Market update –Quarter ending 30 September 2023

Market summary:

Most global equity markets¹ gave up some of the year-to-date gains with a return of -2.6% over the September quarter. On a regional basis, among the major global equity markets, Japanese equities² returned +2.4% (JPY terms) and UK equities³ returned +2.2% (GBP terms), both outperforming the rest of the world.  European equities⁴ returned -4.9% (Euro terms), US equities (S&P 500⁵) returned -3.2% (USD terms), and Emerging markets⁶ returned -2.9% (USD terms). Hong Kong equities⁷ had a volatile quarter, up 7.2% as at end of July but then giving up all those gains to close the quarter with a return of -4.2% (HKD terms).

At a sector level, Energy (+12.5%) was the top performing sector followed by the Telecommunication Services (+2%) while the Financials sector was flat. Other sectors declined over the quarter with the worst three being the Utilities (-8.2%), Real Estate (-7.8%) and Consumer Staples (-5.3%) sectors. From a style perspective, Global Defensive⁸ (-4.7%) underperformed Global Cyclical⁹ (-3.1%) companies in local currency terms; while Growth¹⁰ (-4.3%) underperformed Value¹¹ (-1.4%) companies in local currency terms.

An upward trajectory in bond yields over the quarter resulted in negative returns for Global bonds¹²(-0.6%). Domestic bonds¹³ also generated a negative return (-1.6%). The oil price (WTI crude oil priced in US dollars/barrel) surged 28.5% while gold fell almost 4% (USD terms). The NZ dollar fell 2.1% vs the US dollar resulting in NZD unhedged returns slightly outperforming hedged returns.

Context

The key themes over the September 2023 quarter were: (1) a more resilient US economy than expected despite aggressive interest rate tightening by the US Federal Reserve (the Fed) and (2) a “higher-for-longer” interest rate policy stance adopted by the Fed and other developed market central banks which in turn led to higher and steeper bond yield curves and (3) a much poorer than expected outlook on Chinese economic growth. These themes weighed on sentiment and drove global equity markets lower over the quarter.

Early in the quarter (July) saw equities initially rise as softer than expected June inflation data and positive economic surprise momentum boosted hopes for an economic soft-landing¹⁴ underpinned by improving corporate earnings. Markets continued to be driven by the mega-cap technology stocks and along with the resurgence in the energy sector, the S&P 500 briefly reach its highest level since April 2022. After raising interest rates at its July meeting, the Fed it left options open regarding future meetings, however market pricing indicated that the Fed's hiking cycle likely hit its ceiling and markets were pricing rate cuts by Spring 2024. Data out of Europe also underpinned expectations that inflation had peaked and that an economic slowdown was gaining momentum. In China, weaker activity data alongside signs of deflation in the economy raised speculation for further stimulus measures by Chinse policymakers ahead.

Equity and bond markets ended lower in August. One of the more prominent headwinds for risk assets was rising bond yields. This was chalked up to a myriad of factors, including repricing of expectations that the Fed would start cutting rates in mid-2024 given a stronger US growth outlook, heightened scrutiny of the US fiscal deficit following a downgrade of US sovereign debt by the rating agency Fitch, supply pressures from more US sovereign debt issuance, and the Bank of Japan’s relaxation of its bond yield curve control policy. China growth concerns also played a role in the August pullback as key economic data came in weaker than expected.  A number of other factors in the US raised worries about overbought conditions for equities - these included bank credit rating downgrades/downgrade warnings, softening of loan demand, a looming potential US autoworkers strike, the highest mortgage rates since 2001, lowest home purchase applications since 1995, and the impact on liquidity as the US Fed continues its quantitative tightening program.

Equity and bond markets extended their decline in September as the US Federal Reserve’s monetary policy meeting exacerbated the tightening of financial conditions¹⁵. While the Fed left its target Federal Funds rate unchanged, it indicated fewer rate cuts for 2024 (-50bp worth of cuts, down from -100bp indicated in June). In addition, Fed Chair Powell acknowledged the neutral rate¹⁶ may be higher in the long run. Also in September, there was more discussion about consumer headwinds from depleted excess savings and the resumption of student loan payments, inflation reacceleration risks from rising housing and insurance costs, corporate earnings risk from margin pressures and additional flare-ups in China's long-battered property sector. In Europe, macro-economic data pointed to a continued slowdown in economic activity.

Domestic:

Business and consumer confidence surveys continued to be consistent with recession-like economic conditions. The Reserve Bank of New Zealand (RBNZ) held the OCR (official cash rate) steady at 5.5% in July after 12 consecutive hikes that began in October 2021, as well as in August. The RBNZ reiterated that the OCR would remain at a restrictive level and kept options open for a further hike and less scope for easing if inflation stayed high. Dairy prices were volatile, with prices falling in July and August, but rising in September on the outlook of heading into El Nino weather conditions. The government’s Pre-election Economic and Fiscal Update in September showed further deterioration in the fiscal accounts, with a shortfall in tax revenue (since the New Zealand budget estimates were compiled a few months ago).

¹MSCI World Net Index (local currencies)

² Topix Total Return Index (JPY)

³FTSE 100 Total Return Index (GBP)

⁴ Euro Stoxx 50 Total Return Index (EUR)

⁵ S&P 500 Total Return Index (USD)

⁶ MSCI Emerging Markets NTR Index (USD)

⁷ Hang Seng Index (HKD)

⁸GS World Defensive sectors (local currency)

⁹GS World Cyclical sectors (local currency)

¹⁰MSCI World index growth (local currency)

¹¹MSCI World Index Value (local currency)

¹²Bloomberg Barclays Custom Composite Index (100% hedged to the NZD)

¹³Bloomberg NZ Bond Composite Index 0+ years

¹⁴interest rates raised just enough to slow the economy and reduce inflation without causing a recession.

¹⁵As interest rates increase, access to credit becomes more expensive, i.e. financial conditions tighten, slowing down consumption.

¹⁶a broad indication of the level of real interest rates where monetary policy is neither contractionary nor expansionary.

Source: BT Funds Management