Monthly Market and Economic Update – March 2021

“If you have one economist on your team,
it’s likely that you have one more than you’ll need.” 

Warren Buffett

MARKETS

The chart on the left shows the US share market (the Dow Jones) over the last six months.  The chart on the right shows the US share market (the Dow Jones) over the last year.

Key Points: 

• Do we know enough to contain COVID-19?
• What about the recent mutations of the coronavirus?
• What usually happens to markets when interest rates rise?  Why?
• What is happening to bank deposit rates in NZ?
•  

We just don’t know

The ‘known unknown’ that could potentially significantly impact on markets is the impact of Coronavirus mutations currently underway. 

What we do know now, is that the current round of vaccines are somewhat effective against the main strain of the virus, however what we know that we don’t know is that, as the Coronavirus mutates, the current vaccines become less and less effective.  Indeed, although it looks unlikely at the moment, the current vaccines could quickly become ineffective.

If as an investor you worry about short-term market and economic events that cause your portfolio to rise or fall, then this might worry you as well.  I’m not suggesting you should be worried (but it does not mean that you won’t worry anyway – regardless).

This is relevant because markets appear to be playing the ‘vaccine roll out / global economic recovery’ game. 

Simply, the vaccines have arrived and are being rolled out.  Some parts of the market are recovering, share market tip sheets are rampant, everyone else seems to be making a fortune – the classic FOMO investing environment.

Although the situation is somewhat different, one can easily draw simple parallels between the current environment and the one just prior to the so-called year 2000 ‘tech wreck’ (the technology market correction at the beginning of the year 2000).  I am oversimplifying it however, we see a market mood of bullishness where speculation and gambling are looking to overtake old-fashioned investing, making the latter look slow and out of touch. 

Some significant easy gains have been made in the markets with novice investors once again starting to believe that this must have been a secret that they didn’t know about and this is an easy way to make money.  If only they’d known about it sooner!

Back prior to the year 2000, it was all about some well-known tech companies at the time that have been well forgotten since their demise. 

Now we have the likes of Bitcoin, Tesla, and some other tech related well-known names that have become the stars of the market and what looks like an easy road to fast wealth.

This is not to say that some of those tech companies whose trading prices are rising swiftly are not necessarily worthy businesses.  Many are.  Many more are not.  The trick is to be able to distinguish the difference.

The above graph shows the spiking share price of Tesla compared to other motor vehicle manufacturers

But there is opportunity in amongst it all

I believe it is not limited to the tech sector but there is good opportunity to be had as digital technology continues to change the way we all live and work. 

Most people these days are familiar with Google (owned by Alphabet) and Apple. 

Many years ago these companies were young upstarts and have now become some of the largest most successful businesses in the world. 

Looking back, there were many occasions when markets were unsettled about different events and goings on related to each company.  An obvious one was the passing on of Steve Jobs the founder of Apple, October 2011. 

Generally the market believed that Apple had run out of good ideas once Steve Jobs was gone. 

However I took the view at the time that the economics of Apple were robust and that the company would continue to grow.  This perhaps highlights a solid point about becoming overly obsessed with short-term market events and conditions.  What matters more is the economics of the business, particularly if you are serious about being an investor – one that is successful long term.   

There are others too that you may be familiar with such as PayPal and Adobe. 

These companies are no longer young upstarts but remain worthy businesses in the tech sector that appear to have real growth ahead.  Of course, I’m not attempting to predict the future direction of the share price ( happy to leave that to the speculators).  I’m simply looking at the underlying economics of each business and how that can translate into sustainable long-term growth.

What about rising interest rates!?

In addition to the Coronavirus and recovering markets, we now have rising interest rates and rising inflation. 

The short of it is that, as I’ve pointed out a few times, the US Federal Reserve Chairman Jerome Powell, has allowed inflation settings to run a bit hotter in the US.  It will be interesting to see how this plays out and whether or not inflation gets away and needs to be contained. 

The weapon of choice is likely to be to raise interest rates.  Here is what happened in 1994. 

Although it remains to be seen, inflation and interest rates are in the camp of the ‘known unknowns’, insofar as we know that inflation and interest rates have been rising somewhat.  Nothing significant however the unknown is, how far they will go in an upward direction?  Time will tell …

The Economy

The above diagram provides a dashboard of information about the impact of the Coronavirus globally.

The Coronavirus has not finished with us yet.  A number of my ‘long in the tooth’ sceptical clients have been muttering about this right from the start and they are correct. 

For us as investors, what’s important is the impact on our portfolios and more specifically, how we go about investing. 

I don’t believe in investing in the Coronavirus economic recovery story because at WISEplanning, we are value / eco-Investors that invest in the underlying economics of business. 

We do not play the markets. 

I don’t mind if the cash up value of our investments rise because the market thinks the Coronavirus is beaten. 

I also don’t mind if the cash up value of our investments decline should the market suddenly decide it’s not over yet. 

