Market Update: The battle continues

As in 2022 and 2023, Central Banks worldwide continue to delicately manoeuvre to balance curbing inflationary pressures with sustaining economic growth. But the conundrum persists, evidenced by the rollercoaster of market sentiments observed in recent months.

In this Market Update, we examine how this balancing act is impacting markets, performance shifts in sectors, theoutlook for the NZ economy, and more.

The balancing act and amplified reactions

In December, the MSCI All-Country World Index (NZD hedged) increased by approximately 4%. One of the significant drivers behind this was the surprisingly dovish tone of the US Federal Reserve in its December meeting.

Anticipating a soft landing for the US economy, the Fed signaled its commitment to addressing inflation without facing a recession. The announcement triggered an influx of capital into equity markets and pricing expectations of no further rate hikes and potentially even imminent interest rate cuts.

However, by January 2024, the landscape changed. Despite ongoing concerns about inflation, the US economy demonstrated resilience with GDP growth, wage increases, and a strong housing market. These positive indicators prompted the Fed to revise its stance on potential rate cuts, and the markets, once again, reacted swiftly, with pricing expectations of rate cuts plummeting from 90% in December to 20%in January.

For Central Banks, navigating the balance between inflation and interest rates resembles a game of whack-a-mole. Policy makers strive to rein in volatile market reactions while addressing underlying economic concerns. The markets, inherently forward-looking, react to perceived shifts in central bank policies, amplifying fluctuations.

Of course, markets reacting to Central Bank announcements is not a new pattern. What has changed recently is the strength of those reactions, driven by a combination of factors. For example, one potential explanation lies in the swift and robust emergence of inflationary pressures, necessitating prompt and decisive responses from central banks. Another could be the increase in algorithmic trading. Another could be the increase of liquidity post-COVID, contributing to market exuberance as investors seek avenues for capital deployment.

The important point for investors is that the current investing environment is one of amplified reactions and volatility. Avoid knee-jerk reactions, and if you would like to explore changing your investment strategy, seek professional investment advice that will consider your unique circumstances and needs.

Shifting performance across sectors and the importance of diversification

On a more granular level, there has been a notable shift within sectors. Previously, natural resource sectors, particularly oil and gas companies, enjoyed robust performance while others languished. However, this dynamic has reversed, with communication and information technology sectors outperforming while resources face relative struggles. 

The spike in oil prices, fueled by geopolitical tensions, initially buoyed resource sectors. Yet, as global oil supplies stabilised and alternative energy sources gained traction, the excitement surrounding resource companies waned. Meanwhile, tech giants like Amazon, Nvidia, and Microsoft have flourished, spearheading growth in the information technology and communication sectors. Of course, while the promise of technologies like artificial intelligence (AI) or self-driving cars excites investors, the reality is that the future remains uncertain.

These shifts highlight the dynamism of market trends and the interplay of geopolitical events, technological advancements, and economic policies. It also underscores the importance of diversification to mitigate risks associated with individual companies and unforeseen events that could disrupt specific sectors. 

New Zealand prepares for a challenging year

In New Zealand, the economic landscape presents a contrasting picture to the booming US economy. While the US enjoys robust growth, concerns linger in New Zealand about the extent of its economic weakness. Despite a less optimistic outlook, Reserve Bank Governor Adrian Orr remains cautious about implementing interest rate cuts due to persistently stubborn inflationary pressures, with the OCR remaining unchanged at 5.5% since May 2023.

The contrast between tradable and non-tradable sectors further complicates the situation. While international sectors face downward pressure, domestic inflationary forces persist. This delicate balancing act poses a formidable challenge for policymakers tasked with managing inflation without exacerbating economic fragility.

Overall, domestically, 2024 will likely be a challenging year, made more difficult by the Reserve Bank's reliance on interest rate adjustments as a primary tool to manage inflation. With half of current outstanding mortgages expected to roll onto higher rates, the impact extends beyond individual borrowers, posing potential downsides in broader economic dynamics, including business financing and employment prospects.

Managing risk and finding opportunity in times of volatility

The investment landscape is rife with uncertainties, ranging from geopolitical tensions to technological advancements, how the markets will react to policymaker’s announcements and how policy makers will react to market reactions (or amplified reactions). But as most investors know, times of uncertainty and volatility can also present opportunity.

In this investing environment, seeking professional investment advice is important. Every investor's goals, risk tolerance, and time horizon are different. Professional advice can help you determine what you want your investment to achieve, how long you want to be invested for, what level of risk you are comfortable with and can absorb, and how to diversify your portfolio to mitigate risk and seek emerging opportunities, and more.

And remember: Understanding your capacity for risk (financial and emotional) plays a much more significant role than people commonly realise. Asset allocation, rather than specific investment choices, largely determines overall returns. If not appropriate to an individual's needs, during market volatility, investors can find it challenging to adhere to their chosen investment strategy, succumbing to fear and selling at inopportune times. Conversely, when asset allocation is unsuitable for an investor's risk tolerance and capacity, it can lead to lost opportunity.

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The information contained in this publication is intended for general guidance and information only. It has not been personally prepared for you. Therefore, you should not act on this information if you have not considered the appropriateness of this information to your personal objectives, financial situation and needs. You should consult with us before making any investment decision. Historical market performance may not be indicative of future market performance.

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