And here we go again ...
Welcome back ... we’ve missed you. If you haven’t checked in during January, don’t worry, you haven’t missed much. There’s been some volatility and some scary headlines and attention-grabbing forecasts. And the dreaded R-word reappeared as a sharp drop in world markets over several consecutive days prompted commentators to think a US recession might be on the cards. Other than that, it was just another rocky start to a year, coinciding with a slow news period.
I am of course playing down the events of recent weeks, only because there was nothing really new to have prompted the market to fall dramatically, and there is not too much to read into the market gyrations. At times like this, perspective can be very helpful, because sensational headlines can drive us to make hasty, and often incorrect decisions.
In our December newsletter we summarised the key topics that have influenced market direction and investor behaviour throughout 2014 and 2015. These same issues were cited in the early tumultuous trading days of this year: China’s growth, US interest rate hikes, the US economy and commodity prices. The two that took centre stage in January were China’s growth — data released during the month confirmed slower economic growth but still broadly within the expected range — and commodity prices, with the oil price in particular taking a tumble due to a global oversupply.
Individually, none of these factors was big enough to provide a convincing explanation. Even though China is a significant contributor to global growth, if it turns out that the Chinese economy grows by 6.5% rather than the forecast 7.0%, we will not automatically experience a global recession. None of the developed economies are so dependent on China as to be impacted by a gradual slowing of its growth rate.
As for a falling oil price, it clearly causes misery in the energy sector and in oil producing countries, and for those investors who have an exposure to investments or debt in the oil and gas industry (and this has been a popular hunting ground in recent years), but it doesn’t automatically spell recession. Indeed, as Mark highlights later in this newsletter, there are lots of beneficiaries of a lower oil price, including anybody who drives a car and any businesses that pay for fuel.
The market acted as it did in January because of a change in sentiment, triggered by goodness knows what. There was something of a snowball effect as investors increasingly viewed low commodity prices and a Chinese slowdown as a signal of something ominous. The world needs inflation — central banks have for several years been using interest rates to engineer inflation, or rising prices, in order to achieve economic growth. Falling commodity prices and slower demand from China don’t exactly help in this regard.
This newly cautious ‘risk-off’ sentiment may prevail for weeks or months into 2016. It may result in 2016 being a less than stellar year for investors. These things happen from time to time.
As we said in December, nothing that has happened in the last six weeks should have affected your goals, time horizon, cash flow needs or your long-term investment plan. What has been affected is the opportunity set. Lower prices mean better value and higher future expected returns. So in many ways, the longer that asset prices stay lower while we are saving and investing, the better for us … even though it may not feel like it at the time.
If you need statistics to reassure you, here’s a goodie: There have been 20 market selloffs of equal or greater magnitude in the last 40+ years. Only in three of them was the market lower 12 months later.
Managing Director | Fisher Funds
Carmel's take on rollercoaster markets
It's been a pretty horrible start to 2016 for markets. Carmel Fisher discusses how investors should be feeling and what they should or shouldn't do.
Your KiwiSaver portfolios
Highlights and Lowlights
- Our Australian share portfolio weathered January's volatility well, and despite foreign exchange hedging losses dragging the portfolio down, we remained ahead of the overall market. ResMed reported, beating expectations on a strong sales performance. Medibank surprised positively, upgrading its earnings guidance as it made quick progress on efforts to contain claims expenses. Hospital group Ramsay Healthcare was weak following this announcement, but at this stage we expect Ramsay's scale and best in class execution will see them continue to grow profits.
- The share prices for our New Zealand portfolio companies in January were generally slightly down due to weakness in world share markets rather than any company specific news-flow. Of note, Michael Hill International enjoyed the more buoyant retail environment, reporting a good Christmas sales period, with positive same store sales in all of its geographic divisions. Auckland Airport announced plans to upgrade its international terminal following strong growth in tourist numbers.
- Contrary to expectations, sovereign bond yields have fallen around the developed world following the Fed's December interest rate hike. Our investments in such assets have continued to benefit our portfolio performance. While weakness in high yielding fixed income assets was, until December, largely confined to the structurally weak energy and mining sectors, as global recession fears have grown, other sectors are now being impacted.
