What to do when you're expecting
Hollywood movies make pregnancy seem easy with 4am ice-cream and gherkin cravings seemingly the only challenge to overcome. But any parent will tell you that the waiting is often the hardest part. You know what's going to happen at the end of nine months, but the end seems to take forever to come.
Markets have been pregnant with expectation over the next Federal Reserve interest rate hike. The lead up to the Fed's September meeting was nerve-wracking with the "will they, won't they?" speculation leading to increased market volatility. Investors were left unsatisfied when a rate hike didn't emerge, because it means a nervous wait for another month or two. We know that the Fed will lift interest rates at some point, but now we don't know whether it will be at their October meeting, December meeting or pushed out into the New Year. And so we wait.
Knowing what to expect might help, especially when investors realise that actually, not much is going to change. When the Fed eventually raises rates, there might be an immediate and short-lived reaction in share markets and short-term interest rates, but because rates will likely be lifted only a small amount — we're talking 0% lifting to 0.25% — there is unlikely to be a significant or long-lasting impact.
For those who need proof, analysis completed by equity strategist Bob Doll confirmed that over the past 35 years, the US market is most often up sharply heading into a rate hike, fairly flat in the 250 days after (average gain of 2.6%), then back to normal once 500 days have passed, with an average return in the past six cycles of 14.4% following hikes.
As far as individual companies are concerned, we know that not all companies will be affected by an interest rate hike. Clearly those that are the most leveraged (i.e. have the most debt) will be most adversely affected by increased interest rates as their cost of borrowing will increase.
As for GDP, according to Deutsche Bank, in past cycles interest rates have generally been hiked when the economy was running hot, so GDP has slowed after the lift. This time around, the US economy is experiencing a relatively slow recovery from a particularly bad recession so the GDP impact might well be positive rather than negative. GDP seems to have the most positive response to an increase in interest rates when the economy is strong enough, but not too strong. The Fed has been hesitant to wait until all the signals point to a strong enough economy, so this should be one of the good cycles.
As for bonds, it is more likely to be the yield curve, or the gap between short-term bond yields and long-term bond yields that is affected rather than the yields on all bonds. Short-term interest rates will react more than long-term interest rates, but it is important to remember that short-term interest rates don't have a significant impact on the economy or the availability of credit. As for longer-term interest rates, they reflect long term expectations of economic growth and inflation, so an eventual rate rise will very likely be priced in to long-term bond yields already.
When the Fed eventually moves, it really isn't going to matter anywhere near as much as the media suggests. Even though every word the Fed utters between now and then will be analysed backwards and frontwards, it's all going to be okay in the end. We are in the camp that just wants it done… Let's get this baby out and get on with it! Unfortunately we have another month or three to wait. Ice cream and gherkins anyone?
Managing Director | Fisher Funds
Your KiwiSaver portfolios
Highlights and lowlights
- Volatility in global share markets continued in September as investors focused on concerns about a slowing Chinese economy and whether the US Federal Reserve would raise interest rates. Our international portfolios performed slightly better than the global index it is benchmarked against thanks to having less exposure to the materials sector (under pressure from weaker commodities prices) and positive stock selection in the consumer discretionary sector (non-essential goods and services such as restaurants, travel and media) and utilities sector.
- September was a quiet month for news in New Zealand, although the portfolio performed strongly. The EBOS share price continued the momentum gained after releasing better than expected profits at the end of August. Restaurant Brands produced strong second quarter sales, especially from KFC, while Auckland Airport international passenger numbers continue to be buoyant. The Summerset share price weakened during the month, following a very strong share price performance year-to-date. It was successful in obtaining a resource consent for a second village in Christchurch during the month.
- Another tough month in Australia to conclude the toughest quarter for the share market since 2011. The portfolio performance (-0.6%) compared favourably with the broader market (-4.9%) as key portfolio holding Veda rallied 28% when a bid for it was made by London-based Equifax. A number of portfolio stocks had positive returns through the month, and the portfolio benefited from limited exposure to the Financials and Resources sectors.
- The notable falls in the price of corporate-issued bonds over the last quarter has markedly improved the attractiveness of these assets. The higher yield these bonds now offer should help improve the income our fixed income portfolios generate over the coming years. The increased appetite for safe-haven assets, such as government bonds, and their subsequent rise in value has not offset the declines seen across the corporate bond market. This caused our diversified fixed income portfolios to marginally underperform their benchmarks this past month.
The Turnbull touch
By Manuel Greenland, Portfolio Manager, Australian Equities
During September, Australia saw its fourth change of Prime Minister in just two years. The Liberal Party, fearing the consequences of former PM Tony Abbott's falling popularity in next year's general election, chose to replace him with the more popular Malcolm Turnbull. When grading his performance as a Rhodes Scholar at The University of Oxford, Turnbull's professors wrote of his confidence and ability to "enter life's rooms without knocking". With prices of its commodities falling and its growth rate slowing, Australia may well be ripe for bold reforming leadership.
