Market Review: Markets at a cross-roads?

With the US-led victory in Iraq, geo-political risks have decreased in the short-term. Does this mean we can return to simpler times when successfully investing in equity and bond markets was a matter of “just” correctly predicting economic, interest rate and company earnings trends? The answer is “yes and no”.

“Yes” in the sense that the Iraq war was THE issue for the market over the past six months and this is now resolved – although “winning the peace” may be as difficult for the US, as winning the war.

With the war concluded the markets have started to focus on economic fundamentals. Given this, it was pleasing to see that the March quarter earnings from US companies generally exceeded (beaten down) market expectations. However, it is too soon to say the profit cycle has turned. The all-important outlook commentaries from the US companies remained mixed with considerable uncertainty about what the future holds.

With limited revenue growth most of the US company earnings increases came from cost cutting (mainly job shedding) although a weaker US dollar also helped some US based multi-nationals. The former showed that US companies are more pro-active in dealing with economic down turns than their (inflexible) Japanese and German counter parts. However, the jury is still out whether this will fuel unemployment in the US, thereby depressing consumer confidence and, ultimately, the US economy. It really does feel like the US (and therefore the global) economy and market are at a “cross-roads” with the next few months crucial in determining its direction.

On the positive side, capital expenditure spending levels of US companies remain very low and there may be a post-war bounce back in this area. In addition, a sustained drop in oil prices is very positive for the global economy.

“No” as the US-centric world has probably changed forever after 9/11 and they now live under the constant threat of reprisal terrorist attacks. Hopefully, an attack on the scale of 9/11 will not recur. A more likely scenario is the type of terrorism that London endured with the IRA or Spain with the Basque separatists. While some of their actions were horrendous, they were not of sufficient scale to de-rail the global economy or financial markets.

Of course there is also still North Korea to deal with! This was successfully put on the “back burner” by the US during the Iraq war but the US are clearly re-focusing on it now. It is always hard to get inside the mind of a dictator but it seems that the consensus view was correct in that the North’s (nuclear based) brinkmanship was to get further aid for its struggling economy. If so, North Korea’s actions may have some rationality to them and so a sensible mutually agreed outcome is still probable.

The spectre of a “super” bug is now a constant threat, with SARS the latest example. Although the short-term outlook for China is bleak, particularly in its provincial areas, the hope is that this will remain contained to a few countries, with localised (rather than global) effects. This is confirmed by the fact that the impacts from SARS on the world’s largest economies have been minimal to date - long may this continue!

The New Zealand economy is started to feel the negative impacts of a weak global economy, soft commodity prices and a strong Kiwi dollar versus the US dollar. Throw in SARS and the power crisis and you can see the reason why the Reserve Bank in New Zealand felt compelled to cut interest rates in April. They were obviously prepared to trade this off against the potential to fuel the already strong residential property and building sectors, something Don Brash was not prepared to do in the 1990s.

Looking back on April, most major equity markets were significantly higher at month end. The stand out was the German Index (the DAX) which was up over 21% in April! The French Index (the CAC 40) was also strongly up (+13%) and the US and UK were up 8% (S&P 500) and 9% (FTSE 100). The strong performance of the IT-laden NASDAQ Index was noteworthy, as it is now over 30% above its low in October 2002. The exception to all the global equity market strength was Japan, which was down 2%.

Our local sharemarket lagged, being up “only” 4% (NZSE 50). Ironically, the new NZSE 50 Index under performed the old NZSE 40 Index, which was up 5%. Most New Zealand companies with good yields were well bid through the month, partly in reaction to the cut in interest rates by the Reserve Bank.

The New Zealand dollar had a slight depreciation against a strengthening Euro (down 1%) and, in particular, against the Australian dollar (Kiwi down 2.5%). However, the rise against the US dollar continued, with the Kiwi up 1% for the month and 25% for the past twelve months. A collapse in the US dollar remains one of the key risks over the next year. While unlikely, the impact of this would be a significant negative influence on equity and bond markets.

After a March sell-off, bonds performed well in the April month with gains of 1% for both domestic (CSFB Government Stock Index) and global (Lehman Global Aggregate Hedged Index) bonds. For example, the yield spread between US junk bonds and US Government Bonds has almost halved in the past six months, and has more than halved between investment-grade bonds and US Treasuries.

So it was a month where both bonds and equities performed positively. This has been an unusual occurrence in recent times with the respective markets usually moving in opposite directions.

To see how the numbers stacked up for various markets around the world in the past month and over the year, visit our Monthly Market Reveiw here

Anthony Quirk is the managing director of Guardian Trust Funds Management

Anthony Quirk is the managing director of Guardian Trust Funds Management.

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