Market update - quarter ended 31 December 2021

Risk asset returns were generally positive in the fourth quarter of 2021, although with some divergence at the regional level. Global equities returned 8.1% and outperformed the broader NZ equity market which fell 1.8% over the quarter; Australian equites returned 2.1% while US equities returned an impressive 11.0%. European equities rose 6.4% while emerging markets continued their underperformance relative to developed markets, returning -1.3%. Chinese equities had another poor quarter as three other well-known property developers in China (apart from the Evergrande Group), made headlines over their failure to make payments to both onshore and foreign creditors.

Absolute returns for both NZ bonds and global bonds were negative. For the December quarter, NZ bonds posted a return of -1.70% and underperformed global bonds.  The international fixed interest sector returned -0.21% for the December quarter. Within the international fixed interest market, bonds primarily issued by corporates returned -0.39%, slightly underperforming the bonds issued by governments, which returned -0.12%.

The global listed property market continued its strong run over the previous quarter and returned 10.1% over the December quarter. From a regional perspective, the US was the best performing region for this quarter, followed by the UK. Asia Pacific was the laggard for the quarter and weighed on the returns. The domestic listed property market had a positive return despite a rise in bond rates over the quarter.  The NZ property sector outperformed the broader NZ equities market and rose 1.8% over the December quarter. The global listed infrastructure sector also generated a strong return of over 7.5% as sectors such as North American freight Railroads rose after reflecting effective pricing power in better-than-expected Q3 earnings.

Equity markets began the quarter in a positive mood as Q3 earnings results buoyed market values and COVID cases declined. However, the arrival of the new highly contagious Omicron COVID variant in late November raised a few questions around vaccine efficacy and its impact on the global recovery on the back of further disruptions in ongoing global supply chain issues.

Crucially, inflation data prints surprised on the upside as they recorded multi-decade highs in many regions. Further, wage pressures and housing related costs are expected to increase over the coming months.  Central banks shifted their view on inflation that it could be more persistent than previously thought and to mitigate the chances of high inflation expectations getting entrenched, major central banks led by the US Federal Reserve (the Fed) signalled that monetary policy will need to tighten faster and to a higher extent than indicated previously. The Fed signalled not only a rapid end to its bond purchase program (by mid-March 2022) but also eight rate hikes within three years.

Two other major central banks also signalled a less accommodative monetary policy: The Bank of England (BoE) caught markets again off guard in December. After postponing the expected rate hike in November, it raised the Bank Rate from 0.10% to 0.25% versus the consensus forecast of another postponement due to the Omicron uncertainties. The European Central Bank (ECB)’s governing council decided to further reduce its PEPP (pandemic emergency purchase program) purchases in Q1 and to end them after March 2022 but emphasised that a 2022 rate hike is “very unlikely” despite acknowledging that inflation is more persistent than previously thought.

A tug of war in news headlines between the fast spreading Omicron and rising inflationary pressures however did not deter investor flows into equities.

On the geopolitical front, US President Biden warned Russian President Putin that there would be severe economic consequences for Russia if it invades Ukraine, following the massing of Russian troops close to Ukraine’s border. Commodities which posted strong gains for much of the post-pandemic outbreak period saw some correction in Q4. While European natural gas prices fell, crude oil prices (WTI, USD) were largely unchanged over the quarter although price action during the quarter was volatile as investors navigated COVID-19 related headlines alongside geopolitical risks such as Russia-Ukraine and a scheduled increase in production in 2022 by OPEC.

In New Zealand, economic data releases over the quarter showed the economy was resilient despite lengthy lockdowns. Q3 GDP did contract -3.7% but was a better outcome than anticipated. On the back of this, analysts revised up their expectations for GDP growth in Q4 2021 and Q1 2022. NZ CPI for Q3 surprised on the upside at 4.9% (annualised), and up from 3.3% in the prior quarter. The unemployment rate fell to 3.3% for Q3, down from 4.0% for Q2; the lowest reading since pre-Global Financial Crisis. New Zealand interest rates continued to rise more than its offshore counterparts.

October saw the Reserve Bank of New Zealand (RBNZ) increase the Official Cash Rate (OCR) by 25bp as expected to 0.50%. The RBNZ cited capacity pressures, especially for the labour market, and forecast headline CPI above four percent per annum near term as reasons for the hike and stated that further removal of monetary stimulus could be expected over time. Indeed, the November Monetary Policy Statement saw another 25bp hike, taking the OCR to 0.75%. Employment and growth were believed to be above maximum sustainable levels, capacity constraints remained, and near-term CPI forecasts increased to be greater than 5%.

There are increasing signs of a slower pace of global earnings growth relative to the pace of earnings growth seen in recent prior quarters given higher input costs, diminishing new fiscal impulse, and rising interest rate volatility. That said, a positive backdrop for earnings growth can still be made amid strong consumer demand and high excess savings, even as rising input costs are passed to consumers. Ensuring your portfolio is well diversified remains essential.

Source: BT Funds Management 

Date 4 February 2022