Markets review

- Editor


Second quarter GDP figures for the US and Europe, while negative, were better than expected and manufacturing surveys in both regions were consistent with a recovery in this key sector. The MSCI World Index in local terms has now rallied 50% off mid-March lows.

A meeting of the G20 countries’ finance ministers was held in London in early September. Stronger regulation and oversight of the global banking system was the main focus of the meeting. US Treasury Secretary Geithner summed up by stating “Our objective is to reach agreement by the end of next year on a new standard that will raise capital and liquidity requirements, and dampen rather than amplify future credit and asset price bubbles”.

The same weekend central bankers from a number of countries met in Basel. European Central Bank (ECB) president Trichet said the mood was one of increased optimism but also caution. It was broadly agreed that the stimulus that has been provided should not be withdrawn prematurely given the fragility of the recovery. Similarly the RBNZ reiterated that it would keep short-term interest rates low until late 2010.

A number of leading indicators are now pointing towards an extremely sharp near-term recovery profile. In the US, the ISM ratio of new orders to inventories is at levels only exceeded in 1958 and 1975. Attention now turns to companies’ third-quarter earnings reporting, which begins next month. Second quarter earnings were ahead of consensus, in the most part due to impressive cost-cutting action taken by companies. An improvement in top-line revenue growth will need to be witnessed to confirm economic activity is indeed improving.

Early in August, Chinese officials indicated bank lending would be reined in over the second half of the year. Concerns that this would slow economic growth saw the Shanghai Composite Index down over 23% for the month. However, it is worth noting the index is still up 47% year to date. The spike in risk aversion and volatility in global stock markets, in reaction to falling shares in China, highlighted how important the China growth story has become to global growth prospects.

Regional Economic Summary

United States

•    It is becoming increasingly likely that the recession in the US troughed in July, with economic dataflow continuing the run of positive momentum. An incipient recovery may sow division on whether to begin withdrawing stimulus measures. President Barack Obama signalled confidence in Ben Bernanke by re-appointing the Chairman as the head of the Federal Reserve for a second term.
•    The Conference Board’s coincident index was unchanged in July after falling in 17 of the 19 months since the contraction started in December 2007. The Conference Board’s coincident index tracks payrolls, incomes, sales and production, which, combined with gross domestic product, are the same measures used by the Cambridge, Massachusetts-based National Bureau of Economic Research to determine when contractions begin and end.
•    The more closely watched gauge of leading indicators, which shows the outlook for the next three to six months, climbed for a fourth month. The confidence index also rose in August, the first gain since May – a possible indication that consumers have become less concerned about the outlook for jobs.
•    Sales of existing US homes jumped more than forecast in July to the highest level in almost two years, signalling that more buyers are becoming convinced that there is not a lot of downside left in the housing market. The S&P/Case-Shiller home-price index advanced 2.9% in the second quarter, the first quarterly increase since 2006.
•    The Institute of Supply Management’s (ISM) factory index has posted the biggest two-month gain since 1983, rising to 52.9 in August. The new orders component jumped to 65, a level consistent with the US economy expanding at a 6% pace in the third quarter.
•    The US economy lost fewer jobs in August, even as unemployment climbed to a 26-year high. Non-farm payrolls fell by 216,000 workers (less than forecast) after a 276,000 drop in July. The unemployment rate rose from 9.4% to 9.7%, which was higher than anticipated. Labour market trends are improving, but the pace is a gradual one. Consumer incomes are still under pressure and prospects for growth remain fragile.

Europe

•    The Euro-area economy barely contracted in the second quarter after its two largest members, Germany and France, unexpectedly returned to growth as improving global trade boosted demand for exports and government stimulus programmes rekindled domestic spending.
•    The Eurozone PMI, a key leading indicator of economic growth and a survey of purchasing manager intentions similar to the US ISM, showed manufacturing and service industries expanded in August for the first time in over a year.
•    As in most regions around the world, while the leading indicators are improving, the recovery has fragile underpinnings dependent on government, and is threatened by the highest unemployment and lowest bank lending on record.
•    Europe’s unemployment rate rose to the highest in more than 10 years. Unemployment in the 16-member Euro region increased to 9.5% from 9.4% in June. Retail sales for the region fell in July, highlighting the lack of confidence consumers have while companies continue to cut staff.
•    The ECB left interest rates at a record low of 1% and does not appear to be in any rush to withdraw emergency stimulus measures. Economists don’t expect the central bank to raise rates before the third quarter of 2010.

