Harbour Investment Outlook: Let the good times roll

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Thursday, December 12th 2024, 2:17PM

by Harbour Asset Management

Key market movements

• The MSCI All Country World Index (ACWI) increased 4.4% last month, in New Zealand dollar-unhedged terms, almost matching last month. This time the strength had very little to do with NZD weakness as returns in NZD-hedged terms were 4.1% for November.
• Locally, the New Zealand equity market had another good month, with the S&P/NZX 50 Gross Index (including imputation credits) increasing 3.4%. The S&P/ASX 200 Index also performed well, up 3.8% (3.7% in NZD terms).
• Bond indices gained in November. The Bloomberg NZ Bond Composite 0+ Yr Index gained 0.6%, reversing October’s decline. The Bloomberg Global Aggregate Bond Index (hedged to NZD) gained 1.2% over the month. US 10-year government bond yields were 12bps lower on the month, ending at 4.17%, whilst the New Zealand 10-year yield dropped 10bp to finish at 4.38%.

Key developments

The global economy isn’t likely to experience a hard landing in 2025 as ongoing disinflation allows most central banks to deliver further rate cuts and respond to any unanticipated labour market weakness. Most analysts expect annual growth of around 3%, like 2024. In the US, the consensus appears to be that Trump’s bark will be worse than his bite. Q4 GDP is tracking at an annualised 2.5-3.0% q/q, headline inflation is 2.6% and the unemployment rate is just 4.1%, way below the long-term average of 5.7%.  In response to better US economic data and a Trump victory, the market has lifted the implied trough in the Fed Funds rate over the past six weeks to 3.7%, from 3.3%, which seems appropriate.

China announced a CNY10 trillion stimulus package in early November focused on local government debt relief, disappointing market expectations of broader fiscal stimulus that would help boost consumption and the property sector. The Chinese Government appears cautious about central involvement, emphasising local responsibility for hidden debt to uphold fiscal discipline and mitigate moral hazard concerns. The finance minister reiterated plans to support the property sector, strengthen state banks, and expand fiscal policy next year, but offered no substantial new details.

The RBNZ cut the OCR by 50bp to 4.25%, as widely expected, and the Governor indicated another 50bp cut in February was likely, broadly in line with market pricing. The NZ economy remains in a sad state with the green shoots of rising business optimism yet to be followed by much improvement in the real data. The housing market should be the first sector to respond to the c.120bp drop in mortgage rates since the middle of this year. However, ongoing challenges from moderating population growth, rising unemployment and poor affordability appear to be overwhelming the positive impetus from lower rates. Real Estate Institute data for October showed that house prices dropped on slightly higher sales and it's taking a bit less time to sell houses. The RBNZ appears optimistic, forecasting almost 7% house price growth next year.

What to watch

We’ve shown this chart before but must show it again; the S&P is having its best year since 1997 and its third best year since 1990! The melt-up into year-end that many analysts identified after the US election is very much in train. The election has delivered a decisive result, the US economy continues to grow strongly and falling core inflation should allow the Fed to ease further over the coming year. A trade war is an obvious risk for equity markets next year and would be particularly worrisome for the US market where valuations are expensive.

Market outlook and positioning

There are many cross currents that may impact capital markets over 2025, but we see a sound base of support for NZ share market returns. Falling inflation continues to support further easing in central bank monetary policy. Even if the pace of these cuts moderates, the ongoing recalibration of interest rates supports company earnings and improves the relative attraction of share market investments.

Economic surprises tend to be associated with the direction of company earnings, and share markets usually post their strongest returns in surprise upcycles. While the economic surprise cycle may have peaked globally, economic surprise indicators are turning more positive in NZ, potentially providing support for NZ company earnings. Share markets have historically delivered reasonable returns in a moderate growth, easing monetary policy environment. Geopolitical events have the potential to upset investors, particularly with investor risk appetite at above average levels for some asset classes. While full share market valuation multiples may be a speed limit for returns, we see potential for earnings growth to continue to drive share market returns.

