Special announcement: COVID-19
Market update 10 – Cash is not king
Global share markets have stabilised at levels well above their March 2020 lows. This is due to the extraordinary intervention from governments and centrals banks across the globe. As we discussed in 27 March 2020 | COVID-19 Market update 4, the New Zealand Government announced its largest ever stimulus package. In the United States, the Senate approved a bazooka – the largest economic stimulus package in modern history.
We believe markets will now trade in a range of plus or minus 15% for the remainder of the year. Do not expect a strong rally or a sharp sell off in financial markets. Do expect a large increase in economic stimulus as countries announce further business support and infrastructure spending.
Although markets may be range bound in the short-term, in the medium- to long-term we remain positive that share markets will push higher. Because of the size and power of the government stimulus, it tips the scales in favour of financial assets, even if it takes time for the unemployment rate to fall and economic growth to recover.
In 01 May 2020 | COVID-19 Market update 9 we stressed that NZ Funds’ clients are likely to be better off remaining invested rather than trying to time markets. We continue to see 15 – 20% upside in share markets over the next 12 – 24 months with capital gains significantly higher over the next three to five years.
However, there are two themes that we should be aware of when thinking about the prospects of financial markets.
Theme one: Trade war
We are witnessing a deterioration in relations between the United States and China. President Trump is weighing up more aggressive economic measures against China amid rising anger over China’s handling of COVID-19.
As the disease sweeps across the United States, President Trump rightly or wrongly accused China of covering up its COVID-19 outbreak and failing to prevent its spread around the world. Both sides of the United States political divide have a desire to punish China given it is election year and the polls are telling them to be tough. While it is unclear how far the United States are willing to go, with the economy already damaged from COVID-19, politicians may see nothing to lose by taking a more aggressive stance.
We have positioned portfolios for a possible deterioration in United States-China relations by reducing clients’ exposure to shares and see any sell-off as a buying opportunity. We are also positioned to benefit should China’s exchange rate weaken – a likely scenario in a trade war. These positions should shield against the weakness caused by a trade war which we expect to play out until at least the United States election in November.
Theme two: Inflation is coming
The second theme that is emerging is the inflation pressures brought about by government stimulus. This was also a risk during the global financial crisis in 2009 but inflation never materialised. Much of the stimulus provided in 2009 was absorbed by the banks and finance companies after asset values collapsed and banks required recapitalising.
Fast forward to today and banks are well capitalised and do not require government funds. Therefore, the stimulus may take longer to be absorbed and may result in a higher level of inflation over the coming decade than we have seen over the past decade.
Trade tensions and higher inflation intersect. As part of a growing backlash against globalisation, and China in particular, nations are threatening to bring their offshore platforms back home. While this may increase security of supply, it will also involve higher-cost domestic producers. Inflation may not return while the recession deepens, but as the recovery takes hold, a new world of fragmented, more expensive supply chains may tell a different story.
We are preparing clients’ portfolios for a decade of increasing prices. We retain clients’ long-term exposure to share markets across NZ Funds’ growth portfolios. At the same time, we continue to add to our gold position and inflation protected United States Government bonds.
Cash is not king
While the absolute level of inflation may be modest, say 2 – 3%, in an environment of low interest rates the after-tax returns from cash and term deposits will have a significant wealth impact for retired investors, especially those that have not provisioned for retirement with an investment portfolio or other real assets such as an investment property.
“When you put your money in cash or short-term deposit, look at the interest rate you are getting in relationship to the inflation rate,” says Ray Dalio, founder of Bridgewater Associates, the world’s largest hedge fund. “You will see that your after-tax return will be below the inflation rate. That means that you are experiencing a tax on that cash equal to that difference. So, you can’t keep your money in cash. If you think that is safe, you’re looking at it wrong — it is a sure losing strategy.”
We believe financial markets will recover faster than the real economy. Therefore, those with a medium to long term horizon should remain invested. Remaining invested in financial assets for the long term provides an incredible opportunity to build wealth.
We believe markets will now trade in a range of plus or minus 15% for the remainder of the year. Do not expect a strong rally or a sharp sell off in financial markets. Do expect a large increase in economic stimulus as countries announce further business support and infrastructure spending.
Although markets may be range bound in the short-term, in the medium- to long-term we remain positive that share markets will push higher. Because of the size and power of the government stimulus, it tips the scales in favour of financial assets, even if it takes time for the unemployment rate to fall and economic growth to recover.