- International share markets fell more than their Trans-Tasman counterparts but our portfolio weathered the storm performing better than its benchmark thanks to stock selection in the information technology sector and outperformance from the utilities sector. Of note, Adidas and Nike proved resilient in the recent sell-off, helped by a solid operating environment and in Adidas' case, a well managed transition of CEOs.
The opaque world of oil prices
By Mark Brighouse, Chief Investment Officer
Oil prices have fallen sharply since late 2014 when they hovered around US$100 per barrel. In recent weeks they have dropped into the mid $20s, prompting some commentators to point out that the contents of a barrel of oil are now worth less than a third of the price of the actual steel drum that it comes in!
While the oil price has been sliding for some time, financial markets have only recently begun to attach any great significance to its impact on investment assets. Over the past six months there has been an increased sensitivity to oil gyrations with lower oil prices leading to a) declining share prices (because oil company earnings are adversely impacted), b) higher corporate bond rates (because heavily indebted energy companies are now more risky) and c) lower government bond rates (because inflation forecasts are now lower). The US dollar has also been stronger which is at odds with the historical relationship, possibly because the US shale revolution has left the US less dependent on foreign oil these days.
Stockpiles of oil remain high and the lifting of sanctions on Iran means there is little prospect of an adjustment to the supply situation. The International Energy Agency recently warned that "…the oil market could drown in oversupply".
With this backdrop, we can expect that weaker oil prices will continue to keep a lid on inflation and this could actually be positive for investment assets if it means that central banks can set interest rates lower than they otherwise would. At Fisher Funds we see the volatility in the oil price as a transfer of income from producers to consumers, and believe the positive effects on consumers will be larger than the negative effects on jobs in western economies.
Many of our companies are likely to benefit from lower costs as a result of these moves. Logistics companies such as portfolio holdings Freightways and Mainfreight are obvious examples. Also companies that benefit from improved disposable incomes, from the apparel companies in our international portfolios through to the food retailers in our Australian portfolios.
Fed follow up
By David McLeish, Senior Portfolio Manager, Fixed Interest
Bonds and fixed income investments are relatively straightforward. They provide more certainty than other investments — a bond investor can expect repayment of principal at the end of a period, along with a specified income along the way. Where there is uncertainty about repayment (e.g. a risk of default) investors are offered a higher yield, and can choose whether or not to accept the additional risk for the additional compensation. Bond prices will fall when yields rise, and vice versa. And bonds are supposed to behave differently to shares, providing good investment diversification. Straightforward. Well, not always.
There have been some anomalies in the past couple of months (well longer actually) which has made bonds less straightforward than expected. When we last spoke, the US Federal Reserve was about to lift rates for the first time in ten years. This move had long been anticipated, and the market response should have been predictable. However, as we sit here today, US bond yields — short and long-term — are lower than before the December hike, with the market seemingly thumbing its nose at the Fed. Why has this happened? It is likely a combination of volatile share markets, weak oil prices, and weak/disappointing economic reporting in the US and China.
The expected diversification hasn't quite played out as expected either, because many of the high yield securities that investors have keenly bought in recent years happened to be in the oil and gas sector. Like the shares of energy companies, the prices of these fixed income securities were hammered during January and there was something of a flow-on effect to other high yield corporate bonds in other sectors also.
Despite these contrary moves of late though, fixed income investments have provided a calming influence during a period of anxious and disruptive markets. Whether rates are high or low, the Fed is hiking or cutting rates, bonds still provide a much-needed volatility cushion.
Grizzly bears vs gummy bears
Carmel Fisher discusses a Credit Suisse Securities research paper
Along with talk of economic slowdowns and recession, the chorus of forecasters predicting a global bear market has reached a crescendo in recent weeks. A bear market is defined as a 20% fall from peak levels, and in January several major share markets fell into bear market territory, at least temporarily. A bear market is the opposite of a bull market, with both labels based on the way the animals attack; a bull thrusts its horns up into the air while a bear swipes its paws down.
We found a Credit Suisse research paper more interesting than many of the bear market calls that we've seen of late. It noted Australia has endured twelve bear markets in the last 40 years and so far this year, is one of the few markets yet to enter bear market territory.
