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Bloomsbury Winter Update April - June 2017

Winter scene of snow-covered mountakns ad a frozen lake

In this issue

Market commentary

From April to June 2017 diversified portfolios again delivered generally positive returns, although at a more subdued rate than investors have become accustomed to in recent quarters.

For much of the second quarter major markets were relatively benign, perhaps distracted by the prolonged attention given to two very important elections in Europe.

The first was the victory by 39 year old Emmanuel Macron's upstart En Marche! political party in France.

This result was the latest in a recent string of good news for Europe. Already, Macron is shaping up as just the tonic Europe needs. A fierce critic of Brexit, he wants to ensure that the UK gets no special treatment during its upcoming divorce proceedings. He also champions Greek debt relief, an issue which has plagued the euro zone for years because of Germany's fierce opposition to it. If Macron can help Germany and Greece inch forward on this issue, it would do wonders for EU morale.

Economically speaking, Europe is already in much better shape than it was a few years ago. Every country in the EU is now growing (even Greece...just). Data for the first quarter of 2017 showed the euro zone economy picking up more momentum, even as UK and US growth rates fell short of their forecasts.

In terms of its politics, Europe is looking more progressive. Austria, the Netherlands, and now France have all voted in pro-European leaders, rather than inward-looking populists. Next cab off the rank is Germany, which heads to the polls in September and where Angela Merkel - one of the EU's biggest supporters - is a short odds favourite.

Unfortunately, the uplifting result in France could not have been in greater contrast to the almost farcical outcome of the UK elections in early June.

In mid-April, when Theresa May called for an early election to attempt to shore up her position at the Brexit negotiating table, the Conservatives held a 19 point lead in the polls. Only seven weeks later, they suffered the humiliation of having to form a minority government.

In what has been referred to as 'the revenge of the remain voters', the Conservatives embarrassingly saw their parliamentary seats fall from 331 to just 318; below the 326 needed for an absolute majority.

It was far from the unifying result Theresa May had hoped for. With inflation on the rise and Britain, for the first time since the mid-1990s, holding the mantle of the slowest- growing country in the European Union, the Conservatives headed into the Brexit negotiations with their tails between their legs.

In any summary of political events we, of course, cannot forget about Donald Trump. The US election may have been in November last year, but it seems the world is still struggling to come to grips with 'The Donald'.

The best thing Trump supporters can find to say about the US president is that 'he does what he says he will do'. That might have been perceived as a bigger virtue, except the things he says he will do are usually divisive, often strategically and ethically questionable, and nearly always controversial. Scrapping US involvement in the Trans Pacific Partnership trade deal and failing to ratify the Paris Accord on climate change are two examples.

While global investors might well be concerned about some of the policies emanating from the Oval Office promoting increased US separatism and greater racial inequality, that hasn't translated into any reduced demand for US business output or debt securities.

In that sense, the market response is entirely rational. Regardless of the latest Trump tweet or seat-of-the-pants policy initiative, the demand for Big Macs, or iPhones or Cadillacs, hasn't been affected, and is unlikely to be. Consumerism is inherently apolitical.

As if to reinforce this, the headline US S&P 500 Index registered a gain of 3.1% for the quarter and is now up 17.9% for the last 12 months, and 14.6% pa for the last five years. Other notable equity market results for the quarter were in Japan, where the Nikkei 225 gained 6.1%, and in France, where the CAC 40 Index gained 2.4%. In fact, it was a solid quarter for most developed share markets, with only five of the 23 developed markets tracked by MSCI indices returning negative results.

Emerging markets were, in typical fashion, more volatile. Thankfully, that volatility was more positive than negative this quarter, with the MSCI Emerging Markets Gross Index up 6.4% in US dollar terms. Some of the notable individual results contributing to this performance came from China +11.0% and Korea +12.8%. At the other end of the scale, the Russian sharemarket fell -6.0%, hurt by ongoing oil price weakness and by the Trump administration, against expectations, not repealing sanctions imposed in 2014 which punished Russia for its role in the Ukraine crisis.

The local New Zealand sharemarket delivered a strong result, with the S&P/NZX 50 Index (gross with imputation) gaining 5.9%. This was comfortably ahead of the result of our Australian neighbours, where the S&P/ASX 200 Index returned -1.6%.

New Zealand's strong sharemarket performance may partly be a reflection that economic conditions here continue to look solid and business confidence remains strong. Positive business sentiment certainly bodes well for the future growth rates and profitability of New Zealand facing businesses. On the other hand, while overall Australian data also generally continues to beat expectations, the tailwinds supporting economic growth in Australia appear less consistent, as a spate of company earnings downgrades in June served to highlight.

