Markets continued to deliver pleasing investment results in the third quarter of 2024.
With the daily news out of the Middle East and Ukraine providing an ongoing reminder that the world still faces serious geo-political issues, investment markets have maintained a relatively steadier course.
Most major economies continued to focus on delivering an economic ‘soft landing’ – i.e. cooling high levels of demand and inflationary pressures without pushing their economies into recession. For this reason, the US Federal Reserve announcement on 18 September was noteworthy, as it finally began easing the Federal Funds Rate with an initial cut of 0.50%. The interest rate cut was based on a view that the risks to inflation had declined, while the risks on an economic slowdown and higher unemployment had increased.
This meant the US now joined the ‘rate-cutting club’ already occupied by the European central bank, Canada, UK and New Zealand and their actions clearly highlighted that the pathway for global interest rates is now downwards, at least for now.
Uncertainty about the near-term strength of global economic activity can be seen in weaker commodity prices such as energy (oil prices are currently down about 20% year on year) and steel, although copper (used in construction and manufacturing)has recorded price rises from a low base.
While three months may be a blink-of-an-eye in the world of investing, it is a lifetime in politics. In July we were talking about the intriguing build-up to Donald Trump and Joe Biden once again going head-to-head for the US presidency in November. Today, Biden is no longer in the race, having been replaced as the democratic candidate by the current vice president, Kamala Harris. And, given the unusual electoral college system that ultimately decides the presidency, this contest still looks too close to call.
The long-awaited US interest rate reduction
Globally, interest rates were cut to historically low levels following the emergence of Covid-19 in early 2020. Fearful of the impact that Covid-19 could have on the global economy, policymakers kept interest rates low for several years to hopefully reduce the potential risk of wholesale business failure, and significant unemployment, due to lock downs and border closures. Both of those outcomes looked possible during the highly uncertain early months of the pandemic.
However, as global health fears receded, economic fears also eased, and workers and businesses eventually returned to a post-pandemic version of ‘normal’. Unfortunately, the significant monetary and fiscal stimulus that had been added to the system in the form of historically low interest rates and direct monetary payments from governments, had combined to form a sizable inflationary bubble around the world. With the price of many goods and services having rapidly increased, it contributed to what we still refer to in New Zealand as the cost-of-living crisis.
With the US Federal Reserve announcing a 0.50% interest rate reduction in September, there is growing evidence that global interest rates are on their way down.
As economic data points supported the increasing likelihood of the pending Federal Reserve’s announcement, sharemarkets have been moving higher. This is often the sharemarket reaction when interest rates are thought to be heading lower. While a stronger sharemarket is usually always well received by investors, perhaps a bigger question for many in New Zealand is – do lower US interest rates have any implications on mortgage rates here?
In New Zealand, mortgage interest rates are heavily influenced by the Reserve Bank of New Zealand's monetary policy decisions, which are mainly based on their assessment of domestic economic conditions, and inflation. However, if US interest rates drop, this can contribute to lower global lending costs, which can also help reduce New Zealand interest rates. So lower US interest rates might help take some pressure off total lending costs in New Zealand.
We have now seen our own central bank make two cuts to the official cash rate, which following the announcement on October 9 now sits at 4.75% after spending 12 months at 5.50%. Annual consumer price inflation is now within the 1 to 3 percent inflation target range and converging on the 2 percent midpoint. Activity in New Zealand is weak, and global demand is also subdued, moving the risk of excessive borrowing costs ahead of the risk of inflationary pressures limiting expenditure. Thus, the Reserve Bank of New Zealand (RBNZ) cut the official cash rate to achieve and maintain low and stable inflation, while seeking to avoid unnecessary instability in output, employment, interest rates, and the exchange rate. The next official cash rate announcement is 27 November, and with another 3 months before the following meeting in February 2025, the market is beginning to price another significant cut before Christmas.
What about the safety of cash?
High yielding cash accounts and term deposits can feel like a safe haven, especially in periods when uncertainty and share market volatility are high. However, while cash may be safe, parking too much of your money in cash for too long is usually a bad idea for long term investors.
While you’ll be protected in the event of a potential market crash, the long-term opportunity cost of staying in this lower returning asset is likely to be worse than the crash itself.
To illustrate this point, the chart below compares the following: the compound growth of returns(before any tax and fees) from global shares, a standard 60/40 diversified portfolio, hedged global bonds, and one month term deposits for the 30 years from the end of 1994 to June 2024.