After analysing previous cycles, the authors identified a pattern in which Australian bear markets evolve into one of two types following the initial 20% fall. A Gummy Bear occurs when stock indices rally over the next 12 months (gaining on average 24%) whereas a Grizzly Bear evolves when prices fall further over the following twelve months (with an additional 20% loss on average). Grizzly Bears are generally associated with deep profit recessions and high starting valuations, whereas Gummy Bears are your garden variety bear markets!
Credit Suisse believes, based on their earnings forecasts and current market valuation levels, that if the Australian share market falls into a bear market this year, it will be a Gummy Bear. The firm is forecasting flat earnings per share — no growth, but no decline either — and believes that Australian company valuations are reasonable relative to their historic levels.
It looks as if volatility is here to stay, and the Australian share market may well dip into bear market territory. It is nevertheless comforting to know what sort of bear we might encounter in the months ahead.
A bird's eye view — advertising that still works
Australian Senior Portfolio Manager, Manuel Greenland, discusses the logic behind our investments in the out-of-home media sector.
Acclaimed television drama Mad Men depicts 1960's New York through the lens of a racy Madison Avenue advertising agency. In its first episode lead character Don Draper states, "Advertising is based on one thing: happiness." Of late, advertising executives have found happiness somewhat elusive, as changes in technology and consumer behaviour have made it harder to reach advertising audiences.
Cable and satellite television, and PVR recorders, have turned the one large television audience advertisers used to easily address, into a host of smaller ones. People spend less time on traditional media like television, magazines and newspapers, and more time on the internet. Even internet habits are changing as users' access content less on computers, and more on mobile devices. Audiences themselves have become more sophisticated, increasingly adept at ignoring adverts they don't find relevant.
So how might advertisers find happiness? Out-of-home media like signs, billboards and light boxes present them with a solution. As populations urbanise, people spend more time on streets, in cars and in retail environments, so the out-of-home audience is growing. Out-of-home adverts enjoy higher levels of audience engagement because they can be relevant to specific consumer occasions, such as a billboard advertising car hire at an airport, or a light box advertising perfume in a department store.
Technology is making a positive difference for out-of-home media as traditional signs and billboards are digitised. A traditional billboard advert takes weeks to prepare, and remains on the sign for a similar length of time. In contrast a digital advert can take just days to prepare, and can be played at times relevant to target audiences; the same sign might advertise coffee in the morning and wine in the evening. Recently, in anticipation of severe hailstorms in Queensland, insurance companies used digital roadside billboards to quickly warn motorists to get their vehicles under cover. Far fewer vehicles suffered hail damage, and the insurance companies saved on claims expenses.
Digital signs are also increasingly intelligent. One sign in Sydney played a specific advert only when it recognised vehicle brands with which the advertiser wanted to compete. So the very factors hurting traditional media — technological change and hard to reach audiences — are in fact enhancing the attractiveness of out-of-home media. Advertisers have noticed, and advertising dollars are quickly flowing to the sector.
Our holdings in the sector, APN Outdoor and Ooh! Media have shown impressive sales and profit growth by offering advertisers effective ways to engage with outdoor audiences. We chose to own both businesses because they are complementary, with APN dominating billboards and transit locations, and Ooh! Media dominating the retail environment. In combination the two enjoy strong market share, ensuring they compete rationally for sites and advertising dollars.
With half of all advertising dollars still spent on traditional media, advertising executives like Mad Men's Don Draper are keen to find ways to better reach audiences. Solving advertisers' problems with an innovative and effective solution provides a solid long-term growth opportunity for our portfolio companies.
What we're reading — "Dr Doom's" latest take on markets
Nouriel Roubini is widely known as "Dr Doom" and is one of very few economists to have predicted the housing bubble crash that led to the 2008-2009 global financial crisis.
In February 2013, Roubini predicted that US markets had entered the "mother of all asset bubbles" and that the bubble, bigger than 2008, could well burst in 2016.
In a recent interview he updated his 2016 view.
"No, I don't expect it's 2008 again. I don't expect a global recession or financial crisis.
The current turmoil is driven by a bunch of factors, primarily concern that China might have a hard landing and collapse of its stock market and currency.
