Bloomsbury Autumn Update January - March 2017
In this issue
- Market commentary
- Key market movements for the quarter
- Vision blurred by hindsight bias
- Like what you've read?
We are pleased to report that, once again, the markets have delivered another strong positive start to the year. This stretches the winning sequence to eight years in a row - since the Global Financial Crisis - where the January to March quarter has performed well. More impressively, in seven of those years (including this year) the returns for the quarter have comfortably exceeded our long run expected returns for a three month period.
While market commentators are frequently preoccupied with identifying reasons for market weakness (and usually getting it wrong), the reasons for market strength are often strangely ignored. Presumably, this is because those same commentators assume that favourable news stories don't capture a reader's attention as well as unfavourable ones.
So why did diversified investment portfolios perform so well over the first three months of the year?
The absence of any obvious bad news was certainly a help.
You may recall that, 12 months ago, the Royal Bank of Scotland were predicting that 2016 would be "cataclysmic" for investors. Ironically, they made that prediction in a year when concerns about China were high, the UK voted for Brexit and the US voted for Donald Trump. In some ways they picked a good year for a bold prediction. Unfortunately, the only cataclysm was felt by investors who listened to them. Those who stayed out of the markets missed out on a year of strong returns.
Both Brexit and Trump featured again in the first quarter of 2017, with markets largely ignoring them.
On 20 January, Donald Trump was inaugurated as America's 45th president. He hit the ground running, issuing more executive orders and presidential memoranda than any other president in history. The most controversial of these were two attempted bans on travellers from seven and then six Muslim-majority countries together with the temporary cessation of the US refugee program; all of which were subsequently blocked by Federal District Courts.
On 29 March, Theresa May, the British prime minister, invoked Article 50 of the Treaty on European Union to commence the UK's formal withdrawal from the European Union, a process which will culminate in the UK ceasing to be a member by April 2019.
One of the largest positives for the markets in the quarter was something a little harder to quantify - improving sentiment.
According to the World Bank Group's Global Economic Prospects report published in January, global economic growth is expected to expand this year at the highest rate since the Global Financial Crisis. While this is being led by generally larger expected gains in the emerging nations, small gains are also expected across many developed nations as well, and, for some, it represents the first anticipated improvement in a number of years. In Europe, the USA, Japan, China, New Zealand and elsewhere, business surveys and general economic indicators are largely optimistic.
In New Zealand the growth outlook continues to look positive, supported by ongoing accommodative monetary policy, strong positive net migration, and high levels of household spending and construction activity. However, with no pressing inflation concerns, Graeme Wheeler, the Reserve Bank Governor, indicated in the 23 March monetary policy statement that New Zealand interest rates will be likely to remain at their current low levels for a considerable period. This will be welcome news for share market investors and those with large debt servicing commitments, but less so for retirees relying on income from term deposits.
Looking back over the first quarter of 2017, we see that most asset classes performed well.
After a disappointing end to 2016 New Zealand shares enjoyed a good start to the year, with the S&P/NZX 50 Gross Index (including imputation credits) jumping 2.48% in January, on the way to a healthy gain of 5.08% for the quarter. Whilst a return of this magnitude would normally place the New Zealand share market amongst the better performing markets for the quarter, many foreign share markets eclipsed this in what was a rewarding period for equity markets globally.
For a time local property assets looked like following a similar pattern, with the S&P/NZX All Real Estate Gross Index gaining 2.53% in January. However, negative returns in both February and March saw the index close just 1.60% higher for the quarter. High property valuations, coupled with an expectation that the official cash rate will stay at current levels until mid-2019, encouraged foreign investors in particular to reassess their exposure to this asset class.
Completing the domestic picture for the quarter were useful returns from local bond markets, with the S&P/NZX A-Grade Corporate Bond Index and the S&P/NZX NZ Government Bond Index up 1.75% and 1.39% respectively, as New Zealand yields fell modestly.
The Australian share market performed well, with the main S&P/ASX 200 Total Return Index gaining 4.82% in local currency terms. New Zealanders investing into this market on an unhedged basis also benefited by another 4.52% (source: Bloomberg), as the New Zealand dollar weakened against the Australian dollar over the quarter.
Overseas, share market returns were generally strong.
A review of the Morgan Stanley Capital International index returns in local currencies shows us that the leading developed nations all performed well, with the USA up 6.23%, Germany gaining 7.02% and France 5.86%. Even the UK - with the Brexit cloud still hanging over it - rose 3.82%. The exception, and in fact the only developed market to dip into the negatives for the quarter, was Japan, with a local market return of -0.03%.
Returns across the emerging market regions were, on average, even better than in developed markets. In local currency terms, China jumped 13.13%, India delivered 12.06%, Korea 8.24% and Brazil 7.73%. Once again this highlights the propensity for emerging markets to outperform when investors are prepared to accept greater risk. The main outlier from the emerging market regions was Russia, which fell -10.63% and suffered, at least in part, from the price of Brent Crude oil falling by -7.0% over the quarter.
