Commentary on the September quarter by Russell Investments, UniSaver’s investment consultant and manager.

Global markets

Global share markets made good gains in the September quarter, with the MSCI ACWI Index ‒ Net returning 2.1% in unhedged New Zealand dollar (NZD) terms. Much of the gains continued to be driven by central bank activity; notably in the US, where the Federal Reserve (Fed) lowered its benchmark fed funds rate by 0.50% to a target range of between 4.75% and 5.00%. Whilst the rate cut itself had been widely anticipated, the size of the move had been the subject of much debate in the lead up to the meeting as the Bank’s focus shifted from taming inflation to protecting the labour market and the country’s economic expansion. Speaking after the meeting, Chairman Jerome Powell said the decision to cut rates by 0.50% didn’t imply that the inflation fight was over, but rather that officials had growing confidence it was time for a recalibration of the Bank’s policy stance. The Fed also signalled that it expects to lower interest rates by a further 0.50% this year, another 1.00% in 2025 and a further 0.50% in 2026.

Elsewhere, both the Bank of England and the European Central Bank cut interest rates during the period, while the Bank of Japan unexpectedly lifted its overnight call rate in July. Share markets also benefited from a series of mostly positive corporate updates and a sharp decline in long-term government bond yields. Limiting the advance was heightened geopolitical risks, including a material escalation in Middle East tensions.

At the country level, the benchmark US S&P 500 Index (5.5%), the Dow Jones Industrial Average (8.2%) and the tech-heavy NASDAQ Composite (2.6%) all recorded fresh highs over the period. Stocks were also higher in China (16.1%[1]), Europe (2.2%[2]) and the UK (0.9%[3]) but fell in Japan (-4.2%[4]).

New Zealand shares

New Zealand shares outperformed their global counterparts in the third quarter; the local market returning 6.4%[5]. Stocks benefited in large part from the Reserve Bank of New Zealand (RBNZ)’s surprise decision to begin cutting interest rates; the Bank lowering the official cash rate 0.25% (to 5.25%) in August. Most analysts had expected the Bank to leave rates on hold. In its post-meeting statement, the RBNZ noted that annual consumer price inflation is returning to the Bank’s 1-3% target range and is expected to remain near the (2.0%) mid-point over the foreseeable future. The Bank added that the pace of further easing will depend on officials’ confidence that pricing behaviour remains consistent with a low inflation environment, and that inflation expectations are anchored around the 2.0% target. [Note: the RBNZ cut interest rates a further 0.50% (to 4.75%) following its early October gathering. The Bank didn’t meet in September.]

Global alternatives

The global listed infrastructure market made strong gains over the period, returning 11.2%[6] in hedged NZD terms. Like other interest rate sensitive sectors, listed infrastructure benefited from a series of rate cuts globally and a sharp decline in long-term government bond yields.

Global listed property also performed well in the third quarter, returning 13.7%[7] in hedged NZD terms. Like the broader equity market, property stocks benefited from central bank activity, including the Fed’s decision to begin lowering interest rates with an outsized 0.50% move rather than the standard 0.25% reduction. The market also benefited from a sharp decline in long-term government bond yields; particularly in the US.

Fixed income

Global bonds were higher for the quarter, returning 4.2%[8] in hedged NZD terms. Longer-term government bond yields fell (prices rose) over the period, driven largely by the Fed’s first rate cut since the early days of the COVID-19 pandemic. Bonds also benefited from interest rate cuts in Europe and the UK and the asset class’s traditionally defensive characteristics in the face of heightened geopolitical risks. Global credit markets were stronger for the quarter, with spreads on US and European high-yield and investment-grade debt narrowing throughout the period. Both hard and local currency emerging markets debt recorded good gains.

The New Zealand bond market made good gains over the period, returning 3.9%[9]. Domestic long-term government bond yields fell in line with their global counterparts. Yields were also pressured by the RBNZ’s surprise rate cut in August; the central bank’s first since March 2020. The yield on New Zealand 10-year government debt closed the quarter 43 basis points lower at 4.24%. Local credit markets also performed well, with spreads narrowing throughout the period.

How did markets affect UniSaver’s investment options?

Strong gains from both equity and fixed income markets led to strong returns for all member options over the third quarter. Conservative returned 2.9%, Balanced 3.7% and Growth 4.0% after the deduction of fees and tax. Cash delivered a 1.1% return over the same period.

Over the last year, Conservative, Balanced and Growth options returned 9.5%, 14.5% and 17.4% respectively, after the deduction of fees and tax.

Looking ahead

Markets are priced for a soft landing in the US, so even a mild recession is likely to trigger a significant equity-market correction. The economic data supports the soft-landing thesis, but a slowdown consistent with a soft landing could still be the pathway toward a recession.

For now, a soft landing looks the more likely outcome. Inflation is declining, growth in wages is moderating, and labour-market pressures are cooling. Importantly, the Fed has begun easing before clear signs of economic stress have emerged. We’re not yet out of the woods in terms of recession risk, and the slowdown could overshoot into a hard landing if Keyne’s paradox of thrift takes hold. This is when jobs weakness makes consumers cautious and they spend less, causing firms to cut back on spending and jobs, which in turn triggers more consumer caution. What seems sensible for individual firms and households becomes calamitous in aggregate.

Economic prospects are brightening in Europe and the United Kingdom after both regions experienced near-recession conditions during 2023. Stronger bank lending and rising incomes are boosting Europe. Germany, however, is the weak link, where the industrial sector is struggling due to its reliance on China and where the auto sector has fallen behind in the shift to electric vehicles. Overall, Europe is in a sweet spot where growth is picking up, while moderating inflation allows the European Central Bank to cut interest rates.

The UK economy is finally showing signs of life after being stagnant since the end of COVID-19 lockdowns. Consumer and business confidence are rising, while declining inflation has enabled the Bank of England to begin easing.

The different growth trajectories over the past couple of years mean the U.S. is out of sync with the economic cycles in Europe and the U.K. This makes it likely that Europe and the U.K. can continue to recover if the U.S. experiences a soft landing. A U.S. recession, however, would flow through to the rest of world given the impacts on global trade and confidence.

With virtually zero economic growth since September 2022, the New Zealand economy is set for some respite now that the Reserve Bank of New Zealand (RBNZ) has begun its rate-cutting cycle. Monetary policy, however, is unlikely to become accommodative until the second half of 2025. The RBNZ board members have noted downside risks to the economy and indicated they are open to rate cuts of 50 basis points if required. We do not think that will be required, and instead expect a steady path of 25 basis-point cuts. New Zealand government bonds are close to fair value in our opinion and should provide some return upside if the economic outlook deteriorates further. We are neutral on the New Zealand dollar, with the interest rate differential expected to remain steady as the RBNZ cuts rates along with the U.S. Federal Reserve.