Harbour Outlook: Economic Crosscurrents

• The MSCI All Country World Index (ACWI) continued its decline, posting a -2.7% loss in New Zealand dollar-hedged terms (and a 0.2% gain in unhedged NZD terms). Despite three consecutive months of negative returns, the 12-month return figure for the index stands at 9.5% in NZD-hedged terms and 10.4% in unhedged terms.
• Returns for the month were similarly weak in local markets, with the S&P/NZX 50 Gross Index (with imputation credits) falling -4.8%, and the S&P/ASX 200 Index falling -3.8% (-2.4% in New Zealand dollar terms).
• Bond indices were also negative over the month. The Bloomberg NZ Bond Composite 0+ Yr Index fell -0.2%, whilst the Bloomberg Global Aggregate Bond Index (hedged to NZD) also dropped -0.7% over the month. This came as the US market saw 10-year government yields increase to 4.9%, a level not seen since 2007, with resilience in US economic data prompting the market to largely unwind an expectation that the Federal Reserve would be cutting rates in 2024.

New Zealand and Australian share market returns and valuations continued to be impacted negatively by further sharp increases in long-term government bond yields (New Zealand 10-year Government bond yields up to 5.6% and Australian up to 4.9%) over the month. Military action in the Middle East drove a flight to safe assets as investors feared the potential for a broadening conflict, with capital moving out of riskier investments including smaller capitalisation and pre-profitability shares. The combination of higher interest rates and geopolitics triggered wide deleveraging by hedge funds and systematic funds which added to weakness in the wider share market. During the month the annual general meeting (AGM) and quarterly update season disappointed against market expectations, contributing to further reductions in earnings forecasts.

The US economy continues to show surprising resilience, growing almost 5% in Q3 on an annualised basis. Strength is concentrated in services, rather than manufacturing. Household consumption is being supported by an ongoing reduction in household savings and 30-year mortgages providing a degree of insulation from the impact of higher interest rates. With US house prices rising in recent months, after only modest declines in H2 2022, and global equities still 4% higher YTD, household balance sheets aren't providing much impetus to reduce consumption. US Federal Reserve Chair Powell noted recently that recent strength in domestic demand may require further tightening if it slows progress on lowering inflation and loosening the labour market.

Economic performance in the rest of the world lags the US considerably. Chinese economic growth appears to be stabilising at low levels, growing 1.3% in Q3. A pickup in official PMIs in September suggests the worst may be over for the Chinese economy, but structural challenges remain when it comes to consumption and the property sector. Recent indicators suggest the euro area economy may avoid recession this year, but growth is still likely to be anaemic. As such, markets assume the European Central Bank has finished its tightening cycle.