Global listed property largely mirrored the performance of New Zealand property. With the global investing climate turning more favourably toward risky assets, it was listed equities which reaped the highest rewards. The slightly more defensive listed property sector, whilst performing solidly, did not enjoy the same strong tail winds. Overall for the quarter the S&P Developed REIT Index (total return) was up 1.58% in US dollar terms.
Global bonds delivered positive, if unspectacular, results, with the lack of significant new information contributing to a relatively benign quarter for fixed income markets.
International yield curves were little changed, with USA and UK long term rates trending slightly lower whilst German and Japanese yields trended slightly higher, albeit off very low bases. In aggregate, it meant the returns to bond investors were related more to the income component of bond returns (ie, the underlying bond yields) rather than the capital gain or loss component (ie, any changes in yields). By quarter end, the Citigroup World Government Bond Index 1-5 Years (hedged to NZD) returned 0.58% while the Bloomberg Barclays Global Aggregate Bond Index (hedged to NZD) gained 0.77%.
Although the European Central Bank and Bank of Japan continue to maintain accommodative monetary policy settings, the US Federal Reserve followed its December rate rise by lifting the target for the federal funds rate by another 0.25% on 15 March. This moved the federal funds target to between 0.75% and 1.00%, whilst at the same time maintaining its forecast of two more rate increases in 2017.
It will be interesting to see what transpires here. US rates could be hiked faster if the massive tax cuts and infrastructure spending promised by President Trump were to fuel higher inflation, but the details and timing of these proposals remain extremely unclear. In the meantime, the Trump administration's failure to find a compromise on the Obamacare repeal has provided an early reminder that talk is cheap, and market expectations based on campaign rhetoric may need to be adjusted downwards.
These and other questions will all be answered in due course. For the moment, however, we can reflect on another very rewarding period for diversified investment portfolios. And while it may not always make for captivating news headlines, the first quarter of 2017 was another timely reminder that, for investors, no news really is good news.
Key market movements for the quarter
New Zealand shares +5.08%
The local market bounced back from a weak final quarter in 2016 to post a strong start to the year. With improving global growth expectations, still supportive credit conditions and renewed strength in overseas equity markets, the New Zealand market enjoyed a very good quarter. Leading performers included Tower Ltd +50.9%, A2 Milk +40.4% and Scott Technology +27.9%, while Fletcher Building informed the market of a $110 million reduction in expected profits and saw its share price fall -18.9% for the quarter.
Source: S&P/NZX 50 Index, gross with imputation credits
New Zealand fixed interest +1.75%
The Reserve Bank of New Zealand maintained the Official Cash Rate at 1.75% through both its 9 February and 23 March meetings. More importantly, they reiterated they require a high threshold (in future data) before the next rate rise. The market continues to expect the next rate move will not be before 2019. This steady-as-she goes approach, and a far less threatening international outlook, saw a small rally in the local bond market as it bounced back from a disappointing end to 2016.
Source: S&P/NZX A Grade Corporate Bond Index
New Zealand property +1.60%
The domestic listed property sector only experienced a small rebound over January to March, an apparent confirmation that the repatriation by many foreign yield-seeking investors last quarter represented more than just a tactical shift. With relatively rich local valuations (most listed entities trade at a premium to their net tangible asset value), and the prospect of improving yield opportunities offshore, the domestic real estate index delivered a useful, if subdued, result.
Source: S&P/NZX All Real Estate Index, gross with imputation credits
Australian shares +9.97%
The Australian share market performed well for the second quarter in a row and a weaker New Zealand dollar (versus the Australian dollar) further enhanced returns to New Zealand investors on any unhedged holdings. Large capitalisation companies generally fared the best, with the S&P/ASX 100 delivering +10.23 while the S&P/ASX Small Ordinaries gained +6.45% (both returns in New Zealand dollars). Leading sectors included healthcare companies, utilities and information technology, whilst retail shares struggled as investors anticipated the entry of Amazon into the Australian retail industry.
Source: S&P/ASX 200 Index (total return)
International shares +5.89% (hedged to NZD), +5.29% (unhedged)
With global economic data remaining supportive and the US Federal Reserve content to maintain a measured path to increasing US interest rates, investors continued their enthusiasm for risky assets and developed market shares performed well over the quarter. Commodities generally also performed well, although a committee of OPEC-led producers is currently seeking to restrict oil supplies which has, in turn, seen the oil price drift lower. A slightly stronger New Zealand dollar against the basket of global currencies comprising the MSCI World Index saw reported returns from unhedged equities outperforming the comparable returns from hedged investments.
Source: MSCI World ex-Australia Index (net div.)
