Harbour Asset Management March 2018:
Following on from the same themes in January, markets continued to see strong global economic growth in February, but worried about the top risk on our list for 2018 – namely inflation risk and ultimately concerns about whether monetary stimulus will be removed in a way that is not friendly for markets. We see the heightened volatility in financial markets in recent months as a normalisation of conditions, after a period where volatility and dispersion in markets have been remarkably low for an unusually long period.
Global bonds yields rose sharply higher in early February, following a similar move that occurred through December and January. In early February, the lift in yields was encouraged by the monthly US jobs report, which delivered a robust result for hiring in January. Importantly, the data also reported average hourly earnings, a measure of wage inflation, lifting notably higher. After a long period of strong growth and little inflation, this was one of the first tangible signs that inflation pressures are finally building, which helps justify the US Federal Reserve lifting the Fed Funds rate over 2017 and reinforces expectations that this will continue over the course of 2018.
As a result, the bellwether US 10-year government bond yield pushed towards 3%. This rattled global equity markets, with the initial sell off causing the S&P500 to be down 10% at one stage, driven in part by ETF and futures strategies and the unwinding of derivatives betting on low volatility. Some of this initial correction was recovered through the course of the month, with the majority of global equity markets ending down between 4-6%.
However, global markets remain on edge, particularly after new US Fed Governor, Jerome Powell, gave his first testimony in his new role. Traditionally, since Alan Greenspan, the Fed has been seen as sensitive to market conditions, creating a perception that heightened volatility may encourage rate cuts or at least, postponing plans to hike. By contrast, Powell emphasised the strength of underlying economic data since the FOMC’s last projections in December, reinforcing his case for at least another 3 Fed Fund hikes over the course of 2018. This is now largely priced-in by markets, with a pause in hikes anticipated in 2019 to reassess conditions.
Locally, the major event in financial markets was company reporting season. The New Zealand equity market ended down only around 1%, but this masked heightened volatility and dispersion amongst individual stocks. In particular:
- a2 Milk was a huge standout with the stock price up 44%, making it New Zealand’s largest listed company. Earnings not only beat expectations, but a2 announced a transformational deal with Fonterra that may provide significant growth opportunities in new markets.
- Retirement village operator Summerset rose 11% after reporting a very strong result across the majority of its reporting lines and ahead of the market’s and company’s guidance. More importantly the company signalled a significant lift in build rates and an intention to expand into Victoria, Australia.
- Fletcher Building finished down 17% after announcing a further unexpected significant provisioning in their B&I business, which was several times larger than anticipated by the market.
- In early February, CBL detailed that an actuarial review required additional capital reserves, and an unexpected write-off against their newly-acquired businesses. The subsequent news flow reflected the response of regulators, the cessation of business lines and then an interim liquidation and voluntary administration.