Mark Lister, 2 June 2020

The NZX 50 index rose another 3.3 per cent in May, taking the rebound from the lows in late March to a stunning 28 per cent. The index is now down a mere 5.3 per cent below where it started the year.

So what gives? We are staring down the barrel of a severe economic downturn and yet financial markets, which supposedly reflect all available information, seem far too relaxed.

For a start, the sharemarket isn’t quite as strong as the headlines might have you believe.

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Think of the NZX 50 like a pizza with 50 slices, but where not all of these are the same size. A range of factors determine the size of each slice, but the bigger companies tend to be over-represented. This means when some of the heavyweights move up or down, they push the index in that same direction regardless of how the other shares are moving.

Only six NZX 50 companies are in positive territory this year, but a few of those are some of our most dominant businesses. Fisher & Paykel Healthcare, a2 Milk and Spark have all bucked the trend and performed well this year, the first two particularly so.

These three alone make up almost 40 per cent of the NZX 50 pizza, so these gains have dragged the index higher. However, the average share price change for all 50 companies in 2020 is a decline of 18.2 per cent, which makes for quite a different story.

Furthermore, 21 of these 50 companies are down more than 25 per cent, and the ten worst performers have fallen by an average of 54.6 per cent.

There’s been plenty of carnage across our market. It’s just that a couple of the big hitters have risen strongly, and this has flattered the returns for the headline index.

It’s a similar story elsewhere. The S&P 500 index in the US has rebounded 36 per cent over the past ten weeks and is now just 5.7 per cent down since the beginning of the year.

However, much of the strength has been driven by the ‘stay at home’ stocks, such as Microsoft, Amazon and all the other beneficiaries of the current backdrop. Technology and healthcare have been the two winning sectors by far, but if we exclude these the average decline across the S&P 500 in 2020 increases to a more substantial 18.0 per cent.

Another reason for the very strong rebound is the phenomenal amount of support that we have seen from the Government, as well as the Reserve Bank. The policy response in New Zealand has been significant, with support payments equal to about 20 per cent of GDP and expected central bank QE spending not far off those levels either.

This has come more quickly and in bigger doses than many investors and fund managers had expected. Some of those who correctly foresaw the initial decline undid all that good work by being too slow to reinvest when markets were in the doldrums. This has forced some to play catch up in recent weeks and do some buying, even if their head tells them things have rebounded too quickly.

We also shouldn’t underestimate the impact of the declines in interest rates on investor behaviour. The advertised rate on a six-month term deposit fell to 1.8 per cent last week, a new all-time low (the previous one being 2.0 per cent in 1965).

After tax that falls to a paltry 1.2 per cent, which doesn’t leave much of a buffer (if any) to keep up with cost of living increases.

At the end of 2019, New Zealanders had $185bn of bank deposits. Some of those depositors will have decided (rightly or wrongly) that accepting some potential volatility is an appropriate trade-off if it means getting a more reasonable return on their capital.

I’d estimate the gross dividend yield of the NZ sharemarket to be about 3.6 per cent at present, after factoring in dividend reductions and suspensions from some (but certainly not all) companies during recent months.

Global investors have also found themselves in a more optimistic mood of late. Economies around the world have begun to reopen, while the total number of continuing claims for US unemployment insurance declined last week for the first time since the outbreak took hold.

One cloud on the horizon could be the re-emergence of tensions between the US and China. These never really went away, we simply all found ourselves with bigger things to worry about. The situation with Hong Kong has seen this conflict come back to the surface in recent days.

If things have indeed rebounded a little too far and too fast, that could be a catalyst for markets to give back some of these gains.

However, if there’s anything the last few months have shown us, it’s that it sometimes pays to remain invested (at least to some degree) even when you’re a little nervous. Markets have a funny way of making us look foolish when we start to think we can accurately predict their next move.