Chart 1: Compound growth of $10,000 in selected asset classes over the last 30 years
Despite some large sharemarket setbacks along the way, namely the post dot.com period, the Global Financial Crisis, the emergence of Covid-19 and the post-Covid high inflation period, the chart reveals that shares gained by a factor of 14x, while short term deposits gained 4x. A 60/40 portfolio, combining a mixture of higher and lower risk investments gained 10x.
Short term pain, longer term gain
Similar to the idea that staying too long in cash can be damaging to long term wealth creation, there are a number of perfectly normal behavioural impulses that good investors also need to continually manage. One of the most important is - resisting the urge to sell when markets suffer large corrections.
In our first Autumn quarter commentary this year, we highlighted the strength evident in the Japanese share market in early 2024. Then, on the 4 August, the headline Nikkei 225 Index fell -12.4% in one day. By any measure that’s a big fall and close to the largest single day decline ever in the Japanese share market.
That single day performance is highlighted in the chart below:
Chart 2: The 12 month return of the Nikkei 225 index
As tempting as it may have been at the time, exiting the market on this very negative day would have been a serious mistake. While it might have eased short term concerns, it would have meant missing out on the sharp recovery that commenced the very next day and which, at time of writing, had resulted in a gain of more than 20% from the 4 August low.
Over the last 12 months, as highlighted by the green dashed line, the Japanese market has experienced many peaks and a few troughs. This is the nature of investing in shares when prices can go up and down by large amounts. However, over time, the compensation for taking on the risk of investing in shares can be very rewarding, as seen in the Japanese share market over the last 12 months (up over 22% at time of writing).
But why did Japanese shares fall so much on this one day? Analysts said that a contributing factor was the unwinding of Japanese ‘carry trades’. In a carry trade, investors borrow money from a country with a low interest rate and a relatively weak currency (like Japan) and invest those funds into places or investments that will yield a higher return. However, following the Bank of Japan's decision to raise its key interest rate on 31July, this meant a sudden increase in the cost of maintaining a Japanese yen carry trade, and contributed to some investors selling down shares to repay their carry trade loans.
The benefits of a diversified portfolio approach
Investing, when approached constructively, involves taking an appropriate level of investment risk with the objective of achieving a set of long-term financial goals and objectives.
That’s where any parallels between investing and trading shares in the short-term, buying gold, or buying a rental property usually end.
Yes, buying and selling shares (or other investments) can certainly be a form of investing but, as a generalisation, the aim of many short-term share traders is simply to make money. While making money might be a very welcome outcome, it’s not always a well-defined goal and, on its own, may not enable you to achieve more important goals in life.
This is where diversified investment portfolios can provide significant benefits, that most other single asset class exposures cannot. Most notably, diversified portfolios are more effective at delivering -
1. Risk reduction -by spreading investments across various asset classes (local shares, international shares, bonds, cash, etc) investors can mitigate the impact of a poor performance in any single asset class. Also, in volatile markets, a diversified portfolio helps protect against significant losses, as not all investments will usually react the same way to market events. New Zealand shares were a prime example of this during the volatility in Japan this quarter; after lagging developed markets over the last couple of years our domestic sharemarket was resilient, helping reduce the short-term losses.
2. A focus on long term growth -a diversified portfolio approach aligns well with long-term investment strategies, often focusing on gradual growth rather than on the unpredictability of short-term returns.
3. Reduced emotional stress -a diversified portfolio can help to reduce investor anxiety during volatile markets, as it is much less likely to experience extreme highs and lows. And as different investments are likely to perform well at different times, diversified portfolios often lead to more stable and predictable returns over time, which is valuable for future planning.
While investing is easy, investing well is hard. Prudent diversification is often one important element of investing that most investors, on their own, tend to struggle with.
This is why taking professional advice than can be tailored to your personal circumstances, needs and risk preferences, is such an important component of long-term wealth creation. By embracing the benefits of portfolio diversification, it enables you to better manage risk and stress, on the pathway to financial security.
Performance was generally positive across all asset classes through the third quarter of2024, although all markets were certainly not created equally.
Interest rates remained a key focus for the quarter. Many central banks either began or continued to cut rates, with the US Federal Reserve, Bank of England, European Central Bank and the Reserve Bank of New Zealand, all delivering cuts. These cuts buoyed markets amid weakening economic data. In politics, the UK general election ended in a landslide victory for the Labour Party leading to renewed hope of an economic recovery. Kamala Harris replaced Joe Biden as the Democratic candidate for the US election in November, leading to a surge in support for the Democrats, becoming the marginal favourite over Donald Trump’s republican party, although this still looks too close call.