In the midst of all of this, the New Zealand dollar strengthened over the quarter against both the US dollar (up 4.5%) and the Australian dollar (up 3.9%). A stronger NZ dollar has the effect of reducing the New Zealand dollar value of any unhedged assets denominated in either US or Australian dollars, and that contributed to slightly lower reported returns this quarter.

Theresa May, a hamburger, and balloons

Global bond markets had been relatively uneventful for much of the quarter, although this changed rather sharply towards the end of June when European Central Bank President, Mario Draghi, announced that "the global recovery is firming and broadening and a key issue facing policymakers is ensuring that this promising growth becomes sustainable."

These comments resonated strongly with the market, as they coincided with comments made by Bank of England Governor, Mark Carney, about the potential need to reverse the post Brexit rate cut in the UK, and comments from Bank of Canada Governor, Stephen Poloz, about the potential need to reverse the post oil price crash (2014/2015) rate cut in Canada. In addition, earlier in the month the US Federal Reserve had already signalled its determination to progressively remove stimulus in the US by lifting the Federal Funds rate from 1.00% to 1.25%.

What was less anticipated was the Federal Reserve retaining their future rate projections of one increase in 2017, followed by three hikes in 2018, and another three hikes in 2019.

This is almost the exact opposite of the approach being taken by our own Reserve Bank. In last month's Monetary Policy Statement, the Reserve Bank looked through a string of firmer New Zealand inflation indicators and maintained their earlier projections that New Zealand rates will remain at record lows until 2019. It is apparent that the Reserve Bank believe raising rates too early - something they regretted doing in 2014 - could undermine domestic growth.

Training - woman running up a flight of steps wearing sneakers

Even though all bond markets felt some impact from Draghi's comments and spiked upwards over the last week in June, it was not a sizable enough reaction to impact returns greatly. By the end of the quarter the Citigroup World Government Bond Index 1-5 Years (hedged to NZD) had gained 0.59%, while the slightly longer duration Bloomberg Barclays Global Aggregate Bond Index (hedged to NZD) advanced 1.22%. These were both satisfactory results, given the still compressed global yield curves.

All in all, while it was an extremely interesting quarter on the global stage, it was a relatively quiet quarter in the markets.

The 'glass half empty' view of this would be that we didn't get another three months of the kind of excellent returns we have experienced with surprising regularity in recent years. The 'glass half full' view would be that diversified investors still came out ahead for the quarter, and we got a non- painful reminder that markets can't be expected to only ever go up, and in large leaps.

For all long term investors, this was simply another positive step along the road towards the achievement of your ultimate investment goals and objectives. And, by that most important of all measures, it was another successful quarter.

Note: Unless otherwise stated, all index returns are quoted on a home currency returns basis.

Key market movements for the quarter

New Zealand shares +5.92%

The local market backed up a good start to the year with another strong quarter. With improving global growth expectations, still supportive credit conditions and continuing strength in overseas equity markets, the New Zealand market prospered. Leading performers included Air New Zealand (+33.4%) and Xero (+33.4%), while A2 Milk (+33.8%) and Synlait (+22.2%) also advanced on the back of recovering milk prices. Sky TV (-12.0%) was one of the worst performers, thanks in part to the cancellation of their merger with Vodafone in June.
Source: S&P/NZX 50 Index, gross with imputation credits

New Zealand fixed interest +1.32%

The Reserve Bank of New Zealand maintained the Official Cash Rate at 1.75% through both its 11 May and 22 June meetings. The release of the government budget showed the nation is in a strong fiscal position, which was supported by lower than expected unemployment figures. Even so, the Reserve Bank stressed they require a high threshold (in future data) before next raising interest rates. Yields were little changed through the quarter, which meant a return in line with expectations for this asset class.
Source: S&P/NZX A Grade Corporate Bond Index

New Zealand property +4.43%

The domestic listed property sector followed the broad equity market up. With the Reserve Bank indicating interest rates will be on hold in the medium term, yield seeking investors returned to the relatively higher yields offered by listed property assets. Vital Healthcare Property Trust led the pack, gaining +11.04% as the market favourably priced its recent 'acquisition spree', which included the purchase of a private mental hospital in Sydney for A$30.3 million.
Source: S&P/NZX All Real Estate Index, gross with imputation credits

