Market Review as at 30 September 2021

September saw a sharp sell-off in equity markets, which have otherwise been strong throughout the year. The main cause of weakness was concern about the stability of Chinese equity markets and increased regulation there. The Chinese Communist Party seems to be moving toward trying to achieve a better spread of wealth and quality of life throughout their society, instituting controls over the activities of some of the largest Chinese companies, and even down to issuing edicts about how much screen time children can have.

The property market in China has taken the heaviest losses although not directly related to regulatory change. Property developer Evergrande failed to meet interest obligations, which have had to be largely re-negotiated with the debt holders. With the property sector indirectly representing just under 30% of China’s GDP, the potential collapse of its 2nd largest property developer sparked fears of contagion and comparisons to the Lehman Brothers collapse in 2008 which helped trigger the Global Financial Crisis. Markets recovered some of the loss later in the month as the market concluded that a collapse of Evergrande could be absorbed without a ‘domino’ effect sparking widespread collapses of other companies. However, the state of the Chinese housing market remains a risk, as any significant fall in Chinese house prices, would likely reduce Chinese consumer spending, leading to a potential slowdown in the global economy.

As seen in the chart above, year-to-date, returns across equity markets have been strong, internationally, except emerging markets where returns have been negative. Earnings growth and outlook has been highly positive, as economies have re-opened on high COVID-19 vaccination rates. Companies and households benefitted from low interest rates and high levels of stimulus from Government support payments and central bank support, which flowed through to economic activity.

While there is uncertainty, driven by supply chain disruption, inflation risks, new variants of COVID-19 and the commencement of tighter monetary policy, equity markets have largely looked through these risks due to reasonable valuations and attractive potential for corporate earnings growth.

The New Zealand outlook is different. The country has so far avoided the experience and lockdowns seen overseas, however the outbreak of Delta in Auckland saw New Zealand enter lockdown in August and the government seemingly later renounce its COVID-19 elimination strategy for Auckland and switch focus to increasing vaccination rates.

Cases to date have largely been limited to Auckland and the implementation of Auckland regional border restrictions has enabled the remainder of the country to loosen COVID-19 restrictions and return to more normal levels of activity.

The possibility of New Zealand experiencing something like what has occurred in New South Wales and Victoria cannot be ruled out, with an escalation of cases in the community and a continuation of lockdowns, until a high proportion of the eligible population is vaccinated. Recent efforts to get the vaccination programme to the last groups of the population are showing results and the prospects for a return to a more open economy for 2022 remain tantalisingly good. It is a question of how much more ‘damage’ to the economy and our communities will occur before we can say we have got on top of the pandemic.

Despite this background, the Reserve Bank of New Zealand (RBNZ) increased the Overnight Cash Rate (OCR) by 0.25% to 0.5% in early October. While this was well signalled by the RBNZ in its September meeting, there was some thought they may hold due to the Delta outbreak. The decision to raise the OCR reflected the strong performance of the economy heading into the lockdown, which was flowing through to low unemployment and increased inflation pressures.

Markets will continue to be volatile with plenty of uncertainty both locally and abroad. It is said that markets ‘climb a wall of worry’. Among the current list of ‘worries’ are whether inflation will rise beyond the range that central banks are willing to tolerate, leading in turn to the possibility interest rates will rise strongly to dampen activity; whether changes in China will lead to lower rates of growth there and globally; the impact of rising costs of energy; and geo-political tensions such as exist between the US and China.

When we recount history, we see there have always been issues to worry about. We understand this to be the case when we think about how to construct a portfolio. Accordingly, we continue to emphasise the importance of well-constructed and diversified portfolios. These will see you through periods of volatility and generate good risk-adjusted returns over the medium to long-term.