The artificial intelligence theme began to lose momentum, as investors became concerned over valuations and struggled to see real-world, revenue generating applications for the billions of dollars of investment in AI. These concerns, along with the beginning of a rate cutting cycle has led to a broadening theme across international share markets, with previously lagging sectors leading technology stocks in most markets.
Emerging share markets outperformed developed share markets over the quarter (excluding any currency hedging impacts) as Chinese shares rallied on the announcement of a massive economic stimulus package.
International shares
+4.6% (hedged to NZD)
+1.9% (unhedged)
Developed market shares were volatile within the quarter, but ultimately delivered gains. Returns were not broadly strong across all developed nations, rather, driven by continued exceptional performance from shares in the US.
The US market was up across the board, with 10 of 11 sectors delivering gains through the quarter and the S&P500 posting a +5.9% return (in unhedged US Dollars).Optimism for a soft landing, supported by the Federal Reserve’s 0.50% rate cut, strong corporate earnings and resilient economic data, led to a broadening of the rally with small companies outperforming larger companies. Utilities and real estate led the quarter, and the previously strong information technology sector lagged due to investor concerns over the monetisation of AI related capital expenditures.
Eurozone share market gains were muted in the third quarter. Weak demand from China as well as competition from cheap Chinese imports have led to concerns over Germanys reliance on manufacturing. Escalation of the conflict in the Middle East also contributed to a generally risk averse investor sentiment.
The British FTSE 100 Index was slightly higher over the third quarter, with the Bank of England announcing the first rate cut in four years and the labour government winning the national election, buoying investor sentiment amid weakening economic indicators.
The Japanese share market was extremely volatile as the impact of increasing interest rates strengthened the Japanese Yen and severely dented company valuations. Despite that remarkable -12% day on 4 August, the Nikkei 225 declined ‘only’ -4.2% in the quarter in local terms and, thanks to a relatively strong Yen, advanced +2.8% in unhedged New Zealand dollar terms.
Against most other major currencies, the New Zealand dollar was stronger through the quarter which, in aggregate, meant lower reported returns from un-hedged foreign investments.
The MSCI World ex-Australia Index returned +4.6% for the quarter hedged to the New Zealand dollar and +1.9% for the unhedged index.
Source: MSCI World ex-Australia Index(net div.)
Emerging markets shares
+4.4%
Emerging markets shares delivered solid returns for the third quarter; the MSCI Emerging Markets Index up +6.3% in unhedged local currency.
Despite a weak start due to continuing structural concerns over the Chinese economy and housing market, Chinese shares delivered a strong quarter. In mid-September, the Chinese government announced a massive stimulus package to prop up businesses and the housing market, sending Chinese shares soaring. The S&P China 500 closed the quarter up +16.3% (in local Chinese yuan terms).
Indian shares delivered robust gains as the bull market continued, with the S&P India BMI up +7.8% (in local Indian rupee terms), driven by continued positive investor sentiment regarding Indian economic development. Thailand was a leader in the Emerging markets for the quarter, driven by the first phase of a government stimulus package delivered in September. Taiwan shares were down for the quarter due predominantly to the weak performance of technology stocks.
Shares in Latin America were strong in the third quarter of 2024 with the S&P Latin America BMI Index posting a +4.1% gain (in US dollars). Industrials and utilities were the best performing sectors while Information technology, energy and consumer staples all posted losses. Brazil was amongst the best performers for the quarter, up +4.7% (S&P Brazil BMI, in Brazilian real).
It was a good quarter overall for the underlying emerging markets group. The MSCI Emerging Markets Index producing a quarterly return of +4.4% for unhedged New Zealand investors.
Source: MSCI Emerging Markets Index(gross div.)
New Zealand shares
+6.4%
The New Zealand share market, as measured by the S&P/NZX 50 Index, delivered a solid return for the third quarter, driven by a rate cut and a more accommodating tone from the RBNZ.
The New Zealand market may be beginning to see the light at the end of the tunnel, as the RBNZ expressed confidence about inflation moving to within 1-3%, and finally cutting the OCR by 25 basis points in August, and by 50 basis points in October to 4.75%. The decline in inflation, as expected, has come at the expense of deteriorating economic data as the last 3 years of higher interest rates bite. The unemployment rate has continued to rise, currently sitting at 4.6% versus 3.2% at the end of 2021 (seasonally adjusted). Real GDP per capita is flat both quarter on quarter and year on year the latest spending data is indicating a further deterioration in consumption.
Good results were recorded by one of New Zealand’s largest retirement and aged care providers Arvida Group Ltd (+79%) following the announcement they will be fully acquired by an international buyer. A2 Milk also enjoyed a lift on the back of the Chinese stimulus which included a child allowance, which is likely to raise demand for a2’s milk powder. On the downside, Spark Ltd (-23.8%) declined after FY24 earnings were down 72% from FY23, significantly lower than analyst estimates.