Emerging markets shares +10.48%
Increased global confidence was also favourable to emerging share markets in the first quarter. Emerging market fortunes, which are often linked to commodities markets, regained investor interest and benefited from strong capital inflows. Aside from Russia, which battled against the headwind of a lower oil price, the other main emerging markets delivered impressive local currency returns, with China +13.1% and India +12.1% leading the way.
Source: MSCI Emerging Markets Index (gross div.)
International fixed interest +0.58%
The US Federal Reserve delivered on a well-signalled rate rise in March by lifting the US Federal Funds rate by another 0.25%. More pertinently, they maintained expectations of two further rate hikes in 2017. With little change to accommodative policies internationally and the US meeting market expectations, global yields were largely unmoved, with headline 10 year yields of most major nations remained tightly range-bound. This contributed to a relatively benign bond market environment over the quarter.
Source: Citigroup World Government Bond Index 1-5 Years (hedged to NZD)
International property +0.66%
International property similarly took second fiddle to equity markets over the quarter. The Trump administration's failure to push through healthcare reforms was interpreted as a sign that other proposed stimulatory policies might also be difficult to deliver on. Any lessening in the US reflation story would be likely to have a dampening effect on property demand, and in the US (and globally), equity markets were the clear winners during the quarter while property markets drew breath. The S&P Developed REIT Index returned +1.58% in US dollar terms, while the Australian listed property sector was down, with the S&P/ASX 300 A-REIT Total Return Index dipping -0.08% in Australian dollar terms.
Source: S&P Developed REIT Index (total return)
All returns are expressed in NZD. It is assumed that Australian shares, emerging markets shares and international property are invested on an unhedged basis, and therefore returns from these sectors are susceptible to movement in the value of the NZD.
Vision blurred by hindsight bias
The financial industry is a magnet for jargon. Some of it can be useful, but some can be downright dumb. Top of the 'dumb' list would be a headline that has consistently appeared in many financial publications since 2009. That is, "The easy money has been made".
This comment gives the impression that the past market gains were obviously going to occur. Nothing could be further from the truth.
Yes, many share markets have surged since March 2009. In fact, it's been one of the strongest eight year rallies in history. However, if you think any of that was perfectly foreseeable - or easy - you are suffering from a severe case of 'hindsight bias'.
Hindsight bias (also known as the 'I knew it all along phenomenon') is the irresistible tendency to believe - after an experiment, sports event, election or investment, for example - that the outcome was foreseeable. After the share market drops (it was "due for a correction") or an election is lost (by a "terrible candidate"), the outcome seems obvious, and thus, blameworthy.
However, as research shows, we often do not expect something to happen until it does. Only then do we clearly see the forces that triggered the event, and feel unsurprised. Because outcomes seem as if they should have been foreseeable, we are more likely to blame decision makers for what are, in retrospect, 'obvious' bad choices, rather than praise them for good ones (which also seem obvious). As the 19th century philosopher Søren Kierkegaard said, "Life is lived forwards, but understood backwards."
At every step during the last eight years there has been a seemingly persuasive argument that share values had risen too far and were bound to fall.
In 2009 there was much written about the world teetering on the edge of the second Great Depression. In 2010 we were concerned about the European debt crisis and the over valuation of share markets. 2011 saw oil prices jump 25% and the threat of a double dip recession. 2012 saw Greece fall apart (for the first time). 2013 saw a downgrade in US debt. 2014 saw the end of quantitative easing and a slowdown in the Chinese economy. In 2015 it was Greece (again), China (again) and slumping commodities markets. And last year it was Brexit and Donald Trump.
You can go back even further than this and the picture doesn't change. Every year without exception there has been a compelling reason to worry and an argument to sell shares. Clearly, it has been far from easy over the past eight years. In fact, the future was just as uncertain and scary back then as it might appear to be today.
Only in hindsight do things look so obvious, like, "of course stocks were easy money in 2009. They were abnormally cheap and the US economy was just about to enter a multiyear recovery." But how many people actually believed that in 2009? Not many.
The reason you make money in the share market is because you are willing to hold assets where the future is unknown, bad things can happen, and outcomes are far from certain. Ultimately, you are getting paid for assuming these risks. There is never, ever, such a thing as easy money. There are only hindsight perceptions, and those perceptions are twisted by time and rewritten in our heads as memories of something they weren't.
What are the takeaways from all of this...?
1. Unsustainable markets can last for years longer than you think. The entire history of economics is a continuous ride of unsustainable booms and busts. We may be able to come up with a statistical average of where things should eventually revert to, but the economy and the share market rarely spend any time near average.
"It's different this time" is not the most dangerous phrase in investing. "I'll invest when things are back to normal" is far worse.
2. Good investing takes effort and often involves pain. Investors pay a high price for comfort and get paid a high price for doing what few others will. That will always be the case.
3. The future is as uncertain as the past is obvious, but it's easy to convince yourself of the opposite.
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