US shares returned 31%, the NZX All share index returned 30% and even amongst the lower risk investments high quality New Zealand bonds returned a respectable 5.9%. There were outstanding areas with the US technology sector’s 50% return and Apple’s doubling in price, partly due to share buy-backs, putting much else in the shade.
Why did markets do so well last year?
The overall story for 2019 is best explained by changed monetary policy conditions, specifically markedly lower interest rates. Some 70% of the main global central banks have reduced rates and also have taken other actions to support economies. The sheer number of accommodative actions is only matched by the concerted activities that happened during the Global Financial Crisis (GFC).
Lower interest rates have provided growth assets with tremendous support. This support was both technical and demand driven. The technical argument provides that investments offering future income are more valuable when interest rates are lower. Investor demand also plays a critical role. As the income return from government bonds has reduced investors have refocussed their capital more towards risky asset classes pushing their prices up.
The last quarter of the year provided a change of pace with more subdued returns. Sentiment turned more positive and the trend for bond yield decline halted. Despite the change in bond markets global shares continued to perform as US and China reached a “phase one” trade deal, avoiding planned escalation through additional tariffs on Chinese goods.
How did the Aon KiwiSaver Scheme do during 2019?
With pretty much every asset class making money all our underlying investment managers did really well. Funds with higher exposures to shares, particularly NZ shares, like the Milford Active Growth fund, led returns. Other examples are the Russell LifePoints® Growth fund and the Russell LifePoints® 2055 fund. Both target a very high exposure to shares and returned 21.9% and 24.0% respectively across 2019 (net of manager fees).
Can the very long economic expansion continue?
A lack of spare capacity in the US (and New Zealand) workforce makes it difficult to sustain economic expansion without introducing stress. US unemployment is at 3.5%, the lowest level for half a century. To be sure, the economy and jobs can keep humming away for a bit longer. However, even though such low unemployment rates are not currently resulting in significantly higher wages and inflation in the way they used to, there is still a logical barrier to the expansion that will emerge. Although not widely predicted, a potential outcome of this tension could be that inflation may get out of control.
With shares up so strongly of late, how good is the fundamental support for that market rise? As of now, the jury is out. Across 2019 company profits in all regions stagnated or fell, feeds the suspicion that liquidity, not earnings quality, are behind the strength. Markets now look expensive even taking into account the falls in late February; the US is now at close to the highest valuation levels in the past two decades. The risk though seems concentrated by stock (to large stocks), global sector (in tech) and country (USA). In New Zealand, shares were currently valued at around 40-50% higher than the 10-year average compared to earnings.
It is now a US election year. With impeachment off the table Donald Trump seems to have a good chance of a second term as President. His actions are expected to continue to have mixed benefits for markets. On one hand his expansionary stance is highly supportive of growth. On the other his nationalist “America first” agenda could lead to renewed escalation of trade tensions and uncertainty.
New Zealand has challenges too. Whilst employment is at record levels, weak business investment and soft household necessitates stimulus and the RBNZ expects to keep interest rates low for a very long time. Low interest rates provide an opportunity to fund investment cheaply and Prime Minister Ardern has announced a NZ$12billion fund to spend on infrastructure. While the timing of elements of the new investment package are uncertain, partly given the upcoming election, the overall impact should be positive for New Zealand’s growth, employment and inflation outlooks.
The performance of China, being the largest trading partner, is an emerging concern. Burdened by the Coronavirus epidemic and resultant forced closure of worksites and travel bans, China seems likely to experience a slow-down across the first half of 2020. Whether the economic impact is greater or smaller will depend on the severity of the virus and this remains a very big known unknown. The reduction in Chinese tourists visiting New Zealand is likely to have implications, as is news starting to come through of reduced earnings expectations from companies with sales into China, or reliant on Chinese manufacturing.