The investment market in 2023 was strong – unlike the year prior – largely thanks to an impactful December quarter. It’s a great example of the need for patience and a reminder of the importance of a long-term view when investing.

The positive returns were driven by what we’re calling the “everything rally” – a perfect storm of equities rallying and debt securities (bonds) more than reversing the losses recorded in the previous quarter.

The rally began in November when inflation fell faster than expected and spurred hopes of central banks cutting interest rates in most major economies. This saw recession fears replaced with growing confidence that central banks will achieve their inflation targets without tipping economies into recession.

In December, that confidence was boosted by the US Federal Reserve changing its outlook to include three forecast interest rate cuts in 2024. This fanned investors’ expectations of deeper and faster cuts, which led to higher equity prices.

Equities responded strongly to the news

Equity markets finished the year on a high note, with global equities producing a quarterly gain of +5.4% in New Zealand dollar terms, driven largely by the US equity market finishing just shy of an all-time high. While the “Magnificent Seven” (Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla) produced most of the US equity market gains in 2023, the rally broadened to the rest of the market in the December quarter. You can see this when you look at the tech-dominated NASDAQ Index – up +14.3% and the broader S&P 500 Index’s gain of +11.2% – both in the December quarter.

Elsewhere, equity market returns were more modest at around +2 to +6% returns over the quarter. And closer to home, the Australian equity market produced a strong +8.9% gain in New Zealand dollars, while the New Zealand equity market was more subdued at +2.7%.

Debt securities join the rally.

Before the December quarter, it looked like 2023 would be another ho hum year for investors in New Zealand bonds. But the December quarter delivered strong returns.

Better New Zealand bond returns were attributed to growing optimism that inflation was cooling, and interest rates would soon be lowered. As a result, there was increased demand for bonds, which drove prices up and saw interest rates fall. As a result of the 5.0% quarterly gain, NZ bonds avoided a third straight year of losses, producing a +7.5% annual return.

This in many ways restored value in bonds that was challenged in 2022.

Looking forward in 2024

Globally, economic activity is likely to slow but we see recession being avoided in 2024. While key economic uncertainties remain, severe economic outcomes look less likely than in 2023. After a year to forget in 2022, last year was a lot better for New Zealand bond returns.

We expect New Zealand’s longer-term interest rates to decline, echoing our expectations of global rates. This increases the attractiveness of New Zealand bonds as falling interest rates increase their capital value. On balance, the evidence suggests relatively balanced risks around global equities, which supports a neutral exposure to this asset class.

Investment implications

The 11th-hour rally of the markets to the end of 2023 will have restored the faith of many investors in the markets. That said, for 2024 investors should continue with a disciplined approach to diversified asset allocation in quality assets to ensure they make the most out of having a balanced portfolio.

Note: This article was written on 15 Jan 2024.

Tobias Taylor is Director, Wealth Management Adviser at Jarden. This research has been prepared by Jarden Securities Limited (Jarden) which holds a licence issued by the Financial Markets Authority to provide a financial advice service. The information in this research solely relates to the companies and investment opportunities specified within. The nature and scope of any financial advice included within that research are limited to generic and non-personalised commentary about that investment only, such as the performance and the investment outlook of the company concerned. Any such commentary does
not take into account any individual’s particular financial situation, objectives, goals or appetite for risk. We recommend that you seek financial advice that is specific to your personal circumstances before making any investment decision or taking any action. No fees, expenses, or other amounts will be payable for the provision of any financial advice in this research report. However, if you act on any information or advice contained in this research report, a brokerage fee (and other fees such as an administration and custody fee) may be payable to Jarden. For fees payable for brokerage and other services provided by Jarden, information on our complaints and dispute resolution process, and the duties applicable to us for providing financial advice, please see our publicly available disclosure statement at https://www.jarden.co.nz/our-services/wealth-management/financial-advice-provider-disclosure-statement

Artificial Intelligence, or AI, is a global fixation – one that has driven the Nasdaq to outperform every other major world equity index this year.

