Key market movements Q1 2020
In stark contrast to most of the past decade, the first few months of 2020 delivered an unparalleled increase in market volatility. A thawing of hostile US-China trade relations and the realisation of the long awaited British exit from the European Union in January were quickly forgotten with the emergence and spread COVID-19.
The outbreak of the novel coronavirus in China initially impacted the global economy by disrupting supply chains. This quickly morphed into a global pandemic, causing fatalities worldwide and forcing many governments to impose strict limitations on public movements, in an effort to limit the spread of the virus. This, in turn, caused many firms to reduce or cease production, exacerbating the supply shock. It caused a spike in unemployment, which curbed aggregate consumer expenditure. This compounded the economic stress by adding a demand shock. With future sales now uncertain, many firms paused investment plans, preferring instead to bed down capital in an attempt to ride out the pandemic. The net impact – although yet to be fully quantified – will be a significant temporary reduction in economic output and a sharp rise in unemployment. In economic terms, the global economy has unofficially fallen into a recession.
With expectations for economic output in the immediate future being significantly reduced, today's value of a share in a company’s future earnings was rapidly and significantly discounted. No nation or industry was spared, and every single one of the major equity indices posted double digit declines (refer to table 1 below). From the market high on 19 February, the MSCI World Index declined by -33% by the end of 23 March. This was the fastest decline in excess of -20% in history. Historically, declines of this magnitude have played out over months or even years, yet this peak to trough move came in a staggering 23 trading days.
This unprecedented event was met with unprecedented emergency government support. Central banks counterattacked with a twin assault of highly accommodating monetary policy (lower interest rates) and breath-taking fiscal support allowing money to be pumped into struggling households and ailing firms. These initiatives will hopefully help keep many companies in business and serve as a springboard to recovery once current business restrictions are removed. The most notable bailout plan was the US$2.2 trillion emergency relief bill passed by the US senate on 25 March. With this record stimulus (along with many other relief packages worldwide), the market began to rapidly price in a decreasing likelihood of some of the more frightening economic scenarios. Since the low on 23 March, markets have rallied strongly and the MSCI World Index recovered +14.5% to 31 March to close out a -20.0% quarter. This recovery has continued into April and the return has been a further +7.3% to the 24th.
-20.9% (hedged to NZD)
No developed nation in the index was immune from the economic fallout initiated by COVID-19 and quarterly declines of double digits were almost universal. In local currency terms, the US’s S&P 500 lost -19.6%, MSCI Europe ex UK fell -20.9%, MSCI Japan dropped -17.2% and the UK’s FTSE 100 shed -23.8%.
The worst hit sector was energy. In a recessionary environment, demand for oil will typically reduce as consumption falls, which generally diminishes the value of firms in this industry. To compound matters, negotiations between OPEC (the Organization of the Petroleum Exporting Countries) and Russia over proposed production cuts to stabilise the price of oil, failed. These events contributed to stock market trading curbs (or circuit breakers) being triggered several times, whereby prices had fallen so significantly that all trading was suspended for 15 minutes in an attempt to allow market participants to regain composure and aid in rational decision making.
Other industries more sensitive to economic growth, such as industrials, materials and financials, were also hit hard, while defensive sectors like healthcare, utilities and consumer staples were (relatively) more resilient. Technology firms that might benefit from modified living/working arrangements had more subdued losses as well.
Generally, energy, industrials and materials firms are held in higher than market weights in strategies that employ a value tilt, and due to the unique nature of this event, firms in these industries tended to perform worse than the broader share market average. Small company shares also underperformed large company shares, with the risk of failure generally being amplified for smaller companies.
As is often the case in periods of market upheaval, investment flowed out of New Zealand as foreign investors sought the safety of cash. This reduced demand for New Zealand assets led to a significant weakening in our dollar, especially against other developed nation currencies such as the US dollar, the Japanese yen and the euro. This helped to dampen the losses on holdings of unhedged foreign assets.
In New Zealand dollar terms, the MSCI World ex Australia Index had a quarterly return of -20.9% on a hedged basis and -10.6% unhedged. On an unhedged basis this index has delivered a slender gain for the last 12 months, while the 10 year returns still comfortably exceed 8% p.a. whether hedged or unhedged.
Source: MSCI World ex-Australia Index (net div.)
Emerging Markets shares
Emerging markets fell heavily with the rest of the world as the economic impact of COVID-19 was priced in. The relative strength of the US dollar also served as a headwind to these economies which often have US dollar debt outstanding, and the index fell -19.0% in local currency terms for the quarter.
Given that COVID-19 originated in China, it might be reasonable to expect this nation to be among the poorest performers for the quarter. However, this was far from the case, with MSCI China down only -10.3%. This relatively smaller decline was in part due to China’s further progression in managing and recovering from COVID-19. Reported new cases of the virus have tailed off considerably and large parts of their economy are through lockdown restrictions and getting back to work. The relatively better performance of the Chinese market was also helped by the two largest names in the index. Alibaba and Tencent are engaged in internet related services and telecommunications, which have been significantly less disrupted through the crisis, and together represent over 30% of the index.
South Korea and Taiwan both declined ‘just’ -18.3%, with both indices holding higher than average exposures to the technology sector. Conversely, Latin American commodity exporting nations such as Brazil (-35.8%) and Colombia (-37.7%) struggled the most.
