Market & Portfolio Update – August 2014

Global Shares

Global share markets had a solid month in August, up 3% - driven by good returns in the United States.  While the recovery in the US housing market has shown some signs of moderation, business confidence has remained strong, particularly for manufacturing businesses which are a key indicator of general economic health.  The good underlying share returns were supported by a rise in the US Dollar relative to the NZ Dollar, bringing the gain in global markets to almost 4% when measured in New Zealand Dollar terms. 

These gains bring the rise in global shares to over 20% over the past 12 months.  This strong result reflects the economic improvement over this time, but also builds in a higher level of investor expectations for company earnings looking forward.

New Zealand Shares

After starting the month down 2%, the New Zealand sharemarket recovered to post a small gain of just over 1% for the month. This was behind the performance of the rest of the world, as higher interest rates and lower dairy export prices continued to slow local economic growth prospects. Shares in the New Zealand property sector outperformed the wider market for the fifth consecutive month, despite the downward pressure of higher interest rates on their bottom line. 

August reflected a positive financial reporting season for many NZX listed companies, with over 70% of companies beating the market’s earnings expectations.  The results of Nuplex and Trade Me were the highlights of the month. Both beat expectations considerably after their shares being down over 10% for the six months leading up to the results announcement. Nuplex continues to see strong growth in Europe and Asia, which should continue to support earnings as these economies strengthen.

Australian Shares

The Australian market was relatively flat in August, as company reports on the past 6 months of earnings showed low earnings growth.  The larger mining companies announced earnings improvement, through their continued cost reductions and wind down of large projects.  However their share prices were affected by falling iron ore prices during the month.  Companies in the energy sector buoyed returns, with higher gas prices and updates to major projects giving confidence to investors in Origin Energy (+12%) and Santos (+8%).  The financial sector also performed relatively well as insurers, banks and property companies all showed a continued recovery in earnings.

Interest Rates

Global bond yields fell in August, as it looks more likely that the European Central Bank will introduce further stimulus as well as keeping interest rates low for at least the next several years. Heightened geopolitical tensions in Ukraine added additional “safe haven” purchasing of fixed interest investments.

Locally, with dairy export prices and the exchange rate falling considerably since the last Reserve Bank of New Zealand meeting and lower than expected inflation, the pace of raising the Official Cash Rate is likely to be moderated. 

Summary of Market Movements as at 29 August 2014

Share Markets

29/08

31/07

1 Month Return

3 Month Return

12 Month Return

3 Year Return (p.a.)

5 Year Return (p.a.)

NZX50

5,223

5,168

1.1%

0.9%

15.0%

16.3%

11.0%

ASX 200 (local)

48,315

48,016

0.6%

3.5%

14.4%

14.5%

9.3%

ASX 200 (NZD)

53,984

52,597

2.6%

5.5%

11.0%

10.1%

7.3%

MSCI (local)

3,311

3,223

2.7%

3.2%

21.1%

17.6%

12.5%

MSCI (NZD)

5,517

5,322

3.7%

3.8%

11.9%

16.5%

8.0%

Fixed Interest Markets

29/08

31/07

1 Month Change

3 Month Change

12 Month Change

3 Year Change (p.a.)

5 Year Change (p.a.)

NZ 10-Yr

4.07

4.25

-0.18

-0.17

-0.48

-0.45

-1.60

US 10-Yr

2.34

2.56

-0.21

-0.13

-0.44

0.12

-1.05

NZ OCR

3.50

3.50

0.00

0.50

1.00

1.00

1.00

Currencies

29/08

31/07

1 Month Change

3 Month Change

12 Month Change

3 Year Change (p.a.)

5 Year Change (p.a.)

NZD vs. USD

0.8371

0.8488

-1.4%

-1.4%

7.6%

-0.7%

3.9%

NZD vs. AUD

0.8950

0.9129

-2.0%

-1.9%

3.0%

3.8%

1.9%

MSCI Weighted NZD

 

 

-1.0%

-0.6%

9.2%

1.1%

4.5%

Commodities

29/08

31/07

1 Month Change

3 Month Change

12 Month Change

3 Year Change (p.a.)

5 Year Change (p.a.)

CRB Index

292.8

294.4

-0.6%

-4.2%

0.5%

-5.1%

2.9%

Oil

103.2

106.0

-2.7%

-5.7%

-9.5%

-3.5%

8.2%

Gold

1,287

1,281

0.4%

3.3%

-7.8%

-11.1%

6.2%

Summary of Market Indices as at 29 August 2014

Graphs

The Engine Room of your Global Direct

Much is written on the economy, interest rates and sharemarkets, with forecasts and outlooks opined in local newspapers, websites, radio shows, and most recently, politicians on the campaign trail.  This overflow of information is often a driver of wider markets, and therefore equity portfolio outcomes - however it pays to remember that individual companies are ultimately the engine room driving returns.