September also saw two significant equity raises with Auckland Airport and Fletcher Building raising $1.4 billion and $700 million respectively in issuance of new shares. This influx in capital will help the airport finance current and future capital expenditure, and help the building materials provider to shore up their financials, in particular to meet near term debt obligations.
Source: S&P/NZX 50 Index (gross with imputation credits)
Australian shares
+7.1%
The Australian share market (S&P/ASX 200 Index) posted an outstanding quarter, rising +7.8% in Australian dollar terms.
Across Australian sectors, 9 of 11 posted gains with information technology and real estate leading the pack, and utilities and energy posting losses for the quarter. Materials had a significant rebound at the end of the month as the Chinese economic stimulus is expected to increase demand for Australian raw materials.
Among equity factors, the S&P/ASX 200 equal weight index marginally outperformed the cap weighted index, indicating an outperformance by small and mid-cap stocks. Value also outperformed the broad market with the S&P/ASX 200 Value index reporting an +8.8% gain for the quarter.
The Reserve Bank of Australia (RBA) has stayed steady, continuing to hold their target cash rate at 4.35% at the September meeting. Comments from the subsequent press conference suggests that despite August CPI coming in at 2.7%, the RBA doesn’t yet have sufficient confidence that inflation is sustainably within the target range of 2-3%. The Australian labour market remains tight with only a marginal increase in the unemployment rate reflecting the relatively lower interest rates our trans-Tasman neighbours have had to navigate.
Within the largest firms, there were notable performances from materials firms who stand to benefit from property development aspects of the Chinese stimulus package. Logistics software provider Wise Tech Global (+36.9%) and supply chain logistics company Brambles Ltd (+33.0%) also rallied on the back of strong earnings reports. Cochlear Ltd (-14.4%) and Ramsey Healthcare (-11.5%) were among the worst performers of the quarter.
With the Australian dollar slightly weaker against the New Zealand dollar over the quarter, the reported returns to New Zealand investors were marginally lower.
Source: S&P/ASX 200 Index (total return)
International fixed interest
+3.0%
The third quarter of 2024 represented a turning point for international bond markets, with the US federal reserve finally gaining confidence that inflation is under control, and began to ‘recalibrate’ interest rates to a lower level with their first 0.50% cut. This, along with several other central bank rate cuts, led to bond yields generally falling, driving fixed interest returns strongly positive for the quarter.
US inflation moved up slightly, with 0.2% increases month-on-month in July and August, giving markets confidence that inflation is not falling uncontrollably, and bolstering the ‘soft landing’ narrative. The latest ‘dot plot’, showing the rate forecasts of Federal Reserve policymakers, indicated a further 25-50 bps of cuts this year, with the market currently pricing the higher cut in that band. The European Central Bank cut again in mid-September, dropping the ECB rate to 3.65% from 4.25%. While the Bank of England cut rates by 0.25% in July, with inflation approaching the 2% target and subdued GDP growth.
The US 10-year bond yield dropped from 4.39% to 3.79%, with the two-year bond yield moving from 4.75% to 3.65% marking the first time since mid-2022 that the 10 year has been yielding more than the two year. Germany’s 10-year bond yield fell from 2.49% to 2.13%, while the UK 10-year yield moved from 4.18% to 4.01%.
Japan is on a different trajectory with their central rates trending upwards, inflation rising slightly, and the 10-year bond yield stable (for now) around 1%, after spending the majority of the last decade at, or below 0%.
The FTSE World Government Bond Index 1-5 Years (hedged to NZD) returned +3.0% for the quarter, while the broader Bloomberg Global Aggregate Bond Index (hedged to NZD) was up +4.2%.
Source: FTSE World Government Bond Index 1-5 Years (hedged to NZD)
New Zealand fixed interest
+3.8%
The RBNZ cut New Zealand’s Official Cash Rate by 0.25% to 5.25% at the 10 August announcement (and 0.50% more at the 9 October announcement).
Inflation expectations have the 1- and 2-year rates below 3% and broadly, economic indicators suggest that the NZ economy is continuing to slow, giving the RBNZ confidence that inflation is moving sustainably into the 1-3% target range. For example, weak housing data, decreased investment (as measured by building consents) and persistently lower retail sales all paint a picture of a softening economy. Combine these data points with rising unemployment and it seems likely that inflation is under control. The question now for the RBNZ becomes how quickly to cut rates to ensure that inflation doesn’t fall too far.