In New Zealand dollar terms, the MSCI Emerging Markets Index produced a quarterly return of -13.8% for a -5.7% return over the last 12 months.
Source: MSCI Emerging Markets Index (gross div.)
New Zealand shares
New Zealand shares were not spared in this environment. One of our major exports is tourism and with our borders now closed, and potentially remaining closed for a significant period of time, firms like Air New Zealand (-71%) and Auckland Airport (-43%) suffered considerably. In contrast to this, our domestic market is comprised of a larger than average representation of defensive industries such as utilities (-17%), healthcare (-0.3%) and consumer staples (+7%). Regardless of the economic cycle, New Zealanders will continue to buy power, healthcare and food and these industries performed relatively well. Real estate companies (-20%) struggled as the global slowdown is expected to have an adverse effect on commercial and residential property markets.
Overall, the S&P/NZX 50 Index declined -14.5% for the quarter, but due to the impressive three quarters that preceded this one, remains positive over the last 12 months, and longer.
Source: S&P/NZX 50 Index (gross with imputation credits)
Our neighbours across the Tasman did not fare as well as the New Zealand market, and Australian returns were amongst the lowest in developed markets. The Australian share market is dominated by financials and materials firms which are typically more sensitive to economic growth. The S&P/ASX 200 declined -23.1% in Australian dollar terms as, among the larger firms, only a couple of healthcare companies and the two large grocery stores were able to manage flat or small positive returns.
Energy companies, gambling firms and flagship airline Qantas were among the largest losers, while the performance of small capitalisation firms generally lagged large capitalisation firms.
Returns to New Zealand investors were further eroded by a relatively weak Australian dollar over the quarter, as the NZD/AUD foreign exchange rate flirted with parity during March.
Source: S&P/ASX 200 Index (total return)
International fixed interest
Faced with a global health emergency and economic crisis, fixed income market behaviour paralleled the global financial crisis in the late 2000s, with issuer credit quality being placed firmly under the microscope. High quality bonds such as those issued by central governments were sought after, as many market participants looked to shelter in safer assets. This generally pushed higher quality bond yields down, and their prices up.
Conversely, lower quality bonds suffered declines as the market priced in an increasing risk of default on their future interest obligations. Generally, the lower the credit quality of the bond, the worse the returns. For investors who had been moving down the credit spectrum to chase higher yields as interest rates declined, this unfortunately revealed the higher risk they had been exposing themselves to.
As the crisis evolved, bond market liquidity started to dry up, particularly for lower quality bonds. This meant forced sellers (i.e. investors requiring liquidity) had to accept lower and lower bid prices in order to exit their positions. This, in turn, began to put selling pressure on higher quality bonds as some investors also sought to raise cash wherever they could. This led to a partial reversal of the earlier gains on government bonds, although yields still ended the quarter significantly lower than they had been three months earlier. The US 10 year treasury started the quarter with a yield of 1.92% and, at one point in March, touched 0.32% before finishing the month at 0.68%. To put this in perspective, until February 2020 the yield on this instrument had varied by less than 2% since late 2011, yet it varied by 1.60% in the quarter alone. The story was universal with European, British and Japanese government bonds all witnessing similar yield compressions and volatility.
Part of the roll out of central government relief packages included significant reductions in central bank interest rates. This will reduce the cost of borrowing and will help companies needing to take on new debt in order to navigate the economic challenges ahead. The second aspect of the significant monetary stimulus packages was the restarting of bond buying programs (also known as quantitative easing) where central banks act as large buyers of securities in the bond market. This helps restore liquidity to these markets and to support businesses looking to issue new debt. Early signs were positive as March saw a record issuance of new investment grade bonds in the US as corporates sought to recapitalise.
In aggregate, higher quality sovereign bonds outperformed corporate bonds, and longer duration bonds outperformed shorter duration bonds. The FTSE World Government Bond Index 1-5 Years (hedged to NZD) posted a +2.2% quarter to take its 12 month return to +4.4%, while the broader Bloomberg Barclays Global Aggregate Bond Index (hedged to NZD) returned +1.4% for the quarter and +6.0% for the last 12 months.
Source: FTSE World Government Bond Index 1-5 Years (hedged to NZD)
New Zealand fixed interest
The New Zealand fixed interest market followed the same general trends as the global market. Government bonds were sought after, and lower quality corporate bonds declined in value. The Reserve Bank of New Zealand slashed the Official Cash Rate to an all time low of 0.25% on 16 March and announced a Large Scale Asset Purchases (“LSAP”) programme on 23 March. The LSAP is the biggest to ever be rolled out in New Zealand. It includes a commitment to purchase up to $30 billion of New Zealand government bonds in the secondary market over the next 12 months, across a range of maturities.
Overall, the S&P/NZX A-Grade Corporate Bond Index advanced +1.3% for the quarter and +4.2% over the last 12 months, while the longer duration S&P/NZX NZ Government Bond Index rose by +3.5% for the quarter and +5.3% for the last 12 months.
Source: S&P/NZX A Grade Corporate Bond Index
For a detailed review of the market commentary for the quarter, see ‘Market commentary - March 2020’ or click here to view the full newsletter in PDF.
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Quarterly market commentary - March 2020
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