United Kingdom

•    The UK economy contracted less than previously estimated in the second quarter as manufacturing, auto services and government spending helped mitigate the recession. Gross domestic product fell 0.7%, less than the 0.8% calculated last month.
•    The Bank of England plans to keep buying as much as £175 billion (US$290 billion) of assets to cement the economy’s recovery. The central bank also kept the benchmark interest rate at 0.5%, as expected by most forecasters.
•    UK house prices rose at their fastest pace in more than two- and-a-half years in August, as low interest rates spurred demand and a lack of properties for sale underpinned values. While lack of supply may be pushing up prices, demand for homes is also firming on the back of a gradual improvement in mortgage availability and the improving economic outlook.

Asia Pacific

•    China’s manufacturing expanded at the fastest pace in 16 months in August, driven by record lending in the first half of the year.
•    The China PMI rose to a seasonally adjusted 54 from 53.3 in July. Gains in output, orders, and jobs added to evidence the recovery remains on track and likely to meet Premier Wen Jiabao’s target of 8% growth this year.
•    Chinese industrial production also surprised on the upside, up 12.3% year on year. Investment in real estate and utilities were the major components to exceed expectations.
Australia
•    Australia’s economy unexpectedly accelerated in the second quarter, showing government cash handouts boosted spending at retailers.
•    At this rate, the Reserve Bank of Australia (RBA) may be the first central bank in a developed economy to begin raising borrowing costs in almost a year.
•    Still, the RBA kept interest rates unchanged for a fifth month. Reserve Bank Governor, Stevens, said “…the present accommodative setting of monetary policy remains appropriate for the time being”.

New Zealand

•    Rising consumer confidence, housing demand and immigration are helping New Zealand recover from its worst recession in three decades. It is likely that the economy will start growing in the second half of this year.
•    New Zealand house prices rose for a fourth month in August, signalling that the property market is recovering and may help the economy emerge from a recession.
•    New Zealand’s commodity export prices fell in August after gains in world markets were wiped out by the stronger local currency.
•    The Reserve Bank of New Zealand (RBNZ) kept its benchmark interest rate unchanged and said it maintained a dovish stance reiterating rates would remain low until the second half of 2010 amid expectations the economy faces a slow recovery. Governor Bollard said the economy requires further stimulus from low interest rates because the medium-term outlook is weak, even as a ‘patchy recovery’ gets underway.

Monthly Sector Summary as at 31 August 2009

International shares

The MSCI World Index in local currency terms was up 3.8% for the month of August, a modest gain compared to recent monthly returns, taking the year to date gain to 17.3%. Returns to unhedged New Zealand-based investors were flat, with the NZ dollar 4% higher against a weaker US dollar.

The pace of the recovery in financial markets in recent months has led to a rising sense that the equity market rally has outpaced the economic recovery and is overdue for a correction. Several times in August, risk aversion spiked and equity and commodity prices fell sharply. Despite these concerns, August saw positive returns across all global regions, with the exception of Asia-Pacific ex-Japan down 2.7% due to the sell-off in Chinese sharemarkets.

The developed regions were the best-performing in August, led by the UK where the market was up 7.4%. The sharp rally in large global banks based in these regions helped drive developed country markets higher.
Financials (+9.1%) were the best performing sector and have now rallied over 74% in the last six months, nearly double the next best performing sector over that period. Stock prices of AIG, Freddie Mac and Fannie Mae were up 245%, 269% and 233% respectively, in part due to covering of short positions.

New Zealand shares

The New Zealand sharemarket rose a further 2.9% during August, adding to the previous month’s gain of 7.9%. For the calendar year to date, New Zealand equities are now up 14.1%. However, despite the rise, domestic equities underperformed global equities during the month.