The Top-down Approach

Last month, we discussed the virtues of using active investing to add value to an index based strategy.  Within the Global Shares sector, we complement the use of index funds with a selection of directly held companies that we believe will add significant value over the long term.  These holdings (managed in conjunction with Rothschild Bank, based in Zurich) are deliberately positioned to benefit from a number of key long-term investment themes, using a top-down investment approach.  Each of these themes is expected to provide a tail wind to the profitability of the underlying companies, which to a degree are independent of the shorter-term fluctuations in economic news flow.  Some of the key themes are:

Innovation: As discussed in our November 2013 update, technological advances have infiltrated most parts of our lives. Innovation in industries like retailing, oil & gas, manufacturing, logistics and other areas through technological change are creating cost reductions and efficiencies. 

Climate Change:  While the academics and politicians debate the finer details of changes in our climate, the fundamentals of increasing demand for energy and water scarcity are clear.  The International Energy Agency estimates energy demand will increase 31% by 2035, while the International Food Policy Research Institute projects that water demand will be 40% greater than supply by 2030.  These supply imbalances provide an incentive for companies to strive to be more efficient in their use of resources, and also an opportunity for companies which can develop new products that enhance the management of these resources.

Demographic Change:  Increasing wealth in developing countries coupled with ageing western populations, thanks to modern medicine and better nutrition, is shifting global demographics.  This creates opportunities for companies in healthcare, affluence and agriculture.  Pharmaceutical companies and medical manufacturers are the most obvious beneficiaries, as the demand for healthcare grows significantly and as it becomes more affordable to those with increased wealth.  This increasing wealth is also spilling over into the demand for luxury goods, with China’s middle class approaching 500 million people, driving demand for quality goods and services.  As the world’s population grows, so does the need for food and agricultural products.  We have seen the effects of this demand closer to home, where the export of agricultural products has aided our local economy in emerging largely unscathed from the worst global recession in 80 years.   

The Engine Room

At the end of the day, individual holdings drive returns and your Global Shares Portfolio has exposure to each of the above themes through specific companies.  Last month we added US bank Wells Fargo, which is driving innovation in the banking sector through technology to drive significant returns on equity.  This addition complements ABB which has a 100 year history of focusing on innovation, in power and automation technology.  ABB also benefits from increasing energy demand and recently announced a breakthrough in underground sea cables that doubles power flow and range.  Roche, the Swiss pharmaceutical group, produces medication in niche areas of cardiovascular, infectious, autoimmune, and respiratory diseases, dermatology, metabolic disorders, oncology, transplantation, and the central nervous system. The PowerShares Clean Energy and Water Resources funds give a diversified exposure to the climate change thematic as the sector develops and gains traction.

Conclusion

Companies with a focus on innovation, climate and demographic change will drive large parts of the global economy over the next 20 years, and are largely independent of shorter-term factors and the latest economic news articles.  However, we still need to focus on valuations and identify companies that are currently undervalued and offer long term growth prospects.  This process helps ensure that each of the companies held by your portfolio can contribute to the primary objective of long-term capital and dividend growth.

Summary of Key Portfolio Monitoring Decisions

Global Shares Portfolio

With valuations in the United States continuing to rise, we have shifted 4% of the Global Shares sector towards European markets by purchasing a broad European exchange-traded fund (ETF).  While economic growth rates in Europe are more moderate, the past several years have shown much improvement, with the costs associated with government debt levels also improving.  Meanwhile, valuations are much more supportive on a medium-term basis (especially compared to other markets), while there is also a growing prospect of more comprehensive support from the European Central Bank which would help stimulate future growth.

New Zealand Shares Portfolio

In the aged-care sector we have reduced the portfolio’s exposure to Ryman Healthcare from 7% to 5.5% and reallocated this to Summerset at a 1.5% weight.  Metlifecare has also being added to the portfolio at a 2% weight, offset by a reduction in the portfolio’s cash weight from 5% to 3%.  These adjustments take into account our assessment of relatively better valuations on Summerset and Metlifecare shares.

Global Fixed Interest Portfolio

With the additional yield available on international corporate bonds compared to government bonds falling to historically low levels, we have adjusted the portfolio’s holdings by reducing the allocation to international corporate bonds from 50% to 25% and increasing government bonds from 50% to 75%.  We would expect to return to a more neutral allocation between the two if the general level of “credit margins” widens closer to historical averages.

NZ Cash Sector

As part of the cash sector holdings in managed portfolios, we have included an allocation to the Grosvenor Enhanced Cash Portfolio.  By holding a range of short-term, high-quality fixed interest investments such as bank bills and term deposits, the Enhanced Cash Portfolio is able to extract a higher return on the cash sector allocation.  It also allows us to spread the allocation of cash investments across a range of bank counterparties, to further manage credit risk and optimise yield.

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