Expect the unexpected
Last month the British public went to the polls to vote on staying in the Eurozone (Bremain) or leaving (Brexit). Brexit won by a vote of 51.9% to 48.1%. This shocked markets, with share values declining, the pound dropping to an historically low level, and bond market prices rising. While the result was surprising we feel that when you break down the results, the underlying issues are more interesting.
- The referendum had a turnout of 72% of voters, which was 6% more than the recent general election. People were motivated to vote.
- There was a clear divide in the results by class, with managerial and professional classes voting 62% to 38% to stay, and working class supporters voting 63% to 37% to leave. The working class is clearly frustrated with those in power.
- Within the 12 UK regions only three, being Scotland, Northern Island, and London voted to stay, with the rest all showing a majority vote to leave. Could this lead to Scotland leaving the UK?
This was not some much a vote against the Eurozone, as it was a vote against the wider establishment from some very unsatisfied working class citizens. Viewed in another way this was democracy at work, which allowed the greater masses to express their frustration at a system that feels fundamentally broken to them. There are other underlying reasons for the Brexit vote such as open boarders leading to record immigration numbers, and the Eurozone’s over-regulation, and bullying of member states.
EU member satisfaction survey
This is also potentially just the tip of the iceberg. As shown in the tables below the United Kingdom was not the unhappiest member state of the Eurozone, which were Greece (who chose to stay in the EU recently), and France. The economic uncertainty index, which is a measure of how often certain words appear in the papers around the world, has also spiked for most countries on the back of Brexit, as governments all pause to consider their responses.
Is this the start or a disorderly unwind of the Eurozone?
Most likely not at this stage, but as the title of this section suggests, we should now expect the unexpected. No one expected Brexit to occur, and moving to the US no one expected Trump to be taken seriously.
Something that is becoming apparent around the globe is the increased popularity of right wing populist parties, or candidates, who are getting more air time with disillusioned voters. This is democracy at work and we have to consider how this might impact your investments.
NZX50 continues to defy gravity
Below is a chart showing individual country indices, and their performance since September 2015. January 2016 was the worst January in history for the global share markets, with one interesting exception, being the New Zealand NZX50. This positive performance from the NZX during such a volatile time left commentators and investors alike scratching their heads.
Global Equity Indices since Sept 2015
As shown in the table below the stand-out performer of the NZX50, is due to foreign investors continue to move into our somewhat illiquid share market, driving share prices higher in their global hunt for yield. The level of foreign ownership of the New Zealand share market is now at record levels at just under 50%.
Source: ANZ Charts that Matter 8th July 2016
NZX Foreign Ownership at record levels
Source: Forsyth Barr NZ Equity Strategy
NZX50 – PE Valuation (the higher the more expensive)
Source: Salt Funds/First NZ Capital
Given the New Zealand share market makes up only 0.5% of the worlds share markets, on a market capitalisation measure, and the fact that we are a very illiquid market, we are susceptible to being driven higher or lower by funds flowing in and out of our markets from offshore. As shown in the Price to Earnings (PE) valuation table there is a very strong positive correlation between foreign ownership and movement in the Price to Earnings valuations. This is a key reason to remain alert to the possibility that the New Zealand share market could see a correction down should foreign investors decide to move their capital to other more attractive share markets.
How low can they go?
Interest rates around the world have continued to fall, with the German bonds now trading in negative territory, with 5 years returning -0.41% p.a., and 10 years returning -0.122% p.a.
These negative interest rates have been witnessed all over the world, as shown in the table below, with around 65% of all global government debt trading at interest rates below 1%, and 30% trading at negative interest rates.
Global bond yields in negative territory
One of the more amusing outcomes of this negative interest rate environment is that we are now seeing negative mortgage rates as well. This means that you can borrow money from a bank, and they will pay you interest on the mortgage each month! In Denmark we have recently noted a family that is being paid 0.562% p.a. by the banks on their mortgage!
Where will this all stop?
As we progress through this year we are concerned that, given we have elections and a number of overstressed economies, the uncertainty that is apparent in all markets could increase. We believe that the investing world is becoming more reactive to bad news, and less supportive of good news.
On the flip side the markets are now anticipating that the US Federal Reserve may stay lower for longer, and potentially not raise rates for some time. The ECB continued to provide unprecedented levels of support to its member states, and Japan and China continue to drop interest rates, and purchase shares to support their flagging economies, so we could see the markets continuing to climb on the back of this support, as lower/negative interest rates drive investors to riskier assets in a hunt for yield.
When will this stop? Barring some unforeseen negative event, this level of support from global central banks could drive the markets for the next 2-3 years, and we could see shares and bonds continue to rise.
How do we position your portfolios in this uncertain environment?
As the world becomes more uncertain, and global and local interest rates continue to decline we believe the return that investors can get from investing into riskier assets is no longer high enough to justify investors taking the risk, and as such we continue to recommend lower percentages held in local and global shares, and the exclusion of local and international passive bond holdings.
Whilst remaining invested in share markets, in anticipation of possible continued growth into the end of the year, we hold these positions with managers who can offer investor’s good downside protection should volatility return again.
Markets remain very sensitive to new information, and we recognise the potential for a major sell off should a “black swan” event occur. Accordingly on a tactical basis our share exposures remain underweight. If markets do reduce further, we will look to identify a share price level where investors might wish to consider increasing their share exposures.