The August reporting season delivered some mixed results, but generally reinforced the widely held view that the first half of 2009 was very tough for most businesses. Guidance for future profits was limited due to the uncertain economic environment.

Nuplex Industries was one of the strongest performers, rising just over 30% over the month. While profit fell 65% for the year, the result was ahead of expectations and this, together with news of a special dividend, saw the stock regain favour in the market. Pumpkin Patch also continued to gain ground, rising 15.6% during August and taking the calendar year-to-date gain to 100%, making it the best-performing stock in the index.
PGG Wrightson continued to languish, falling a further 24.7% in August. NZ Refining was down just over 27% after announcing that it would not pay an interim dividend. Both companies suffered in the wake of the continued strength in the NZ dollar.

Australian shares

The Australian equity market (S&P/ASX200 Accumulation Index) performed strongly again in August, gaining 6.6% over the month, with earnings delivery throughout the reporting season generally better than had been expected. This was the market’s sixth consecutive monthly rise and it took the rally from its closing low at 6 March 2009 to a gain of 42%. June half-year earnings reports dominated corporate news flow in August, with numbers on average ahead of consensus expectations and well received.

The Financials sector (+13.3%) produced standout returns in August, with all sub-sectors – including real estate (+16.1%), banks (+13.1%), insurance (+13.0%) and diversified financials (+8.4%) – outperforming the market. Telecommunications (-7.1%) brought up the rear, but cyclical sectors did not have it all their own way, with materials (-1.3%) also lagging the market.

International fixed interest

Long-dated US bond yields were largely unchanged for a third straight month in August, despite the continuing improvement in global sentiment and risk appetite during the month. Bond market participants seem to understand the fragility of the anticipated global recovery and that it will only materialise if interest rates remain low.

The latest GDP data out of the US and Europe was not as weak as had been feared, while Germany and France appear to have already exited recession. European PMIs and the US ISM survey are consistent with a recovery in the global manufacturing sector, while improving US home sales spurred hopes of a stabilisation in the US housing market.

Various central bank commentaries appeared to endorse the market optimism about the economic outlook. In particular, Fed chairman Bernanke said “…economic activity appears to be levelling out…prospects for a return to growth in the near term appears good”.

Conditions in credit markets continue to slowly normalise, which also provided a prop for sentiment. Credit spreads tightened further in August. As counterparty concerns abated, access to liquidity continued to improve. Globally, short-term money markets spreads contracted a further 2-10 basis points (bp) in August (with the exception of Australia) and are now at levels below the crisis average. Against a backdrop of stabilising financial market conditions and improving global growth prospects, investors’ appetite for risk has increased to more normal levels.

New Zealand fixed interest

The New Zealand government bond market returned 0.40% for the month, outperforming cash, which returned 0.23% over the same period.

In New Zealand, the economy appears to have reached a turning point, as evidenced by strengthening domestic leading indicators and supported by improving expectations for the global economy.
Current market pricing is consistent with the first RBNZ hike coming in March next year and a further four hikes over the next 12 months. This is despite the RBNZ’s assurances that the OCR will remain at, or below, current levels until the latter part of 2010. With markets contemplating a return to RBNZ tightening, longer-dated (swap) yields were pressured higher over August, assisted by a sharp sell-off in Australian rates. The NZ 2-year swap rate rose by 29bp to 4.2% – the highest since March. On the other hand, longer dated government yields actually fell, as offshore investors in particular saw New Zealand’s high nominal yields as attractive.

Currency

In August, commodity sensitive currencies such as the NZ dollar (NZD) performed strongly, outperforming all major crosses. The NZD/USD traded a range between the July close of US$0.659 and US$0.6897, before ending the month at US$0.6847. The NZD gained 1.8% against the JPY, +3.1% to €0.4775 against the EUR, and +6.4% against the GBP. This is the highest level for the NZD/GBP cross since 1997. The NZD/AUD cross ended the month up 2.6% at AD$0.8127.

