Global share index concentration, the NZX on the turn, interest rate divergence and jacked-up geopolitical tensions are all pinging on the Harbour risk (or opportunity) radar for the remainder of 2024.
In a follow-up to its annual ‘top 10 risks’ for the coming 12 months published at the end of 2023, Harbour has cherry-picked the most relevant factors set to influence investment decisions as the rest of this year plays out.
Unsurprisingly, the outsize influence of a handful of US stocks on global share market returns is ringing alarm bells for those schooled in the traditional asset allocation arts.
Authored by Chris Di Leva and Hamish Pepper – respective Harbour head of multi-asset, and fixed income director – the note says about two-thirds of the NZ dollar-hedged 15 per cent return delivered by the MSCI All Country World Index year-to-date came via just nine stocks.
“The key return driver has been the US market and, in particular, the tech-laden information technology and consumer discretionary sectors.
“… This has seen the US market reach a valuation measured by the price to earnings ratio of 25 times trailing earnings and around 23 times the next 12-months’ earnings. This level of valuation has typically led to below average returns in the following 12-month period.”
But over the last three years the S&P500 equal-weighted index, which strips out the impact of the cap-weighted mega-companies, has gone nowhere, implying a more lucrative hunting ground for investors in less-engorged parts of the US markets.
“In our opinion, mid-cap company valuations are attractive (noting that even the smallest companies in the S&P500 are larger than New Zealand’s largest listed company),” the Harbour analysis says. “Additionally global infrastructure stocks are trading at near-low relative valuation levels vs. broader equity markets, making these sectors potential candidates for investor attention.”
And despite a slump in the local economy coupled with a disappointing year or two for NZ shares, the NZX could be set to bounce from the bottom amid an interest rate cutting-cycle and more realistic valuations – down from 30-times earnings at its peak to almost 20-times today.
“Better valuations, lower interest rates and underweight positioning suggests we may get a follow through in demand for local shares,” the Harbour report says. “The sufficient condition to call a real turning point could be a better second-half earnings outcome for our largest stocks although, in the short term, we may still see further earnings downgrades across the market. It is fair to say that, on a relative basis, the set-up for the local market is a lot more attractive than three years ago.”
The update also suggests NZ interest rates have farther to fall than in the US, where markets have priced in an end to the cutting cycle at just below 3 per cent.
By contrast, the Reserve Bank of NZ could push rates down below the consensus view of 3 per cent to stimulate a flagging economy capital, in turn making gains for local “fixed income more likely over the coming quarters”.
Harbour also highlights the prospect of further rate hikes in Japan as a potential threat to global financial stability as investors unwind the popular ‘carry trade’ while ever-present geopolitical risks – notably, wars in Ukraine and Gaza – present other dangers and opportunities for markets.
However, if war or the vagaries of the US election process remain out of investor control, there’s always the comfort of market numbers.
“… one unmistakable part of investment research and asset management is that the starting point matters,” the Harbour note says. “Be it equity market valuations where we have 100 years of data telling us if you buy equities when the Shiller Price to Earnings Ratio is high then returns for the next decade will be lower than average, or in bonds, where the best predictor of forward returns over the next five years is your starting yield.”