2017 has got off to a great start. Once again, the markets have delivered another strong positive start to the year. This stretches the winning sequence to eight years in a row - since the Global Financial Crisis - where the January to March quarter has performed well. More impressively, in seven of those years (including this year) the returns for the quarter have comfortably exceeded our long run expected returns for a three month period.
While market commentators are frequently preoccupied with identifying reasons for market weakness (and usually getting it wrong), the reasons for market strength are often strangely ignored. Presumably, this is because those same commentators assume that favourable news stories don’t capture a reader’s attention as well as unfavourable ones.
So why did diversified investment portfolios perform so well over the first three months of the year?
The absence of any obvious bad news was certainly a help.
You may recall that, 12 months ago, the Royal Bank of Scotland were predicting that 2016 would be “cataclysmic” for investors. Ironically, they made that prediction in a year when concerns about China were high, the UK voted for Brexit and the US voted for Donald Trump. In some ways they picked a good year for a bold prediction. Unfortunately, the only cataclysm was felt by investors who listened to them. Those who stayed out of the markets missed out on a year of strong returns.
Both Brexit and Trump featured again in the first quarter of 2017, with markets largely ignoring them.
On 20 January, Donald Trump was inaugurated as America’s 45th president. He hit the ground running, issuing more executive orders and presidential memoranda than any other president in history. The most controversial of these was an attempted ban on travellers from seven Muslim-majority countries, which was subsequently overturned by the Supreme Court.
On 29 March, Theresa May, the British prime minister, invoked Article 50 of the Treaty on European Union to commence the UK’s formal withdrawal from the European Union, a process which will culminate in the UK ceasing to be a member by April 2019.
One of the largest positives for the markets in the quarter was something a little harder to quantify - improving sentiment. According to the World Bank Group’s Global Economic Prospects report published in January, global economic growth is expected to expand this year at the highest rate since the Global Financial Crisis. While this is being led by generally larger expected gains in the emerging nations, small gains are also expected across many developed nations as well, and, for some, it represents the first anticipated improvement in a number of years. In Europe, the USA, Japan, China, New Zealand and elsewhere, business surveys and general economic indicators are largely optimistic.
In New Zealand the growth outlook continues to look positive, supported by ongoing accommodative monetary policy, strong positive net migration, and high levels of household spending and construction activity. However, with no pressing inflation concerns, Graeme Wheeler, the Reserve Bank Governor, indicated in the 23 March monetary policy statement that New Zealand interest rates will be likely to remain at their current low levels for a considerable period. This will be welcome news for share market investors and those with large debt servicing commitments, but less so for retirees relying on income from term deposits.
Looking back over the first quarter of 2017, we see that most asset classes performed well. After a disappointing end to 2016 New Zealand shares enjoyed a good start to the year, with the S&P/NZX 50 Gross Index (including imputation credits) jumping 2.48% in January, on the way to a healthy gain of 5.08% for the quarter. Whilst a return of this magnitude would normally place the New Zealand share market amongst the better performing markets for the quarter, many foreign share markets eclipsed this in what was a rewarding period for equity markets globally.
For a time local property assets looked like following a similar pattern, with the S&P/NZX All Real Estate Gross Index gaining 2.53% in January. However, negative returns in both February and March saw the index close just 1.60% higher for the quarter. High property valuations, coupled with an expectation that the official cash rate will stay at current levels until mid-2019, encouraged foreign investors in particular to reassess their exposure to this asset class.
Completing the domestic picture for the quarter were useful returns from local bond markets, with the S&P/NZX A-Grade Corporate Bond Index and the S&P/NZX NZ Government Bond Index up 1.75% and 1.39% respectively, as New Zealand yields fell modestly.
The Australian share market performed well, with the main S&P/ASX 200 Total Return Index gaining 4.82% in local currency terms. New Zealanders investing into this market on an unhedged basis also benefited by another 4.52% (source: Bloomberg), as the New Zealand dollar weakened against the Australian dollar over the quarter.
Overseas, share market returns were generally strong. A review of the Morgan Stanley Capital International index returns in local currencies shows us that the leading developed nations all performed well, with the USA up 6.23%, Germany gaining 7.02% and France 5.86%. Even the UK - with the Brexit cloud still hanging over it - rose 3.82%. The exception, and in fact the only developed market to dip into the negatives for the quarter, was Japan, with a local market return of -0.03%.
Returns across the emerging market regions were, on average, even better than in developed markets. In local currency terms, China jumped 13.13%, India delivered 12.06%, Korea 8.24% and Brazil 7.73%. Once again this highlights the propensity for emerging markets to outperform when investors are prepared to accept greater risk. The main outlier from the emerging market regions was Russia, which fell -10.63% and suffered, at least in part, from the price of Brent Crude oil falling by -7.0% over the quarter.
Global listed property largely mirrored the performance of New Zealand property. With the global investing climate turning more favourably toward risky assets, it was listed equities which reaped the highest rewards. The slightly more defensive listed property sector, whilst performing solidly, did not enjoy the same strong tail winds. Overall for the quarter the S&P Developed REIT Index (total return) was up 1.58% in US dollar terms.
Global bonds delivered positive, if unspectacular, results, with the lack of significant new information contributing to a relatively benign quarter for fixed income markets. International yield curves were little changed, with USA and UK long term rates trending slightly lower whilst German and Japanese yields trended slightly higher, albeit off very low bases. In aggregate, it meant the returns to bond investors were related more to the income component of bond returns (ie, the underlying bond yields) rather than the capital gain or loss component (ie, any changes in yields). By quarter end, the Citigroup World Government Bond Index 1-5 Years (hedged to NZD) returned 0.58% while the Bloomberg Barclays Global Aggregate Bond Index (hedged to NZD) gained 0.77%.
Although the European Central Bank and Bank of Japan continue to maintain accommodative monetary policy settings, the US Federal Reserve followed its December rate rise by lifting the target for the federal funds rate by another 0.25% on 15 March. This moved the federal funds target to between 0.75% and 1.00%, whilst at the same time maintaining its forecast of two more rate increases in 2017.
It will be interesting to see what transpires here. US rates could be hiked faster if the massive tax cuts and infrastructure spending promised by President Trump were to fuel higher inflation, but the details and timing of these proposals remain extremely unclear. In the meantime, the Trump administration’s failure to find a compromise on the Obamacare repeal has provided an early reminder that talk is cheap, and market expectations based on campaign rhetoric may need to be adjusted downwards.
These and other questions will all be answered in due course. For the moment, however, we can reflect on another very rewarding period for diversified investment portfolios. And while it may not always make for captivating news headlines, the first quarter of 2017 was another timely reminder that, for investors, no news really is good news.