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  • NZ Funds Monthly Review – January 2021

    25th February, 2021
  • New Zealand economic update

    For some time now there has been a steady stream of better than expected economic indicators which have suggested growing strength in the New Zealand economy. This strength was confirmed this month with the release of inflation and unemployment numbers which were well ahead of expectation. The inflation reading showed that CPI Inflation is very close to the Reserve Bank of New Zealand’s (RBNZ) target midpoint of 2.0%. However, the surprising release was the quarterly unemployment numbers which showed a sharp decline from 5.3% down to just 4.9%. This is only 1.0% above the pre-COVID unemployment level. More importantly, it is significantly below the RBNZ’s most recent forecast for unemployment which had unemployment rising in early 2021 before falling to a low of 5.2% at the end of 2023. Not surprisingly, the wholesale interest rate market has moved interest rates higher in response to this positive news. Long gone are expectations of a negative official cash rate (OCR). This effectively has unwound all the COVID-19 induced decline in interest rates. Many New Zealanders believe that interest rates are now low forever. They may be in for a rude surprise later this year as the chance of a rise in the OCR before the end of 2021 is rapidly increasing. The various New Zealand bank economists are not brave enough to make this call; however, we sense that it is only a matter of time before this happens.

    The New Zealand share market started 2021 with a +0.1% increase in January. Thematically, the market return was led by cyclical shares while growth shares lagged. The highest sector return was financials up 7.3%, given the move higher in longer term interest rates. This was followed by materials up 5.2%. Energy performed the worst, returning -8.2% in January.

    International economic update

    One of our international advisers has used the analogy of a power cut to describe the impact that COVID-19 has had on the world’s major economies. To us this explains the path that we have experienced in New Zealand – a sudden stop and then a quick return to normal life. It also highlights the potential that a post-vaccine global economy, boosted by massive government stimulus, will quickly move from the current lockdowns to relative normality. Indeed, the size of the stimulus being discussed is such that massive is a possible understatement. In the United States the Biden presidency is proposing stimulus of approximately US$1.6 trillion. The nominal GDP of the United States economy is around US$21 trillion. So, the proposed stimulus is almost 8.0% of GDP or the equivalent of two to three years of economic growth on its own. We suspect this will act like a steroid injection for economies returning to normality and drive a very strong global rebound.

    After a strong start to the month, most equity markets gave up their gains as the month ended. Developed market equities ended the month down 1.0%, although emerging markets significantly outperformed, ending January up about 3.0%.

    How has this impacted your investments?

    Income Generator

    Income Generator started 2021 with a small decline of -0.3%, a pleasing outcome given the volatility of global share markets and the negative returns generated by the New Zealand bond market over the month. This takes the return since inception to 4.6%. The Fund continues to hold five New Zealand dividend-paying companies and eight Australian dividend-paying companies. The average dividend yield of the companies held is 4.3% (including imputation credits). The Australian holdings led the way in January with five of the eight shares producing a positive performance. The performance of the New Zealand companies was more mixed with two companies up, two companies down and one flat.

    The top performer for the month was Wesfarmers, the owner of Bunnings Warehouse. Strong housing momentum in Australia and New Zealand will further drive home spending, supporting Bunnings’ growth. Rising house prices will in turn incentivise developers to build more homes and provide a tailwind to renovations activity. The largest detractor during January was Contact Energy. The weakness in Contact’s share price reflected the unwinding of the sharp 19% increase in the share price the previous month. Contact energy has been purchased aggressively by a large offshore green energy focused exchange traded fund. Despite the share’s short-term price weakness, we believe it is well placed to continue to pay strong cash dividends which are attractive in this low interest rate environment.

    Income Category

    The Income Category enjoyed a positive start to 2021. Last month we commented that longer term interest rates had remained subdued in December and traded within a very tight range. We had used this period to add to short interest rate positions and this positioning paid dividends in January as longer-term interest rates broke out of their trading range and moved above 1.0% for the first time since March 2020. The catalyst for this move higher was the confirmation of the Biden presidency and in turn the expectation of a significant stimulus package. This has seen the markets begin to factor in higher inflation. The expected inflation over the next 10 years has risen from
    below 1.0% per annum during the March sell-off back to the current level of 2.25%. We continue to believe that long term interest rates need to move higher given the fiscal spending and inflation impulses that will occur in 2021. Given this view we continue to add to our short interest rate positions throughout the month.

    Inflation Category

    A key driver of the Inflation Category is the NZ Funds-managed Absolute Return Strategy which returned 2.3% in January. Performance in January was driven across all its strategies with credit investments in particular outperforming. Short United States and Australian 10-year government bond positions generated the largest bucket of returns in the Absolute Return Strategy. Like the Income Category, these positions are based on our view that interest rates are heading higher as the global economy recovers from the coronavirus pandemic at a faster rate than has broadly been expected by the market. Uber continued to be a strong performer in the Absolute Return Portfolio, with Uber call options owned increasing in value as market volatility increased. Higher volatility increases the value of ‘out of the money’ call options even when the underlying share price remains broadly flat. Uber has been demonstrating the benefits of its dual business lines of ride hailing and food delivery that complement each other well. For example, while the ride hailing business has suffered due to lockdowns in the United States and Europe, the food delivery business has been growing at above 100% growth rates year over year as locked down people order more food from home. With the company guiding to reach profitability by the end of calendar 2021 we continue to see significant further upside from this investment.

    The Category has also been driven higher by its exposure to commodities. With the rollout of vaccines starting to gain momentum in the United States, the demand for commodities is increasing. Add to that the increase in supply chain difficulties due to global shipping and we believe commodities prices will continue to grind higher.

    Growth Category

    It was a game of two halves for growth assets in January. After a strong start to the month, most equity markets gave up their gains as the month ended. However, the diversity of themes and positions within the NZ Funds’ Growth Category meant returns were significantly above most developed market indices. The sell-off in shares towards the end of the month is not a reason for
    concern for long-term investors given the likely strong rebound in growth that will accompany the rollout of vaccines. Despite delays in New Zealand and Europe, the vaccine rollout is progressing well in the United States. Further positive news was also announced from both the Novavax and Johnson & Johnson vaccine trials. In fact, there are exciting opportunities for growth investors to benefit from the reopening of global economies. Robust economic data and only a moderate wave of COVID-19 infections continued to support risky assets in north Asia. Strong returns from Greater China contributed to the outperformance of the Category given its overweight position to China shares. Strong returns were also generated through the Category’s exposure to our macro themes. This includes short interest rates which profit when interest rates increase, commodities exposure and Bitcoin, which we remain positive on given the number of corporates, including Tesla, starting to also take positions in Bitcoin.

    Please contact us for the full report