Australian shares -5.28%

The Australian share market posted a loss for the quarter, down -1.58% in Australian dollar terms. Small capitalisation companies fared better than larger firms, with the S&P/ASX Small Ordinaries down only -0.35% relative to -1.70% from the S&P/ASX 100 (both returns in Australian dollars). Returns to unhedged New Zealand investors were further reduced by a relatively weak Australian dollar. Leading sectors included industrials and healthcare companies, whilst telecommunications shares struggled as TPG Telecom announced a decision to launch Australia's fourth mobile network, putting stress on their larger peers.
Source: S&P/ASX 200 Index (total return)

International shares +3.16% (hedged to NZD) and -0.33% (unhedged)

As mentioned above, developed markets equities delivered generally positive returns. Europe's big players all advanced, with the French election of Macron, in particular, well received. Japan was also one of the better developed markets (even with increased North Korean tensions), with many firms reporting annual profits above expectations. A slightly stronger New Zealand dollar, against the basket of global currencies comprising the MSCI World Index, saw reported returns from hedged equities outperforming the comparable returns from unhedged investments.
Source: MSCI World ex-Australia Index (net div.)

Emerging markets shares +1.77%

Emerging markets outperformed developed markets, as exporting nations such as China and Korea rallied strongly amidst signs of an improving global growth outlook. Greece was one of the best performers, with Eurozone finance ministers agreeing to provide the financial assistance required to end uncertainty about the Mediterranean nation's ability to meet upcoming debt repayment obligations.
Source: MSCI Emerging Markets Index (gross div.)

International fixed interest +0.59%

This quarter saw the release of positive economic data from both the US and Europe. However, with inflation remaining stubbornly subdued, central banks continue to provide accommodative monetary policy. The quarter concluded with several 'hawkish' comments from central banks signalling the possible need to raise rates. This caused global yields to rise steeply in the final week of the quarter, resulting in an overall small gain from the international fixed interest asset class.
Source: Citigroup World Government Bond Index 1-5 Years (hedged to NZD)

International property -2.51%

Ongoing accommodative monetary policy benefitted international property, with American and European assets generally advancing. The S&P Developed REIT Index returned +1.92% in US dollar terms, while, conversely, the Australian listed property sector was down, with the S&P/ASX 300 A-REIT Total Return Index declining -3.05% in Australian dollar terms. A weak US dollar further reduced reported returns to New Zealand investors holding unhedged investments in this asset class.
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.

When the fear is just too much

by Carl Richards

Hindsight glasses

When the markets go from acting 'normal' to acting 'scary', we hate the idea of doing nothing with our portfolios. It feels like we're sitting in front of an oncoming train! We should be doing something; anything, really.

But if we do act, it often has nothing to do with our plan and everything to do with stopping the pain.

First, you should know these feelings are normal. Very few people can avoid feeling scared when the markets start jumping around.

But your situation is a little different from most people. You don't need to worry and react to what the market does. You've already invested plenty of worry in building a solid financial plan based on your goals and values.

But what if the fear is just too much? What can you do?

First, give yourself a break. For a long time, we've connected markets going down to pain. We're hardwired to get away from pain, a trait that's helped us survived as a species. But it hurts us when it comes to investing. Here's what you can do instead.

Grab a piece of paper, and write down the answer to this question, "Why is money important to you?" Make sure you get specific. For instance, freedom and flexibility are nice values, but push yourself to define what those words really mean to you.

Next, answer the question, "What do I want?" Think of this question as a way to identify your goals. Maybe you want to travel after retiring or start a second career with a nonprofit.

Finally, it's time to look at how you're supporting your values and goals. Does the way you invest give you the greatest chance of meeting your goals and supporting your values?

If the answer is, "No," then it might be time to hit the pause button and have a chat with your adviser. Life happens, and things change. You may not have realised that your goals and values changed. That's ok, and it's why this exercise is so useful.

Of course, many of you will have sailed through this exercise, and your 'why', 'what' and 'how' align perfectly. If so, you've done everything you need to do and confirmed that you don't need to do anything else, even (and especially) when markets bounce around. It's a great feeling to know you're on the right track.

When you revisit these questions during the next scary market, you may find that your values or goals have changed. But only then, will you need to worry about updating your investments.

Carl Richards is currently based in Nelson, but hails from Salt Lake City, Utah. He is a Certified Financial PlannerTM, creator of the weekly Sketch Guy column in the New York Times, a columnist for Morningstar Advisor, and a frequent keynote speaker at financial planning conferences around the world.

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