AI is having its moment, and a knock-on effect of its popularity is that semiconductor companies have reemerged in the spotlight as one of AI’s crucial initial beneficiaries.

Semiconductors are the elements that conduct electricity voltages between that of typical conductors and insulators. These electrification properties enable semiconductors to be used in computers and other electronics to control the flow of electricity, store memory and convert energy.

This isn’t the first time semiconductors have been popularised recently. Pandemic supply constraints and lifestyle adjustments like working from home drove demand in the early years of the COVID-19 pandemic, but there was a brief period of quiet where they weren’t performing as well.

The factors that caused this initial demand have not gone away, but the demand for AI is eclipsing any other driver of semiconductor use.

So, the Nasdaq is benefiting from this upward swing, but why exactly are semiconductor companies benefiting so much from the AI boom?

Chips – Logic and memory:

To understand why semiconductors are benefiting from AI’s popularity,
it’s important to understand the role the materials have played in the advancement of technology. Computer chips are made from semiconductors and are used for calculating and storing data.

In order for AI to function, it too relies on the use of chips. The two major types of chips are logic and memory.

Logic chips, sometimes referred to as microprocessors, are the ‘brains’ of electronic devices. In this context, logic implies ‘processing’, and the chips perform instructions and tasks that the device needs to execute. Every electronic device needs a storage unit, and memory chips serve this purpose.

The process of manufacturing semiconductor chips is one of the most complex engineering and scientific feats that humans have achieved. To the untrained eye, this process seems like pure magic.

The process begins with the design of the chip, where engineers use complex software to design the circuit of transistors. Post design completion, the blueprint is sent to a foundry (a metal castings factory) for manufacturing. The ‘magic’ of semiconductors lies in their ability to scale and continually get smaller over time.

In 1965, businessman and engineer Gordon Moore proposed that the number of components on a semiconductor would double every year.

In 1975 he revised his forecast that the rate would double every two years. Since then, his prediction held, and has widely become known as Moore’s law. Some manufacturers have made their chips smaller and more efficient than others. In the world of chips, the leading-edge is a term used to describe the smallest and fastest chips produced.

Companies with the highest profit margins are the leaders of the leading-edge space, as they have access to large capital investment that in turn funds research and development costs. As the number and type of devices worldwide seems to exponentially grow, so does demand for these chips. Data centre servers, smartphones and other advanced computing devices account for a large amount of this increased demand.

AI is the newest driver of this demand.

Chip hungry Artificial Intelligence:

Artificial Intelligence models including OpenAI’s ChatGPT require vast amounts of computation, memory, and data to run.

Having always experienced high demand, leading-edge chips regularly eclipse analyst estimates. Leading-edge graphics processing units (GPUs) are used to train the world’s most advanced AI models, and as AI has developed at a significant speed, so has the demand for GPUs. The newest generation of chips are more economical than previous generations, meaning training these models is more efficient per dollar spent.

For AI to operate effectively it needs to run off chips that are efficient and economically viable. For investors looking for semiconductor-related investments they can look towards companies that are tied to leading-edge semiconductors.

This includes Nvidia and AMD in chip design, ASML and KLA Corp who provide machines that measure chips, and TSMC which manufactures chips as a contract manufacturer. Predictions for the future of the semiconductor industry are bright, with McKinsey and Company assessing a trillion-dollar valuation for the industry by 2030.

Of all the recent winners that have emerged from the AI boom – tech giants, cloud titans, even cyber-criminals – chipmakers may just be the biggest.

Tobias Taylor is Director, Wealth Management Adviser at Jarden.

The information and commentary in this article are provided for general information purposes only. It reflects views and research available at the time of publication, using external sources, systems and other data and information we believe to be accurate, complete and reliable at the time of preparation. We make no representation or warranty as to the accuracy, correctness and completeness of that information, and will not be liable or responsible for any error or omission. It is not to be relied upon as a basis for making any investment decision. Please seek specific investment advice before making any investment decision or taking any action. Jarden Securities Limited is an NZX Firm. A financial advice provider disclosure statement is available free of charge at https://www.jarden.co.nz/our-services/wealth-management/financial-advice-provider-disclosure-statement

At times of market and economic uncertainty, combined with relatively low expected returns for many asset classes, we should consider more widely the assets we hold.

