After a stellar performance in 2020, the New Zealand sharemarket has underperformed other markets so far this year by quite some margin.
The local market’s S&P/NZX 50 index finished the year at 13,092 – up 14 per cent on the substantial lift in the previous year.
But since early January the index has dropped by 7 per cent.
In contrast, America’s Dow Jones Index has gained 2.8 per cent so far this year.
Australia’s ASX200 has done better, firming 3.4 per cent.
Softness in the local market can in large part can be put down to bond yields, which are gaining as investors start to factor in inflationary pressure further down the track.
Government bond yields are rising rapidly, with the NZ 10 year-bond yield having gone from 0.4 per cent last year to over 1.5 per cent now.
Just three weeks ago, the 10-year bond was at 1.0 per cent.
They are, on the face of it, very small numbers but they do signify a shift for the financial markets.
Milford Asset Management portfolio manager Mark Riggall said the trend in bond yields had accelerated in recent weeks.
“It’s been building and it’s been talked about by financial market professionals for a few months now, but it seems to be gathering steam.”
Short bond yields have not ventured far away from the Reserve Bank’s 0.25 per cent official cash rate, but it’s a different story in the longer-dated maturities.
The message from central banks here and around the world is that they want interest rates to remain anchored at low levels while their economies recover from Covid-19.
But that hasn’t stopped the longer end of the yield curve shifting higher globally, driven by the “reflation” theme.
Last September, when the prevailing market talk in New Zealand was about negative interest rates, the NZ 10-year bond yield was at 0.43 per cent.
Now, the perception is that the 0.25 per cent official cash rate will be as low as it goes.
The baffling strength of the economic rebound in New Zealand has been evident, to a lesser extent, in other parts of the world.
“The economic damage and unemployment rate is much lower than people expected,” Riggall said.
“So we are in a much better place, and part of that has been reflected in the bond market,” he said.
“Then there is the forward-looking aspect of vaccination programmes progressing at a reasonable pace, depending on the country,” he said.
“Clearly there is a lot of pent-up demand for goods and services.
“Household balance sheets are in good shape because of the fiscal response from governments, mortgage interest rates are lower and asset prices are higher.”
Riggall said the stage is now set for heavier consumption, with a likely flow-on impact on inflation.
“That’s leading everyone to expect a boom in growth, a boom in consumption and increased demand for goods and services, which will drive up prices, so inflation is expected to increase further down the track.”
A steepening yield curve is generally seen as a sign of economic growth ahead.
Riggall said people do not expect to see inflation run away to 1970s levels.
“But there will be a least a little bit more inflation, given the supportive policy dynamic of low interest rates, aggressive central banks, and aggressive actions from governments,” he said.
“We have not seen those elements acting in concert globally for such a long period of time that if we are ever going to see inflation, it’s going to be in the next 12 months,” he said.
In the US, 10-year Treasury yields are at 1.3 per cent but would start to become a problem for the central bank if they hit, say, 1.75 per cent, Riggall said.
The New Zealand sharemarket – which is dominated by the big electricity generators – shot higher last year due in no small part to heavy buying from “green” exchange-traded funds.
Expected changes to some of the index weightings for those funds have seen the generators retreat from their highs.
New Zealand is chock full of dividend-paying, bond-like companies, and with bond prices falling, yields rise, so those dividend yields are looking less attractive.
“Those companies have been in less demand for global investors so that’s part of the reason why New Zealand has not performed yet,” he said.
Harbour Asset Management portfolio manager Shane Solly said markets globally were reacting to early signs of inflation, albeit off a very low base.
“Bond investors are looking at this creep up in inflation and are asking: hang on we need to be compensated for this.
“Central banks, looking forward, might not be so supportive,” Solly said.
Reserve Bank Governor Adrian Orr is set to deliver the Reserve Bank’s monetary policy statement on Wednesday.
Few expect Orr to “rock the boat” but he may well opt to comment on what’s been happening in the bond market, particularly since the bank has been spending close to $600 million a week on buying bonds to keep yields low.
The weekly pace of the Reserve Bank’s bond-buying peaked in August at $1350m, but has since fallen to $570m – partly a result of the reduced issuance pace and partly due to the limited pool of bonds available.
ASB Bank chief economist Nick Tuffley said the economy is currently in a much better position than many had earlier envisaged, including the Reserve Bank.
Tuffley said the central bank’s dual inflation and maximum sustainable employment targets are that much closer to being reached again on a sustained basis.
“In our view, the huge monetary policy stimulus in place at present is likely to start getting unwound a little sooner than anyone would have contemplated even late last year,” he said in a commentary.
Tuffley expects the Reserve Bank to start lifting the official cash rate gradually from the second half of next year.
“But in the here and now, life remains uncertain – and we expect that message will be the one the Reserve Bank will want to emphasise despite the better starting point.”
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