My view of China is that it's going to have a bumpy landing, not a hard landing. Growth this year might be 6% going to 5%. Those who say it's slower don't realise that the service sector is rising and growing much faster than the manufacturing sector.
The US is slowing down, especially manufacturing. And the fall of oil prices is a negative, at least in the short run, because the US is a major producer of oil and energy. But more importantly, it's not just a supply shock that is driving oil prices but concerns about global demand — China, emerging markets, and weakening demand are negative for the global economy.
The Middle East is a mess. And even in Europe, there's terrorism and the migration crisis, the risk of Grexit, the risk of Brexit, austerity and bailout fatigue — there are plenty of issues that can go wrong. So, suddenly, the market is becoming nervous and there's a correction.
Whether the correction becomes a true bear market depends firstly on whether these shocks are more or less persistent or less persistent, and second, on the policy response.
At this point, the PBOC (central bank of China) will have to ease more. The Fed will have to signal more clearly they're going to wait longer before they hike rates again. And the European Central Bank and the Bank of Japan will have to ease more.
If all central banks try to do more, you can maybe stop or reverse this particular correction. If you don't have a strong policy response, this could become an outright economic slowdown."
Fisher Funds view: We think Roubini's summary of the 2016 market outlook is right on the money. We expect a continued commitment by central banks to manage their settings to achieve growth and inflation will see a recession or crash averted.
Getting to know ... corporate bonds
Bonds can seem confusing to even seasoned investors, not least because of the various shapes and sizes they come in. Over recent months, the bond market has been preoccupied with the impact that higher interest rates could have on corporations and their bonds.
Corporate bonds are essentially a loan taken out by a company. They generally have a set date in the future when they mature and carry a pre-agreed interest rate. Uniquely, these two features make it possible to calculate what the return of the investment is going to be at the time you first buy it — provided you hold the investment to maturity and the company meets its financial obligations.
Despite this certainty of return, a corporate bond's value will still fluctuate. A major reason is the perceived risk that the borrower might not be able to meet their future repayment promise. A rise in this credit or default risk can come from either company-specific issues or a worsening of the broader economic environment making it harder for all companies to make money. As investors in all global markets have become more risk averse and uncertain about the future, it is the latter that investors seem most concerned about.
The sell-off of corporate bonds over recent months has led to a significant improvement in the valuation across many parts of the global corporate bond market. This is all the more striking considering that a recovery in the price of these bonds is not required to achieve the new and greatly improved expected returns they offer.
Managing your KiwiSaver account: KiwiSaver myth-busters — part two
This month we continue the series we started last year "busting" a few of the common myths about KiwiSaver.
MYTH #4: You can get your money out when you want and use it for anything
No you can't.
KiwiSaver is primarily designed to help you save for your retirement. It is not like a bank account that you can withdraw funds from to pay your everyday bills. Typically you can only withdraw your funds once you turn 65 and have been a member for five years.
Of course, sometimes life doesn't go to plan, so in limited circumstances you may be able to withdraw your funds early, for example, in the event of significant financial hardship, permanent emigration (excluding Australia) and serious illness.
Subject to meeting eligibility criteria, you may also be able to withdraw all of your KiwiSaver savings (less $1,000 and any amount transferred from an Australian Super Scheme) to help buy your first home.
MYTH #5: The government can take your money
No they can't.
The savings in your KiwiSaver account are 100% yours. It is held in trust for you on your behalf in the name of an independent trustee, Trustees Executors Limited (TEL). Their sole function is to protect the interests of KiwiSaver members and other investors. TEL is New Zealand's oldest and largest trustee, supervising over $30 billion of investors' assets.
MYTH #6: I have to join the KiwiSaver provider my employer tells me to
No you don't.
While employers can nominate a preferred KiwiSaver provider that new employees who aren't already KiwiSaver members are automatically enrolled into, you are free to choose your own KiwiSaver provider at any time. This also applies to existing employees.
There are many things to consider when choosing your KiwiSaver provider. We think the following factors are important:
- Access to financial advice to help you invest your savings appropriately
- Regular communication to help you understand what is happening with your money and why
- Consistent long-term performance
- Little extras like reminders to top up your KiwiSaver account to maximise the annual Government contribution
- Competitive fees