Moving into 2021, COVID-19 continues to impact on the world’s economies. Peter Forster, General Manager for BNZ’s Wealth business, looks at one of the key recent drivers of financial markets and the impact it is having on the performance of some of our funds.
Most countries have been in a state of lockdown, or have faced some form of restrictions, both socially and economically. Share markets have more than recovered from the initial sharp declines experienced in the first quarter of 2020, while economies and financial markets continue to be supported by historically low interest rates and unprecedented amounts of government stimulus.
News of vaccine breakthroughs in December last year and their immediate availability have helped push some global share markets to record highs in 2021, including in the US and New Zealand. Hopes that countries would be able to come out of lockdown has spurred markets on, as this would be good for economic growth, company profits, and employment.
Signs of inflation have become a concern during recent weeks
As the economic outlook improves and world economies reopen however, investors will have to contend with the impacts of an unanticipated rise in inflation.
The concerns come as the global vaccine roll-out continues in earnest. In the US, a third vaccine has now been approved; Johnson & Johnson’s single-dose vaccine. With other countries likely to follow suit, markets are now expecting a sooner-than-expected rebound in growth.
Joe Biden’s $1.9 trillion COVID-19 relief bill, approved by the senate in March, is also expected to add to inflationary pressures. The package includes a one-off payment of $1,400 to many Americans – and the fear is that this may lead to a surge in consumer spending.
Why is inflation a concern for markets?
Sudden increases in inflation, or inflation expectations, can be a challenge for investors. When input prices of goods and materials increase, company revenues and profits can decrease, as they may struggle to pass the additional costs on to consumers in the near term. In instances where costs can be passed on, consumers may end up buying less.
High inflation usually also means higher interest rates, particularly in today’s environment where many of the world’s central banks have been tasked with creating an environment of sustainable rather than rampant growth. Higher interest rates help take the heat out of the economy by encouraging saving, rather than spending.
How have markets reacted?
Worries about inflation and the prospect of higher interest rates have spilled over into investment markets. Bond investments have borne the brunt of this change in sentiment, as they are more sensitive to movements in interest rates. In short, bond prices (and therefore bond markets) tend to fall when investors expect interest rates to rise.
Share markets also tend to be more volatile when inflation is rising. Dividend-paying companies and those geared to growth can underperform, while those with solid cash flows can do well. Technology companies have therefore been weaker this year, while blue-chip companies have fared better. This is also the reason why New Zealand shares have underperformed international shares, since the local market has several high dividend-paying companies. The more divergent performance has meant that while some share markets have seen a pullback, others have pushed on to reach new record highs.
How has this affected the returns for our investors?
Most of the funds we manage for our BNZ KiwiSaver Scheme and YouWealth members invest in a combination of shares and bonds; our conservative funds* have a higher weighting to bonds, while our more growth-oriented funds have a higher weighting to shares.
The recent falls in the value of bond markets has passed through to the performance of our funds*, particularly our more conservative funds, which have around 80% of their holdings in bond investments. Ordinarily, investors in our more conservative funds might not be used to seeing the value of their investments both rising and falling. However, the weakness in bond markets means that these funds have been particularly impacted over recent weeks.
It’s not only our conservative funds that have had a bumpy ride. Our balanced and growth funds have also seen some dips in their value, as share markets have also delivered mixed performances.
What does the future hold?
The recent jump in inflation expectations and the dip in investment performance is a timely reminder that there is risk associated with all investing – even if you invest in one of our more conservative funds. While it’s hard seeing the value of your investments go down, you should also remember that most investment markets have had a strong run over the last 10 years and that ups and downs are part and parcel of investing.
Although markets and economies look forward to ongoing recovery, further volatility is expected in financial markets. However, continued monetary and fiscal support through low interest rates and ongoing government support continues to reassure businesses and markets – and we don’t expect that to change anytime soon.
As always, we would encourage investors to consider their investment decisions in the context of how long they will be investing for, which for most will be several decades. Of course, being in a well-diversified investment, managed by a team of professionals which utilises an approach that places a particular emphasis on quality, will also help.
* With the exception of the BNZ KiwiSaver Scheme Cash Fund, which only invests in cash instruments.
This article is solely for information purposes and is not intended to be financial advice. If you need help, please contact BNZ or your financial adviser. While BNZ has made every effort to ensure that the information provided is accurate, neither BNZ nor any person involved in this article accepts any liability for any loss or damage whatsoever which may directly or indirectly result from any advice, opinion, information, representation or omission, whether negligent or otherwise, contained in this article.
BNZ Investment Services Limited, a wholly owned subsidiary of Bank of New Zealand (‘BNZ’), is the issuer and manager of the BNZ KiwiSaver Scheme and YouWealth. Download a copy of the Product Disclosure Statement for each scheme from bnz.co.nz. Investments made in the BNZ KiwiSaver Scheme and YouWealth do not represent deposits or other liabilities of BNZ or any other member of the National Australia Bank Limited group, and are subject to investment risk, including possible delays in repayment and loss of income and principal invested. None of BNZ or any other member of the National Australia Bank Limited group, the Supervisor, and any other director of any of them, the Crown or any other person guarantees (either fully or in part) the performance or returns of the BNZ KiwiSaver Scheme and YouWealth or the repayment of capital.