Equity positioning is getting crowded and an unwind of optimism may be something to watch for in the middle of 2025 should growth slow. Investor sentiment is currently relatively optimistic pretty much everywhere except New Zealand, with allocations to growth assets at above long-run average levels but not at maximum long / overweight levels. A slowing in global activity, near-term policy uncertainty from the new U.S. Government, and ongoing geopolitical risk in the Ukraine and in the Middle East may see investors revisit the defensive growth and secular growth shares which dominate the New Zealand market.

Within equity growth portfolios, Harbour’s strategy remains to be patient, position for a range of scenarios and to be selective, focusing on quality growth. We continue to focus on companies delivering earnings per share growth, particularly where that earnings growth has the potential to be higher and last for longer than consensus expectations allow for. We continue to see the secular tailwinds of digitisation, disruption, de-carbonisation, and demographic changes as supporting company earnings. Lower interest rates may support a further pick-up in merger and acquisition (M&A) activity by providing greater funding certainty, but M&A activity only brings forward future value, it does not create value, long-term earnings growth creates value. Within the portfolio, we are selectively overweight growth at a reasonable price (GARP) shares in the healthcare, information technology, and materials sectors given they offer the potential for compound growth. We continue to have a bias to quality, well-capitalised businesses that are well-positioned to fund value-adding growth opportunities. The portfolio remains underweight in the lower growth utilities, telecommunications, infrastructure and real estate sectors.

In fixed interest portfolios, with inflation in NZ now essentially under control and the market pricing a return to an Official Cash Rate close to neutral, the fixed interest market was roughly fairly priced on a medium-term outlook. This is quite different to the experience we have had through the COVID and inflation years, when yields swung through a large and fast range. From a strategy perspective, a more tactical approach to investing becomes appropriate. This implies smaller and more liquid position sizes. This approach was used in November, as we added duration when yields initially rose, then started to unwind these when rates subsequently fell. At present, we expect an uncertain few months, as one cannot be sure of decisions that we will get out of the new administration in the US. These may affect not only the US economy, but the wider global environment as well. In New Zealand we are acutely aware that the economy is hinting at a rebound, but, at this stage, activity is still subdued. It may prove to be a slow process restoring confidence, especially in the employment market.

Within the Active Growth Fund, we have continued to see a broadening in markets with strong gains coming from outside mega-cap tech as well as small companies. We think there is a strong case for market broadening to continue, particularly in the US where tax cuts and deregulation hopes have helped underpin greater hopes of stronger economic growth. Within the Active Growth Fund we have exposure to small companies through Baillie Gifford and one of our core global equity managers, Epoch, has an overweight position to mid-cap companies where valuations are more reasonable than mega caps. We are, over the longer term, wary about the more muted return expectations we have for listed asset classes and have been spending a fair amount of our research time looking at private market exposures which may provide more robust long-term returns.

In the Income Fund, we continue to hold a neutral allocation (32%) to equities. We have been balancing a recognition that global valuations are fairly expensive with a judgement that there are few downside risks across the Australasian market, where we primarily invest. With inflation declining and rates being cut, we have a fairly positive backdrop. The lift in business confidence in New Zealand, from a very low base, is also reassuring. Our preference is to await some policy clarity from the new US administration and look to change the equity allocation if there are good reasons to do so. Our current predisposition is to reduce global equity exposure on any significant rallies.

 

IMPORTANT NOTICE AND DISCLAIMER

This publication is provided for general information purposes only. The information provided is not intended to be financial advice. The information provided is given in good faith and has been prepared from sources believed to be accurate and complete as at the date of issue, but such information may be subject to change. Past performance is not indicative of future results and no representation is made regarding future performance of the Funds. No person guarantees the performance of any funds managed by Harbour Asset Management Limited.

Harbour Asset Management Limited (Harbour) is the issuer of the Harbour Investment Funds. A copy of the Product Disclosure Statement is available at https://www.harbourasset.co.nz/our-funds/investor-documents/. Harbour is also the issuer of Hunter Investment Funds (Hunter). A copy of the relevant Product Disclosure Statement is available at https://hunterinvestments.co.nz/resources/. Please find our quarterly Fund updates, which contain returns and total fees during the previous year on those Harbour and Hunter websites. Harbour also manages wholesale unit trusts. To invest as a wholesale investor, investors must fit the criteria as set out in the Financial Markets Conduct Act 2013.

Important disclaimer information

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