Investment returns (before tax and fees)* for the quarter ending 30 June 2023 are:

* rounded to one decimal place.

Economic growth has been somewhat sturdy as we report on another positive quarter. In our mind, there are two key questions in the market at this point.

Will interest rates rise further from here?

Reductions in energy prices (e.g. oil), easing supply constraints, and reduced spending on goods have all contributed to a reduction in headline inflation. There are some lingering concerns around the pricing of certain services such as costs of travel, hospitality, wages, and food. However, central bankers around the world have managed to, for the most part, cool inflation in a red-hot economy.

Are share prices today correct in anticipating a rosy future?

Share and bond markets have very differing views today about future outcomes. Share investors are optimistic, feeling the worst has passed and better times are ahead. However, bond investors are cautious because of their concerns about inflation.  

Share investors feel optimistic largely because share prices have increased significantly in the past year. For the year ended 30 June 2023, the prices were up for indices such as the USA Dow Jones (12% price increase), S&P 500 (18% price increase) and NASDAQ (25% price increase). There has also been the belief that the gains from artificial intelligence (AI) may be significant, especially for some technology companies.

At the same time, share investors may feel that the market is currently experiencing some form of stability. The VIX, an index that measures the expected volatility in share prices, is reporting that the stock market expects to be half as volatile compared to what it reported in October last year.

Bond investors remain cautious, given that interest rates have risen strongly in the past year. There is still considerable uncertainty about whether central banks will raise rates further. Whilst headline inflation (the rate reported by the Consumer Price Index) has reduced, domestic inflation (which mainly considers housing, transport, medical, electronics prices etc. and does not include food and energy prices) remains stubbornly high and of concern to central banks.

While we are reporting on another positive quarter, there is a sense that investors are not all in agreement in their feelings about the market at this point in time because there are plenty of reasons to be both optimistic and cautious.

We think interest rates could rise further, and shares come under pressure at these levels. We remain cautiously invested, diversified and continue to hold higher-than-normal amounts in cash.

Investment returns (before tax and fees)* for the quarter ending 31 March 2023 are:

This latest quarter saw better returns than last year when interest rates rose (both bond and shares prices fell). The first quarter of this year began with positive sentiment on the growth outlook as energy costs fell and China’s economy reopened.

Due to swift action by the regulatory authorities, the global banking sector now appears less of a concern. However, those actions may result in slower credit creation, which could lead to slower growth (e.g. tighter lending standards as banks become more cautious).

The banking concerns in March dwarfed concerns around inflation. As markets reacted to fears of a banking crisis, government bond markets went from pricing in rate hikes (i.e. falling bond prices) to pricing in rate falls later this year (i.e. where bond prices rise).

Global equities also gained in the quarter, buoyed by declining recession worries in developed markets.

Locally the Reserve Bank of New Zealand (RBNZ) surprised the market in February 2023 with a 50 basis points increase in the Official Cash Rate (OCR), thereby lifting the OCR to 5.25%. The concern is that the domestic economy may already be slowing. The RBNZ is expected to increase the OCR by another 25 basis points (to 5.50%) in May 2023. The market’s attention could then increasingly focus on the timing and extent of the next easing cycle.

Despite the banking sector concerns, Central Banks continued to fight inflation with tighter monetary policy (via official cash rate increases).

While there were signs that hiking cycles were already biting (particularly in housing markets), we think the full spill-over effects to the broader economy are yet to come.

In our view, the inflation outlook is mixed. Whilst inflation appears to be reducing (largely on the back of lower oil prices), we remain concerned that demand still appears to be strong, for example, food and rental prices. Wage growth in this tight labour market is also keenly observed.

In April 2023, the International Monetary Fund (IMF) warned that the recent turmoil in global banking systems would slow global economic growth. In their latest Global Financial Stability Report, the IMF said the financial markets remain fragile and stressed. Whether the measures taken so far have been sufficient to fully restore confidence in markets and institutions remains to be seen. The IMF expects global economies will grow 2.8% in 2023 and 3% in 2024. Each of these forecasts has been revised down by 0.1% since January. In 2022 global economies grew by 3.4%. IMF expects global inflation of 7% in 2023, slightly down from the 8.7% achieved in 2022. Growth predicted by the IMF is the lowest in 20 years.

We remain cautious about the outlook because the rapid increase in interest rates will have a long and variable lag effect on the economy. Higher rates are still to impact the real economy fully. In addition, any tightening of credit standards (reduced lending) and increased capital costs for banks will weigh on the economy. We see risks to both bond prices (interest rates) and earnings growth (share prices).

In this environment, we remain cautiously invested and diversified and continue to hold higher-than-normal amounts in cash.