Revenue surprises support equity returns

The Harbor Investment Outlook is a compilation of key views on recent market trends, what we are closely monitoring and the outlook for fixed income and equity markets.

Friday, November 26, 2021 12:41 PM

Harbor asset management

Key Point

  • The MSCI All Country World (Global Share) Index rose 5.0% in the US dollar in October, with a three-month return rising to + 2.9%. NZD returns are more modest, up 1.3% in the month and 0.7% in the last three months.
  • October brought a strong earnings season in the United States. At the time of this writing, 440 S & P 500 companies reported results, with a long-term quarterly average of 66% since 1994, while 360 ​​(82%) exceeded revenue estimates. increase.
  • A new trend is that price-determining companies that have survived supply-side constraints have exceeded expectations and have been able to significantly increase profits. I think this trend will continue selectively.
  • Bond yields continued to rise until October. New Zealand’s 10-year bond yield increased 0.54% to 2.63%, while the US 10-year bond yield rose from 0.06% to 1.55%. This contributed to the decline in major New Zealand and global fixed income indexes.

Main development

The global stock market continued to push the US reporting season in a balance that exceeded market expectations. However, many management comments have highlighted inflation, especially labor, energy and input costs. This was not lost in the bond market, the interest rate curve flattened and there was a sharp sell in the local market. New Zealand’s two-year swap rate rose 0.80% a month to close at 2.23%, with similar moves in Australia and the world.

Despite a strong AGM and quarterly renewal season, New Zealand’s stock market has receded, falling below the more cyclical offshore stock market. Rising interest rates continue to weigh on New Zealand’s structural growth and defensive yield stocks, exposing the New Zealand market to these sectors compared to global benchmarks. New Zealand’s circulating stocks were almost flat this month, with mixed earnings outlooks and curtailed performance.

The Reserve Bank of New Zealand (RBNZ) has begun a tightening cycle, raising rates by approximately 1.75% next year and planning an official cash rate (OCR) of 2.25% or higher. In a monetary policy review in October, the central bank noted that the recent outbreak of COVID-19 has not changed its medium-term outlook. Further removal of the stimulus was expected, and it became clear that emergency policy settings were no longer appropriate.

Inflation in New Zealand is surprisingly strong, and survey data suggest that there is little reserve economic capacity. The Reserve Bank of New Zealand’s recommended core inflation index has risen to its highest level since the third quarter of 2009 (2.7% year-on-year). NZIER’s Business Opinion Quarterly Survey (QSBO) reported high levels of demand and employment willingness among companies in the third quarter, despite the blockade. Companies are experiencing significant difficulties in finding a workforce. The utilization rate is the highest in 50 years (96%) between manufacturers and builders.

Globally, most economies have returned to pre-pandemic activity levels as vaccines and blockades have tamed COVID-19. Growth beyond potential should continue to remove excess capacity and add inflationary pressure. The recent weaknesses in US and Chinese economic activity are partially offset by the strength of Europe.

The broad consensus is that the global economy is on track for growth of 6% this year and 4.5% next year. Very simple monetary policy continues to support demand through loose fiscal conditions and high asset prices. Thanks to government support programs, household balance sheets remain strong. Inventory levels for manufacturing customers remain low, suggesting that replenishment will be an additional impetus for next year’s demand.

What to see

Stagflation: Do You Need to Worry? The number of internet searches for the term stagflation (a combination of high inflation, high unemployment and low GDP growth) is skyrocketing. However, while higher inflation may turn out to be more sustainable than originally thought, the other necessary conditions do not appear to be raising their ugly heads. First, when it comes to unemployment, the global economy is approaching or at that pre-COVID unemployment level, at the lowest post-GFC level. Second, GDP growth may have slowed recently, but it is healthy and outperforms its potential.

Market outlook and positioning

The macroeconomic environment remains largely positive for stock market returns, but market volatility can rise from very low levels. Due to the global and regional recovery of economic activity, the level of activity has returned to pre-2020 levels. Global growth is expected to continue, but COVID-19 mobility controls may stop recovery and prolong it. Some parts of the world economy may be past the fear of the “peak” delta (for example, the US and Europe with high vaccination rates), while others are at risk of impacting the turmoil in world trade. And not all economic sectors participate in the recovery – some may be compromised for some time. As a result, the rate of economic recovery can slow from steep to solid, pushing the timing somewhat to the right.

Capital markets are rapidly considering normalization of monetary policy, including rising interest rates, as the economy resumes from the blockade of COVID and inflation reoccurs. Equity markets are generally volatile during the transition period of monetary policy, and equity market volatility is expected to continue to increase from low levels over the next few months. We also expect capital rotations between sectors, depending on whether the market is focused on short-term inflation risk or the risk that global growth will turn out to be slower than expected next year. Tighter monetary policy settings are envisioned) NS). The New Zealand stock market is well-valued and biased towards utilities and growth stocks make it more sensitive to higher interest rates than other markets. Its bias towards utilities and growth stocks makes its earnings base more resilient if global economic growth continues to slow.

Within the equity growth portfolioOur strategy is to “cut noise” and build a diverse and resilient portfolio based on long-term trends. We are backed by long-term themes such as digitization (every internet, big data everywhere, e-commerce, automation, robotics), demographic changes, urbanization, rapid medical advances, and the rise. We continue to actively invest in a combination of high quality sustainable growth stocks. Of sustainability. Economic expansion continues to be positive, but rising volatility increases the need to actively recognize valuations. It also reinforces the need to focus on selective and long-term sustainable structural trends, competitive advantage, and pricing power.

Within the fixed interest rate portfolioThe main view made last month reflects the determination that global inflationary pressures are likely to last longer than most central bank and market consensus suggests. That should lead to the removal of common simple financial terms over time throughout the developed world. In New Zealand, the market is already fully anticipating our scenario, as the RBNZ has already raised OCR, pricing and raising market yields further. In fact, prices are likely to be higher than expected, and higher yields in October have motivated us to invest in one- to three-year bonds. However, the global market has just begun to reset prices. We look forward to more coming. Therefore, we are wary of long-term securities and hold short-term positions with maturities of around 10 years.

Within Active Growth FundOur strategy within the portfolio was to reduce exposure to areas of the market that are likely to be sensitive to interest rate paths in the short term. This has reduced the allocation to the listed infrastructure. Active growth funds have an overweight position on the entire stock market. We believe there is still room for further earnings upgrades, as future earnings adjustments remain modest. The portfolio is leaning towards high quality growth stocks that we believe can grow profits faster than inflation.

Within Income fundIn September, we moved the fund’s asset allocation to a more cautious position, reducing equity exposure to 29%. We warned that rising inflation and higher equity valuations suggest that expected returns may be weak. The fund holds 5% exposure to the higher performing offshore market. In the fixed rate sector, portfolio duration is steadily increasing. Market prices appear to be too tight with respect to the number of increases expected by the Reserve Bank of New Zealand over the next two years, so we are ready to invest in the two- to three-year portion of the New Zealand yield curve. In early November, we raised the bond term to 4.2 years. The beginning of this year was just 1.1 years.

This is not advice for anyone.

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Revenue surprises support equity returns

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