The reality is that markets have looked through the Coronavirus to a large extent whereas the economic recovery is a bit further behind. 

It must be further behind because there are sectors across a number of countries around the world that are continuing to struggle.  Here in New Zealand of course, it is the hospitality an the tourism sectors that are hurting a lot.

Global Economic Growth

The above chart shows the economic activity of a number of countries and economic areas over 2020 and projects forward into 2021 and 2022.

As the chart above shows, economic growth resumes over 2021 and continues in 2022 all things equal.  Normally those numbers would seem quite positive but given they’re on the back of significant economic contraction over 2020, they are merely catch-up numbers rather than continuing progress and growth. 

Still, we’ll take it – better than ongoing economic contraction and entrenched deflation.

Covid-19 Spread

The above charts indicate the rate of the spread of the Coronavirus across the US, China, UK and around the world

I know, I know…..we’re all tired of hearing about the Coronavirus.  As I mentioned earlier, it aint over yet. 

It’s fair to say that the spread of the current strain of the virus is starting to subside and China, having made a solid effort appears to have had good success. 

Hopefully mutations will be dealt with and the global economy will have the opportunity to get back on track with economic growth, however that is a “known unknown”.  We just simply do not know. 

The Coronavirus is tricky and whilst there has been stellar success where the vaccines have been developed at speed against the current strain, we don’t know for sure how this will play out in the short to medium term, particularly if a new strain of the virus becomes difficult to contain. 

I don’t mention this to create worry and fear but simply to provide a balanced view as a reminder that, the current investment environment is not straightforward and not without complication. 

From an economic perspective then, the global economy is heading in the right direction however we await the outcome of progress regarding containment of the current strain of the coronavirus.  It looks promising.

The known unknown of real interest is new strains emerging and what will be required to deal with them.

The above chart tracks the spread of the Coronavirus in New Zealand

New Zealand has made good progress by comparison to many other countries although the recent community cases reinforce just how tricky the virus can be and the fact that it’s not over quite yet.

10 Year Treasuries – USA

The above chart tracks the movement in the 10 Year Treasury interest rate

As you can see, the chart above continues to demonstrate an ongoing increase in 10 year Treasuries. 

As reported a number of times over the last few months, the US Federal Reserve is allowing inflation settings to run a bit hotter than usual to help stimulate the US economy. 

The question or in other words the “known unknown” is whether or not at some point Jerome Powell (the US Fed Chairman) will need to take decisive action to head off excessive inflation should it start to get out of control? 

It is difficult to predict however, it would appear that, based on what we know (the known knowns) that it is possible for inflation to rise and form a transition into either full-blown rampant inflation or a longer sustained period of low inflation, subdued growth and ongoing low interest rates – the latter is the way it looks right now although there are no guarantees.

I mention inflation and interest rates in the US because they can impact on inflation and interest rates elsewhere, but more specifically on trading prices across share markets.

You know how it goes……interest rates rise, asset prices decline.  Interest rates decline, asset prices rise. 

At least that’s how it usually works.  We now live in a world where unusual conditions are at play (e.g. significant Central Bank intervention).

There are a number of variables that can impact on trading prices across the share market and I regard interest rates as one of the bigger ones to watch.  In other words interest rates can have a significant impact on trading prices.

Inflation – New Zealand

The above graph tracks the inflation rate in New Zealand

Interestingly New Zealand’s inflation rate is tracking at a comfortable 1.4% which the Reserve Bank will be reasonably happy with because it is within its guidelines. 

It is of course supported by the stimulus provided by the Reserve Bank over 2020.  At this stage though inflation is not too hot and not too cold here in New Zealand.

Deposit Rates – New Zealand

The above graph tracks the deposit interest rate in New Zealand

The deposit interest rate is the average rate paid by commercial banks to individuals or corporations on deposits.  It’s not the top rate or the best rate, but the average rate.

Interesting to note in the graph above that there is a slight uptick in deposit rates in New Zealand since around December last year till now.

As you probably know, short-term rates continue to decline however longer term rates have started to rise.

The New Zealand economy continues to perform reasonably well by comparison to many economies and whilst this latest round of community infection cases is disappointing, it is likely that it will be contained. 

Indeed it’s good to see the government taking decisive action once a community case emerges and to actively trace the origins of the case along with other potential infections.  It all does seem rather fragile looking from the outside in, however as the Prime Minister said, it has worked so far.

To Summarise

Apart from interest rate movement, there’s been no real change since my last update in February.  The global economy continues to progress as it rebounds from the impact of the Coronavirus over 2020.

Markets on the other hand, whilst they can change their mind at any point, continue to look through the Coronavirus and appear to be focused on the roll out of vaccines, as well as rising inflation and interest rates. 

There was some volatility across the markets a week or so ago which was a direct result of the market stopping and becoming focused on 10 year Treasuries continuing to rise.

I suspect we may see further volatility ahead as interest rates continue to rise.  I will keep you posted.