A Much Brighter Second Half
The first half of the year was all dark clouds, but there could be some sunshine breaking through, writes Greg Smith of Devon Funds.
15 November 2022
After a traumatic first half of the year for stock markets, the second six months of 2022 started off on a much brighter note. The NZX50 index lost more than 16% in the six months to June but rallied 5.7% in July. This was the strongest gain since the bounce from the ‘pandemic crash’ in April 2020.
It was a similar story for other markets around the world, including the US where the S&P500 benchmark surged 9%, the best July for the broader index since 1939. The massive rebound brought relief to investors following the worst start to a year in over five decades.
Doom and gloom – then a reset
Early on in 2022, all the ‘market’ messages were mainly about economic ‘doom and gloom.’ The cost of living skyrocketed, exacerbated by the war in Ukraine. Inflation was running hot. The RBNZ lifted interest rates, putting pressure on many mortgage holders, whose confidence was already dented by falling house prices.
Emotive headlines always garner attention, so it was no surprise that when Kiwi shares went into a ‘bear market’ in June (falling 20% from last year’s peak), it was widely reported.
So, what happened in July?
The market’s performance had the hallmarks of a ‘reset’ by investors after so much bad news had been priced in. Intertwined concerns around inflation, interest rates and the economy remained, but the idea grew that the worst-case outcomes might be avoided. Comments from the US Federal Reserve that fears over a “real” recession were overblown, and that interest rates rises might be “moderated”, also helped sentiment. Robust labour markets were also supportive, with the US economy creating nearly 528,000 jobs in June.
The reporting season from US corporates (including many multinational names) highlighted that the world economy wasn’t in that bad a place. Most S&P500 companies which reported beat earnings expectations. Revenues were generally pushing higher; outlook statements were often optimistic and companies with pricing power were combatting inflation by passing on cost increases to consumers. Investors will be looking out for similar signals in the New Zealand earnings season which gets underway in mid-August.
Is New Zealand heading for a recession?
Many have been quick to suggest that New Zealand is in or heading for a recession, and – with a rising cost of living and higher interest rates – consumer spending will fall off a cliff. The annual CPI to June was at a 32-year high of 7.3%, higher than expected. However, the market largely took this in its stride when reported in July.
Signs have also emerged that inflation could be peaking. Oil prices fell below US$90 a barrel, cutting the price of petrol, helped by the Government’s extension of fuel tax cuts. Shipping costs, while still elevated, have been coming down. Some supply chains are starting to free up, despite the continuation of the war.
Not that you would know it from the weekly grocery shop, but food prices have every reason to be coming down. Soft commodity prices have fallen from their recent peaks. The price of wheat has dropped by more than a third in recent months. So, are markets now finally pricing in the narrative that inflation might not be quite as entrenched as some are thinking? Price moves for oil, food and other commodities will be under scrutiny during the coming quarter.
Meanwhile, the local jobs market is buoyant. Our June quarter unemployment rate was 3.3%, up slightly on the previous quarter but still close to historic lows.
The borders also opened fully from August (and cruise ships are allowed back in!). The influx of tourists can have a meaningful positive impact on the economy, with a weak Kiwi dollar increasing the allure for travellers. More workers will be arriving too, which should help sectors experiencing labour shortages.
Time will tell whether New Zealand avoids a technical recession. June quarter GDP numbers are due in mid-September, but there is cause to believe that, just like the US, we are not facing a ‘real’ recession, and certainly not to the extent seen in the GFC. Stock markets will regard such an outcome favourably. Also in focus will be the RBNZ strategy: will it see the potential for reining back the pace of rate increases while still getting inflation under control?
A game of two halves?
Will 2022 prove to be a game of two halves for markets? Will the worst fears priced into markets in the first six months of the year fail to transpire? We will know a lot more, but not all, by the end of the third quarter.
The stock market rally in July was encouraging. But many challenges remain, and there is no guarantee that a rising tide (market) will lift all boats. At Devon, the investment team’s emphasis remains on seeking out high-quality companies with strong growth prospects at a reasonable price. Many companies in this camp appear to remain good value despite the rebound we have seen at the start of the current quarter.
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