s the eighth consecutive fall for this data series and highlights the ongoing challenges households are facing from high borrowing costs.

Finally, against this backdrop, the Reserve Bank of New Zealand (RBNZ) left the Official Cash Rate (OCR) unchanged at 5.50%. It also delivered a somewhat dovish statement, with the central bank lowering its forward track – the rate it expects the OCR to peak – to 5.60%, down from 5.69%, implying a less-likely chance of further interest rate hikes.

Global equity markets continued their stellar performance, with several share markets in the US, Europe and Asia reaching record highs as optimism that central banks were on track to cut interest rates later this year grew.

In the US, the S&P 500 rose 10.6%, while the NASDAQ 100 was up 9.3%. Communications services and technology were the two standout sectors, while energy stocks also had a good quarter, buoyed by rising oil prices.

Meanwhile, in Europe, inflation fell to its lowest level since 2021, propelling several share markets within the region to record highs – some finishing the quarter with double-digit gains. The best-performing was the Euro Stoxx 50 Index, which ended the quarter up 12.8%.

Finally, in Asia, Japan’s Nikkei 225 remained one of the best-performing share markets over the quarter. It rose 21.5%, helped in part by a revitalisation of the local economy, which has been stuck in deflationary periods over the last decade. Meanwhile, in China, the Shanghai Composite Index finished the quarter slightly higher, but remained one of the weakest global share markets as its property sector continues to pose headwinds.

New Zealand equities finished the quarter modestly higher, with the NZX 50 up 2.8%, which moved the market into positive territory over the past 12 months. However, its return lagged those of its global counterparts.

The underperformance came in part due to ongoing inflation worries, with the rate of inflation one of the highest in the developed world. Adding to the broader economic worries was news the economy entered a recession in the final quarter of 2023, with Gross Domestic Product (GDP) declining 0.1%.

At a company level, A2 Milk was the standout performer, with its shares rising by over 45% after it reported first half 2024 earnings that comfortably beat expectations. The company reported EBITDA of $113.1 million and a NPAT of $85.3 million. 

Meanwhile, in Australia, the ASX 200 returned 5.3%, outperforming the New Zealand market, but also well behind most global share markets. The underperformance was largely due to weakness in the mining sector, which struggled against the backdrop of falling iron ore prices that saw dominant players, Rio Tinto and BHP Group, down more than 10%.

Global bond markets were generally lower over the quarter, reversing the trend of late last year. US bonds faced headwinds against the backdrop of ongoing resilience in the local economy, which saw growth data come in stronger than expected and further job gains to start the year. Signs that certain sectors were still experiencing bouts of inflation also kept bonds under pressure.

Despite this, the Federal Reserve (Fed) stuck with its projection of three interest rate cuts by the end of 2024, when it released its economic projections in March. 

European bonds were also lower, despite several of its economies showing better progress on inflation, raising the likelihood that the ECB could begin cutting interest rates as soon as June. One outlier was Switzerland, where its central bank began cutting interest rates, saying that it was comfortable that inflation would revert to target levels, while adding that it believed a rate cut would boost economic activity.

New Zealand bonds had a volatile quarter. Initial weakness in bonds was driven by domestic employment data, which showed the labour market remains significantly tight and that this is likely to underpin wage pressures.

However, bond yields fell (meaning prices rose) in the latter stages of the quarter, after the RBNZ delivered a relatively dovish statement and the news the country was in recession to end 2023. Interest rate markets suggest the next move by the central bank will be a cut.

By the end of the quarter, the yield on the New Zealand 10-year government bond was up 22 basis points, to 4.54%. However, this was down from an intra-quarter high of 4.98%.

The New Zealand listed property sector returned 0.1%, struggling against the backdrop of higher bond yields. Of the ten companies that make up the property index, half delivered a positive return, with the best-performing ones being NZ Rural Land Company and Property for Industry. It was a much better story in Australia, with the listed property index rising 16.8%, helped in part by a softening of inflation.

Listed infrastructure stocks made good progress over the quarter but were behind some other major sectors. The FTSE Global Core Infrastructure 50/50 Net Index (100% hedged NZD) delivered a 2.9% return over the quarter.

Our base case is that growth continues to slow, but remains positive over the short term in the US, with weaker growth in Europe and New Zealand. We expect labour market demand to continue to soften, partly due to an easing in consumption in the face of new headwinds. The recent strength of the US economy is raising the possibility that while it slows, it diverges from many of its global peers and does not enter a recession – or it is pushed out to 2025.

Some of the key pillars we’re monitoring include:

Progress has stalled somewhat in the US, with annual inflation holding above 3%, driven largely by the ongoing rise in shelter inflation. Although rents in many US states have declined, it appears several are still experiencing rental rises amid population increases, while the lag of data may also be keeping the headline shelter inflation rate elevated.

While we are comfortable that inflation will revert to its target rate, upside risks remain – notably oil prices amid the geopolitical unrest, and wage pressures as labour markets remain tight.

The Fed and European Central Bank appear set to start cutting interest rates in the middle to latter stages this year, with both seemingly comfortable that restrictive monetary policy over the past two years has done enough to cool growth and bring inflation back to manageable levels.

The risk is that the Fed delays its cuts due to the ongoing strength of its economy. Despite this, the Fed maintained its projections for three interest rate cuts in 2024 when it met in March.

The outlook remains challenging. Strong immigration has driven rents and construction costs back up, with economic growth declining the last two quarters. Given strong immigration, per capita GDP has contracted even more, leaving the RBNZ in a waiting pattern.

Although inflation remains elevated, the weakness in the economy suggests it’s only a matter of time before waning demand brings inflation back to target, leading to interest rate cuts to support a weakening economy.