The NZD rose early in the month, buoyed by a strong result from the Fonterra auction, where milk prices were up 26%. For the rest of the month, the NZD traded in step with global equity markets, rising steadily apart from during short bouts of risk aversion. On these occasions, the NZD fell several cents lower before rallying. Upward pressure on New Zealand interest rates also helped drive the NZD higher with the NZ-US yield spread widening 50bp over the course of August.

New Zealand listed property

The New Zealand Property Index (gross) returned +3.6% in August, outperforming the broader equity market (NZX50 gross), which had a return of +2.9%. Over the last three months to the end of August, the sector has rallied 15.5%, outperforming the broader equity market which returned 12.4%.

Due to weaker performance earlier in the year, the sector has underperformed year to date with a gross return of 6.1% compared to 15.0% from the broader equity market. However, despite the weak start to 2009, the property sector has outperformed on a rolling 12-month basis, with a return of 0.10% compared to -6.02% for the NZX50 Index (gross).

Some of the more heavily discounted LPTs such as National Property Trust (NAP), Kermadec Property Fund and ING Property Trust (ING) were the best-performing listed property vehicles during the month, with returns of 20.0%, 14.9% and 11.6% respectively. Large capitalisation trusts AMP NZ Office Trust and Kiwi Income Property Trust also had strong months, with returns of 5.7% and 5.1% respectively. Underperformance was recorded by sector stalwarts Property for Industry with -2.6% and ING Medical Properties Trust with 0.9% which took a rest, following strong outperformance in previous months.

Corporate news during the month consisted of assets sales announcements from NAP, Goodman Property Trust (GMT) and ING. NAP announced the sale of two adjoining buildings in Newmarket for $49 million, or 6% below 31 March 2009 valuations. With these sales, the gearing of the vehicle has fallen to around 25%, below the sector average of 29%. GMT announced the $27.5 million sale of Pernod Ricard House in the Viaduct, Auckland, at a 3.3% discount to its March valuation. Finally, ING announced the sale of a further three properties for a total of $10.4 million, all at prices ahead of the latest valuations.

Australian listed property

The Australian property sector saw its sixth consecutive monthly rise in August, with the index up 16%, outperforming the broader equity market (ASX 200) by nearly 10%. The sector has now rebounded a staggering 64% from its March 2009 lows. However, despite the rebound, the sector is still down a very disappointing -34.5% for the 12 months to the end of August, underperforming the broader equity market by 26.4%.

The continuation of the recent theme was evident with the re-emergence of risk appetite following the recapitalisation of the sector and an improved economic outlook. Other positive news included news that credit spreads have continued to fall with further evidence that good quality Real Estate Investment Trusts (REITs) are issuing debt at increasingly tight spreads.

The best-performing REIT during August was ING Industrial Fund with an 87.0% return, followed by Goodman Group with a 33.9% return and Stockland with a 20.0% return. Under-performers were Bunnings Warehouse Property (-7.8%), Dexus Property Group ( 2.1%) and Astro Japan Property Trust ( 2.3%).

International listed property

Real estate stocks around the globe delivered positive returns in August, thus extending a rebound which began over five months ago. The UBS Global Investors Index of real estate stocks produced a positive total return of 13.5% (local currencies). Year to date, global real estate stocks are up 16.9%.

By region, performance was led by property companies in Europe, which achieved a total return of +18.2%, followed by North America +13.9% and the Asia Pacific region +1.7%. US REITs recorded a particularly strong month with a total return of +14.1%, catalysed by credit markets, which continue to be accommodative, and 2Q09 earnings releases which demonstrate that public company management teams have successfully navigated the worst of the recession, with an eye to being opportunistic looking forward.

With the second-quarter 2009 earnings season behind us, we have a clearer picture of how listed property management teams have navigated and intend to manage through the remainder of the economic recovery. While property companies generally met or beat expectations for the quarter, all eyes remain on the balance sheet and how management teams intend to capitalise on opportunities coming out of the current recession. From an operational perspective, pressure on operating earnings could continue for another 12 to 18 months in most regions. Positive earnings growth, which we anticipate will return in 2011, is a tailwind for valuations.