Quarterly market commentary - June 2023
As the grey clouds gather for winter, it's pleasing to report the sun is still shining on portfolios.
Global share markets advanced again during the quarter, with the gains being led by developed markets and, most notably, large US technology companies.
After declining over the first quarter, global interest rates were generally on the rise again with most major central banks continuing to raise rates over the quarter.
However, in a positive move signifying that inflation (at least in the US) may now be in retreat, the US Federal Reserve was the first central bank to pause their rate hiking programme in June.
AI – the rise of the machines
It’s remarkable to note that the returns from only seven companies (Apple, Microsoft, Nvidia, Amazon, Meta Platforms, Alphabet and Tesla) account for almost three-quarters of the total US share market return so far this year.
The first six on this list are technology companies which have benefited from the growing hype and excitement surrounding artificial intelligence (AI) - specifically natural language processing tools such as ChatGPT.
Some are labelling it the start of a fourth industrial revolution that will help transform life on earth. Others say the sudden enthusiasm for AI has the same hallmarks as the meteoric rise of cryptocurrencies and meme stocks during the Covid pandemic, or the mania surrounding the internet companies of the dotcom era during the early 2000s.
The challenge for investors is that even if AI is to become a utility in our daily lives, it doesn’t mean every AI company is automatically worth buying, especially at their current (much higher) valuations.
In that regard, the dotcom bubble may hold valuable lessons. Hype about the internet drove up the technology-heavy Nasdaq Composite index by 400% between 1995 and 2000. When the dotcom bubble finally burst, the Nasdaq subsequently fell nearly 77% between March 2000 and October 2002, with many of the once high-flying internet companies falling all the way to zero.
Looking back, excitement about the long term benefits of the internet was well founded, but that didn’t stop investors eventually losing a lot of money chasing the hype.
Investing during a recession
Based on recent growth data, the New Zealand economy is in a technical recession (where a recession is defined as two consecutive quarters of contraction in economic activity). In simple terms, it means the economy is shrinking. However, it doesn’t mean investment returns will also shrink.
During all recession periods since 1945, the main US share market index (the S&P 500) has actually increased by an average of around 1%. In part, that’s because share markets usually peak before the start of a recession and bottom out before their conclusion. In other words, the worst is generally over for shares before it’s over for the rest of the economy.
When we look at the performance of our own share market over the period from September 2022 to end March 2023, when the New Zealand economy is now acknowledged to have been in a recession, we find a similar story. The local S&P/NZX 50 Index (gross with imputation) went up 3.79% between September and December 2022, followed by a further increase of 3.89% between January and March 2023.
These returns are welcome in any economic environment.
Interest rates – what next?
We need to continue taking our cues from the Reserve Bank, because they are responsible for setting the level of short term interest rates in New Zealand.
In November 2022, the Reserve Bank projected a peak in the OCR of 5.50% and, after another 0.25% increase at their May 2023 meeting, that is where the OCR now sits – at exactly 5.50%. The wider market is not yet convinced this will be the end of New Zealand’s rate rising cycle, but through the quarter the market consensus was that the Reserve Bank will pause at this level, at least for a while. By pausing here, it will allow time for the lagged effects of the previous rate rises to continue to gradually slow the economy down and bring inflation back towards their long term target band of 1-3%.
On the positive side, there is enough early evidence to suggest that monetary policy is beginning to work. Economic growth is already contracting. Inflation, on a quarterly basis, is slowly dropping and taking inflation expectations with it. And the labour market has moved from being extremely tight to now showing a very slight increase in the unemployment rate.
If these trends continue, there is plenty of scope for short-term interest rates to begin falling again in New Zealand in 2024.
Stay focused on what works
Following the significant Covid interruptions of early 2020, central banks around the world are still trying to navigate the best route to take for their economies to achieve greater stability and prosperity.
It hasn’t been straight-forward. The economic reboot from a near global shutdown has thrown up a myriad of unexpected challenges – supply chain issues, production shortages, cost pressures, labour shortages, galloping inflation and, recently, rapidly rising global interest rates.
However, one by one, these challenges are being met.
That economic growth has come under pressure in the meantime, is entirely understandable. That policy makers will eventually win this battle, is equally inevitable.
As individual investors, we simply need to keep our focus on the things we can control – following our strategic plan, staying diversified and maintaining discipline.
Challenges, fads, speculation and uncertainty will always be a part of why markets will deliver positive long term returns. It’s the reward paid to investors for taking investment risk.
And the best way to manage those risks is to acknowledge their existence, develop strategies to manage or mitigate them, and then relentlessly implement those strategies – something all good advisers are ideally placed to help with.
For a detailed review of the asset class performances for the quarter, see ‘Key market movements -June 2023’
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Key market movements - June 2023
Central banks maintained their laser-like focus on combatting inflation by continuing to raise interest rates globally during the quarter. But as these had already been factored into share prices last year, we saw most share markets still perform strongly over the quarter.
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Quarterly market commentary - March 2023
Following an upbeat end to 2022, investment markets continued to deliver generally positive returns over the first three months of 2023. However, there are signs indicating the interest rate tightening cycle still had further to run.