On the back of the general trend of falling bond yields internationally, the New Zealand10-year bond yield decreased from 4.75% to 4.28% over the quarter.
The S&P/NZX A-Grade Corporate Bond Index gained +3.8% for the quarter, while the longer duration but higher quality S&P/NZX NZ Government Bond Index gained +4.0%.
Source: S&P/NZX A-Grade Corporate Bond Index
Table 1: Investment class returns to 30 September 2024
"The only function of economic forecasting is to make astrology look respectable." - John Kenneth Galbraith
In the history of share markets, you’ll find that the things that really move share markets quickly are surprises. COVID is a good example. While a few exceptional people saw something big happening prior to the global outbreak, most did not and of those that did, most saw it as a lower-level event, like bird-flu. The economic shock was large and unexpected, and prices moved quickly once that was appreciated.
By contrast, one of the most anticipated events (thus anything but a surprise) is the US election. And with the election about a month away, we thought it was a good time to make two interesting observations.
1. Presidential elections tend not to have an important impact on share prices.
2. Whether the New Zealand Warriors make the NRL Top 8 has a massive impact on share prices (said tongue in cheek).
What do we mean?
Let’s start with the first observation, and move on to the second, with the intention of highlighting the folly of paying too much attention to “events” when investing.
First, the party in the White House makes almost no difference to the returns of the New Zealand share market. According to Russell Investments (using Morningstar data from 1994 to 2023), the New Zealand share market has averaged about a 12% return with Republicans in the White House compared to 10% for Democrats.
The chart below, provides a more detailed and longer dated analysis based on US market data. It shows that the average return of a 60% share and 40% bond portfolio the year after a US presidential election, starting from the 1932 Roosevelt - Hoover election and going all the way through to the 2020 Biden - Trump election. The average post-election year return of a 60/40 portfolio has been a useful, but not astounding, 8.5%.
The chart also shows that in 20 out of 23 years there was a positive return the year after an election. In the three years there wasn’t a positive return, the reason had nothing to do with the election itself.
Based on this evidence, our earlier assertion that “Presidential elections tend not to have an important impact on share prices” is very reasonable.
This leads us to the much more interesting assertion, “Whether the New Zealand Warriors make the NRL Top 8 Finals, has a massive impact on share prices.”
Since 1994, the New Zealand Warriors have made the Top 8 in the following years: 2001-03, 2007-08, 2010-11, 2017-18, and 2023. While that’s great for the Warriors, it hasn’t corresponded to good news for the New Zealand share market. It turns out that when the Warriors make the Top 8 the average New Zealand share market return has been 3%. When they finish outside the Top 8, the average return is a much more attractive 13%.
What are we meant to make of this data? Do we cheer for the Warriors and get poor share market returns or cheer against them and enjoy the investment bonanza?
The answer is cheer for the Warriors, because how they perform is entirely unrelated to the performance of the share market. The data presented above, although accurate, is also completely spurious.
Spurious relationships occur when the data looks meaningful, but the results are actually random. The media love spurious relationships and simple narratives (like elections) because they give the false sense that we can control the future. Here are a few additional relationships that have made headlines in the past but have subsequently proved not to be that insightful:
The Negative Divergence Indicator
The Hindenburg Omen
The Titanic Syndrome
The McClellan Oscillator
There are no lack of indicators, theories and prognostications (often with scary names) about what future share prices will be. Some of these theories come with impressive backward-looking statistics and even some economic or geo-political rationale. Most will provide great fodder for click-bait headlines but will prove no more effective in forecasting prices than tarot cards or tea leaves.
The unfortunate truth is relatively boring. Prices are affected by anticipated earnings. Anticipated earnings trend up but can go down in concert with surprising economic or geopolitical events. Markets are always trying to anticipate these events so once you trade, the odds of an event one way or the other is likely already in the price. The best approach for a long-term investor is to hold your position in all markets unless you need to spend the money.
And lastly, if you do need to spend in the short term, this should be reflected in bond/cash allocations which aren’t as volatile as shares. This will help to protect your purchasing power even if the prices drop at the wrong time for you.
This may sound rather dull, but as Paul Samuelson, one of the first Nobel Prize winners in Economics, wisely stated many years ago -
"Investing should be dull. It shouldn't be exciting. Investing should be more like watching paint dry or grass grow. If you want excitement, take $800 and go to Las Vegas... It is not easy to get rich in Las Vegas, at Churchill Downs (Kentucky horse race track), or at the local Merrill Lynch (share trader) office."
Still, the “Warriors Omen” does have a certain ring to it, don’t you think?