In 01 May 2020 | COVID-19 Market update 9 we stressed that NZ Funds’ clients are likely to be better off remaining invested rather than trying to time markets. We continue to see 15 – 20% upside in share markets over the next 12 – 24 months with capital gains significantly higher over the next three to five years.
However, there are two themes that we should be aware of when thinking about the prospects of financial markets.
Theme one: Trade war
We are witnessing a deterioration in relations between the United States and China. President Trump is weighing up more aggressive economic measures against China amid rising anger over China’s handling of COVID-19.
As the disease sweeps across the United States, President Trump rightly or wrongly accused China of covering up its COVID-19 outbreak and failing to prevent its spread around the world. Both sides of the United States political divide have a desire to punish China given it is election year and the polls are telling them to be tough. While it is unclear how far the United States are willing to go, with the economy already damaged from COVID-19, politicians may see nothing to lose by taking a more aggressive stance.
We have positioned portfolios for a possible deterioration in United States-China relations by reducing clients’ exposure to shares and see any sell-off as a buying opportunity. We are also positioned to benefit should China’s exchange rate weaken – a likely scenario in a trade war. These positions should shield against the weakness caused by a trade war which we expect to play out until at least the United States election in November.
Theme two: Inflation is coming
The second theme that is emerging is the inflation pressures brought about by government stimulus. This was also a risk during the global financial crisis in 2009 but inflation never materialised. Much of the stimulus provided in 2009 was absorbed by the banks and finance companies after asset values collapsed and banks required recapitalising.
Fast forward to today and banks are well capitalised and do not require government funds. Therefore, the stimulus may take longer to be absorbed and may result in a higher level of inflation over the coming decade than we have seen over the past decade.
Trade tensions and higher inflation intersect. As part of a growing backlash against globalisation, and China in particular, nations are threatening to bring their offshore platforms back home. While this may increase security of supply, it will also involve higher-cost domestic producers. Inflation may not return while the recession deepens, but as the recovery takes hold, a new world of fragmented, more expensive supply chains may tell a different story.
We are preparing clients’ portfolios for a decade of increasing prices. We retain clients’ long-term exposure to share markets across NZ Funds’ growth portfolios. At the same time, we continue to add to our gold position and inflation protected United States Government bonds.
Cash is not king
While the absolute level of inflation may be modest, say 2 – 3%, in an environment of low interest rates the after-tax returns from cash and term deposits will have a significant wealth impact for retired investors, especially those that have not provisioned for retirement with an investment portfolio or other real assets such as an investment property.
“When you put your money in cash or short-term deposit, look at the interest rate you are getting in relationship to the inflation rate,” says Ray Dalio, founder of Bridgewater Associates, the world’s largest hedge fund. “You will see that your after-tax return will be below the inflation rate. That means that you are experiencing a tax on that cash equal to that difference. So, you can’t keep your money in cash. If you think that is safe, you’re looking at it wrong — it is a sure losing strategy.”
We believe financial markets will recover faster than the real economy. Therefore, those with a medium to long term horizon should remain invested. Remaining invested in financial assets for the long term provides an incredible opportunity to build wealth.
Source: The Peterson Institute for International Economics, February 2020.
This document has been provided for information purposes only. The content of this document is not intended as a substitute for specific professional advice on investments, financial planning or any other matter.
While the information provided in this document is stated accurately to the best of our knowledge and belief, New Zealand Funds Management Limited, its directors, employees and related parties accept no liability or responsibility for any loss, damage, claim or expense suffered or incurred by any party as a result of reliance on the information provided and opinions expressed except as required by law.
This document has been provided for information purposes only. The content of this document is not intended as a substitute for specific professional advice on investments, financial planning or any other matter.
While the information provided in this document is stated accurately to the best of our knowledge and belief, New Zealand Funds Management Limited, its directors, employees and related parties accept no liability or responsibility for any loss, damage, claim or expense suffered or incurred by any party as a result of reliance on the information provided and opinions expressed except as required by law.
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James Grigor is Chief Investment Officer for New Zealand Funds Management Limited (NZ Funds) and a member of the NZ Funds KiwiSaver Scheme. James' comments are of a general nature, and he is not responsible for any loss that any reader may suffer from following it.
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