Australians have fared relatively well since the GFC. They've seen their wealth grow on rising house prices and increasingly valuable share portfolios. Broadly, they have kept their jobs. The economy, despite challenges, has continued to grow. Yet consumers have been reluctant to spend and businesses reluctant to invest. This, in combination with a government intent on reining in spending, has seen weak demand growth generally. Weak demand growth has meant tougher conditions, which has only made consumers and business leaders more cautious. It would seem then that a change of mood could be the key to turning this vicious cycle into a virtuous one. Improving sentiment could trigger spending which would increase demand, which in turn could improve sentiment.
Politics, they say, is the art of the possible. If it is an art, then Turnbull's masterstroke could well be to paint a vision of the future in which Australians can believe. Early indications are positive with reported improvements in both business and consumer confidence in response to his assuming leadership. However Australians also have to accept the limits of what is possible, so Turnbull may also have to persuade voters to accept some of the country's tougher realities. We look forward to seeing his work...
Widening the moat
By Terry Tolich, Senior Investment Analyst, Australian Equities
"Every day, in countless ways, the competitive position of each of our businesses grows either weaker or stronger. If we are delighting customers, eliminating unnecessary costs and improving our products and services, we gain strength. When our long-term competitive position improves as a result of these almost unnoticeable actions, we describe the phenomenon as "widening the moat." And doing that is essential if we are to have the kind of business we want a decade or two from now."
Warren Buffett, Berkshire Hathaway Shareholder Letter 2005
Brambles is one of our significant Australian shareholdings. It is the world's largest owner of pallets (you may have seen their blue wooden CHEP pallets) and is a quality business with a successful track record of profitability and growth over a long period.
Brambles' management has taken Warren Buffett's words to heart. As part of its recent 2016 outlook, management indicated it would step-up the rate of investment into the business, even if this means that profit growth will be limited in the short term. This news was not particularly well received by the market.
We take a longer term view and support Brambles' plans. Brambles owns hundreds of millions of pallets and other specialist equipment used to ship goods. This business is very competitive, and in order to maintain and grow market share, the company needs to buy more pallets and equipment and make customers want to use their gear rather than competitors'.
The additional investment (a tiny part of which is interesting — think sensors on a pallet to show customers how much of their product has moved, and to where) will result in better customer service and will help the company to do more business with current customers and win new customers. This will ultimately deliver higher long run profits and a more valuable company.
As the share price declined on short term views we took the opportunity to increase your holding in the company.
Milk price volatility and the domestic economy
By Murray Brown, Senior Portfolio Manager, New Zealand Equities
You could be forgiven for getting confused over the recent volatility in the milk price and what it means for farmers and the domestic economy. The volatility has been abnormally large, and the flow-on impacts are not always clear-cut.
Firstly, the volatility: From its peak the milk price (as measured by the Global Dairy Trade Index) fell by two-thirds from April 2013 until early August this year. This is a very significant fall and placed farmers' incomes under increased pressure. In the last couple of months the milk price has bounced strongly and is up 48% off its recent lows. This bounce is due to a forecast reduction in New Zealand farmers' milk production this year of over 5% and the further threat of a major drought in New Zealand this summer impacting milk supply.
The good news for farmers is that the bounce in dairy price has seen their forecast milk pay out from Fonterra for the 2015/16 season increase from an estimated $3.85/kg of milk solids to $4.60/kg, however it still remains below the industry break-even estimate of $5.30/kg, so farmers are still hurting.
Unless you are directly involved in farming, the volatility is unlikely to affect people on a day-to-day basis. Although, as a cornerstone industry to the New Zealand economy there is a "trickle down" impact from lower farmer spending, particularly in regional areas. The fall in the milk price has caused New Zealand to lose our "rock star economy" status bandied around by offshore commentators 18 months ago, when the New Zealand economy was forecast to grow at around 3.5%pa and the milk price was near a six year high.
The Reserve Bank of New Zealand is now forecasting the economy will grow at a more moderate 2.0% in the next year, but this should be seen in the context of our long-term average growth rate of around 2.5%. Although the 2.0% estimated growth rate is below long-term trend, it is still strong enough for our corporates to continue to prosper and reward shareholders with increasing profits and dividends, necessary for positive shareholder returns.
Managing your KiwiSaver account
The beauty of dollar cost averaging
In last month's newsletter we wrote about the recent market volatility and how to think about the ups and downs in the context of your KiwiSaver account. This month, we continue with that theme and explore the concept of dollar cost averaging.
Market volatility can promote some unusual behavior among share market investors. Some see it as a great opportunity to buy shares and try and time their entry into the market to maximise returns. Other investors get nervous about losing money and sell their investments, turning a paper loss into a real loss.
In our experience, chopping in and out of the market, trying to get the timing right is fraught with danger. For most of us, we can't possibly know when the "right" time to invest is. A good way to reduce the risk of getting the timing wrong (especially in volatile times) is to invest smaller amounts on a regular basis.
