Market update – quarter ended 30 June 2023

Commentary on the June quarter by Russell Investments, New Zealand Fire Service Superannuation Scheme’s investment consultant.

Global markets

Global share markets made strong gains in the June quarter, with the MSCI ACWI Index ‒ Net returning 8.4% in unhedged New Zealand dollar (NZD) terms. Contributing to the gains were increasing expectations the US Federal Reserve (Fed) would soon hit the pause button on interest rates, which it did; the Bank maintaining its benchmark fed funds rate at a target range of between 5.00% and 5.25% in June. In its press release accompanying the decision, the Fed said, “holding the target range steady…allows the Committee to assess additional information and its implications for monetary policy.” However, a majority of officials still believe that high inflation, together with the enduring strength of the US economy, will likely warrant further rate increases this year. Elsewhere, the European Central Bank (ECB) and the Bank of England (BoE) raised interest rates twice over the period as inflation in both regions remained elevated. The ECB lifted its main refinancing rate from 3.50% to 4.00% and described another hike in July as “very likely”, while the BoE lifted its benchmark interest rate from 4.25% to 5.00%; including a surprisingly aggressive 0.50% increase in June after core inflation in the UK hit a 31-year high in May. Stocks also benefited from fresh economic stimulus in China, an end to the standoff between Democrats and Republicans over the US government’s debt ceiling and a series of mostly encouraging earnings updates; which is to say earnings were ‘less bad’ than the market had anticipated.

In the US, the Dow Jones Industrial Average (3.4%), the benchmark S&P 500 Index (8.3%) and the tech-heavy NASDAQ (12.8%) all performed well over the period; the NASDAQ in particular rising on the back of strong gains across index heavyweights Apple, Microsoft and Meta (formerly Facebook). Share markets were also higher in Japan (14.2% ) and Europe (1.9% ) but fell in the UK (-1.3% ) and China (-5.1% ).

Global bonds were relatively flat for the quarter, returning just 0.1%  in hedged NZD terms. Longer-term government bond yields rose (prices fell) amid higher interest rates in the UK and Europe, potentially higher US interest rates and an end to the standoff between Democrats and Republicans over the US government’s debt ceiling. Credit markets were stronger, with spreads on US and European high-yield and investment-grade debt tightening over the period. Hard and local currency emerging markets debt also performed well.

New Zealand shares

The New Zealand share market recorded modest gains in the second quarter, returning 0.4%  amid further economic stimulus in China – our largest trading partner – and a strong lead from US stocks. Limiting the advance were further domestic interest rate hikes, with the Reserve Bank of New Zealand (RBNZ) lifting the official cash rate twice in the face of still-high inflation. Consumer prices rose 6.7% in the 12 months to 31 March, which was down on the 7.2% we saw in the 12 months to 31 December but still well above the RBNZ’s 1-3% target range. In response, the RBNZ lifted interest rates by 0.50% in April and by a further 0.25% in May, taking the official cash rate to 5.50%. Stocks were also impacted by higher bond yields and softer domestic growth, with the local economy shrinking 0.1% in the March quarter. The outcome, which follows the downwardly revised 0.7% contraction we saw in the final quarter of last year, means the New Zealand economy entered a ‘technical recession’. At the sector level, information technology was the best performer, followed by materials and financials. Utilities also performed well, while consumer-related names and healthcare underperformed the broader market.

New Zealand fixed income

The New Zealand bond market weakened over the period, returning -0.6% . Long-term New Zealand government bond yields rose amid tighter domestic monetary policy and higher bond yields globally. In contrast, bonds benefited from the asset class’s traditionally defensive qualities in the face of heightened geopolitical uncertainty. The yield on New Zealand 10-year government bonds closed the quarter 43 basis points higher at 4.6230%. Meanwhile, local credit markets were positive, with spreads narrowing slightly over the period.

How did markets affect NZFSSS investment options?

Strong gains from equity markets this year means that 12 month returns are now back in positive territory for all member options. Over the last year the Conservative option has returned 3.1%, Balanced 5.2% and Growth 8.2%. The Cash option has delivered a 2.9% return over the same period as the Official Cash Rate has risen.

Over the last ten years the Conservative, Balanced and Growth options have returned 3.4%, 6.1% and 7.8% per annum respectively, after the deduction of fees and tax.

Looking ahead

Equity markets have been strong post the debt-ceiling resolution and banking fears subsiding in the U.S. Pair that with Artificial Intelligence (AI) enthusiasm, still plenty of cash on the sidelines and resilient economic growth, and we can see a path where stocks are supported in the near-term as the economy continues to slow down, slowly.

Despite that, we see risk skewed to the downside. A recession in the United States seems probable over the next 12-18 months. The tipping point will likely come when corporate profit pressures force firms into austerity measures such as layoffs and capital expenditure delays, and households—having exhausted pandemic savings—respond by cutting back on discretionary spending. The industry consensus, as surveyed by Reuters in June, has a recession starting in the final quarter of 2023. This is possible, but we suspect that the gradual and uneven pace of the downturn could delay the recession until sometime in 2024.

A later recession should be a milder recession for the simple reason that by 2024 inflation should have fallen by enough to allow the Fed to ease aggressively. A recession that starts in 2023 while inflation is still above the Fed’s target would limit the pace of easing.

New Zealand will experience a significant tightening of household finances, as many fixed-rate mortgages reset to much higher rates following the Reserve Bank of New Zealand’s (RBNZ) aggressive tightening. The recent budget provides some support, with the fiscal impulse for 2024 larger than most economists had expected. Similarly, a pick-up in net migration is helpful. After lifting rates by more than most developed central banks, the RBNZ has pulled back its guidance on the need for future rate hikes. We expect its hiking cycle is now over.

The information contained in this publication was prepared by Russell Investment Group Limited (RIG). RIG is the investment manager for NZFSSS. This publication has been compiled from sources considered to be reliable, but is not guaranteed. This publication provides general information only and should not be relied upon in making an investment decision. Before making an investment decision, you need to consider whether this information is appropriate to your objectives, financial situation and needs. All investments are subject to risks. Past performance is not a reliable indicator of future performance.

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