One of the great things about the way KiwiSaver was set up is that it provides that discipline to keep contributing regardless of what the market is doing. Most KiwiSaver members will benefit from dollar cost averaging due to making regular contributions from their pay or via direct debit. This means you are always "buying" and are able to take advantage of dips in the market smoothing out your investing returns.
We can look back in history to 2011 and 2012 when markets went through a patch of volatility on the back of fears the US Federal Reserve would slow down its Quantitative Easing program or the "taper tantrum" as it was commonly referred to. At the time it might have been scary to see prices falling but as the following table shows, those people who were making regular contributions ended up buying "more" units which has been well rewarded over subsequent years without them having to worry about whether they timed it right.
|Date||Growth Fund unit price||Contribution||Units purchased||Total value|
|Value if investing on day one||$1,188|
|Value if investing using dollar cost averaging||$1,243|
|Value if investing on last day||$1,200|
Disclaimer: While actual unit price data for the Fisher Funds TWO KiwiSaver Scheme Growth Fund has been used, this is a hypothetical example and each individual's experience will vary depending upon when their contributions were invested.
If you are self employed or not employed and want to take advantage of the government's $521 member tax credit each year, you can set up a regular direct debit. As well as ensuring you maximise this incentive, it also means you don't have to find $1,042.86 each June to top up your KiwiSaver account.
What we're reading
Respected Australian fund manager and author, Roger Montgomery, recently wrote a piece about investors who withdrew funds a month after investing in his newly launched global fund, having been unnerved by global market volatility.
When surveyed, investors in Roger's international fund who withdrew their investments cited fears about an economic slowdown in China and its potential impact on markets globally.
This jumping-at-shadows behaviour leads to poor outcomes.
According to the latest 2014 release of Dalbar's Quantitative Analysis of Investor Behavior (QAIB), which has now been running for 21 years, the problem is not the returns of the funds. In many cases, the funds have outperformed their market benchmarks. The problem is that investors are producing lower returns than the funds they invest in.
According to the report, the average mutual fund investor has simply not accomplished either the goal of maximising capital appreciation or the goal of minimising capital loss.
Investors who try to time the market invariably buy at the highs and sell at the lows. Of course this is a function of the minute-by-minute quotation of share prices. The same behavior would be seen in property if house prices could be seen changing every second. In that scenario property owners would spot trends and draw charts and then start trading property; "come on Darling, four bedders are going down, we need to sell now and buy one-bedders."
Silly behaviour emerges when instead of focusing on a business, investors focus on economics, or the market's gyrations.
Roger wrote the following in his 2010 book, Value.able:
"Consider the US IPO of Coca-Cola in 1919 at $40 per share. A year later the stock was trading at $19.50 — the result of rising sugar prices and a perpetual contract Coca-Cola had with its bottlers to supply syrup for $1 per gallon. What would have happened if your grandparents or great-grandparents purchased a single share in 1919 at $40 and held on through the subsequent decline to $19.50 in 1920, then on through the great crash of 1929, the subsequent depression of the 1930s, World War II, a baby boom, dozens of other wars and skirmishes, an oil crisis, assassinations, the fall of the Berlin Wall, yuppies, innumerable recessions, booms, busts and scandals, as well as a war in Vietnam, two in Iraq and a global financial crisis? If they kept this share in the family and reinvested all their dividends, they would on 8 January 2010 have 126,321 shares and their investment would have a market value of $6,966,603.15."
The company has continued to pay dividends in the five years since, and by March of 2015, after 14 further dividends and the two-for-one split, the value of that single Coca-Cola share in 1919 had grown to $11.7 million.
|Fisher Funds view: We are certainly aware that market volatility can be unsettling for some investors. It can often lead to investors making the wrong decisions at precisely the wrong time. We encourage investors to focus on their own investment goals and strategy when making investment decisions, rather than be influenced by market movements. Daily market movements reflect the collective views of multiple investors, whose circumstances and investment objectives may differ entirely from yours.|
Getting to know ... interest rate risk
Interest rate risk is the risk, taken by bond investors, that interest rates will rise after they buy. Interest rates and bond prices move in opposite directions. All else being equal, when interest rates rise, the value of a bond falls in value. Conversely, when interest rates fall, the value of a bond rises.
All bonds involve interest rate risk, and some involve more than others. The more interest rate risk a bond involves, the more its price will fall as its yield rises.
Lack of awareness of interest rate risk causes many investors to severely underestimate their total portfolio risk. For example, a retiree on a fixed budget may invest in a government bond fund because government bonds are generally considered to be some of the safest bonds in the world. However, the word "safe" here refers to their credit risk.
While long-term government bond funds have basically zero credit risk, they have a lot of interest rate risk. In fact, if interest rates rise by just 1%, the value of many long-term government bond funds will drop by 10% or more. Hardly the safest bond funds in the world when looked at from that standpoint.
When choosing the bond fund that is right for you, you want to find the best mix of total return and understand how much credit and interest rate risk the fund is taking to generate that return.