It’s important to have a portfolio strategy, designed with discipline, embracing market opportunities while preparing for the unexpected. There are several components of a well-constructed portfolio, including a robust strategic asset allocation that’s consistent with your long-term goals and objectives. A mix of asset classes and strategies all have a role to play. In more recent times, we’ve been challenged to look beyond traditional alternative asset allocations like gold, silver, commoditised debt and emerging markets (amongst others).

This is where carbon has a role to play. Growth in carbon markets may have wide-ranging implications for climate finance, corporate strategy, and global trade. Now when constructing a portfolio for retail investors, carbon can be a serious consideration. It is our view that the New Zealand carbon market was surprised last year when the Government rejected the Climate Change Commission’s (CCC) advice to reduce the number of NZUs up for auction and raise the price settings.

We understand the rationale for the CCC’s recommendations may have been that it wanted to reduce what is perceived as excess supply in the system. In short, it looked to raise the auction floor price, reduce the number of NZUs auctioned and move the Cost Containment Reserve (CCR) much higher than present levels. The CCR is the price level where the Government will sell more NZUs if demand exceeds the regular auction supply.The Government considered the recommendation was likely too inflationary as our petrol, electricity use and landfill trips all have a carbon cost embedded into them.

Given the NZU market had seen the CCR as a magnet previously and both CCRs were fully used in the 2021 and 2022 auctions, it was concerned carbon prices would jump too high on the CCC recommendations. The Government decided to keep with the current plan of the CCR being $80.64 in 2023 and to rise it incrementally to $129.97 by 2027.

The market underwent a significant correction on that announcement – one of the biggest seen in its fifteen-year history, falling $20 or 25% from a high of $88 to the current price of $67. So where to from here for prices? There are two questions. What will the Government do next, and then where do prices go from here?

Whether you agree with the Government’s view or not is somewhat irrelevant. NZUs have been deflationary since the announcement, and whilst we need higher carbon prices – not lower to decarbonise – the ETS is a market where prices will change, both up and down. Regulatory risk is the fundamental risk you assume if you trade in the ETS.

The reality is that domestic and international targets remain. It’s just become harder to achieve. Unless we start making emission reductions now, carbon credits on the ETS become shorter in supply. The ETS covers roughly half of our emissions – circa 40 million tonnes per year. That’s approximately the amount of NZUs that need to be surrendered by liable entities in our ETS every year. Some liable entities are fuel companies, coal and gas users and electricity companies.

They collect the carbon from us in cash, buy NZUs in the market or at auction, and hand them to the Government every year. 1 NZU equals 1 tonne of CO2e emissions. Looking at the following table, you can see if emissions remain flat and the government supply falls from 2023 to 2027 through auctioning, the market will be short 45 million tonnes in 2027 if the CCR is taken out every year, and 85 million tonnes in 2027 if it is not.

Source – CCC and Jarden This means that the shortfall will have to come from actual emission reductions, such as forestry or the current registry stockpile. All these (extra) NZUs sit in the hands of private actors. We know some will come to market, but we don’t know how much. What is required is approximately 10 to 20 million NZUs per year for supply to equal demand – we’re not sure that is achievable. Carbon prices may be impacted.

Tobias Taylor is Director, Wealth Management Adviser at Jarden. The information and commentary in this article are provided for general information purposes only. It reflects views and research available at the time of publication, using external sources, systems and other data and information we believe to be accurate, complete and reliable at the time of preparation. We make no representation or warranty as to the accuracy, correctness and completeness of that information, and will not be liable or responsible for any error or omission. It is not to be relied upon as a basis for making any investment decision. Please seek specific investment advice before making any investment decision or taking any action. Jarden Securities Limited is an NZX Firm. A financial advice provider disclosure statement is available free of charge at https://www.jarden.co.nz/our-services/wealth-management/financial-advice-provider-disclosure-statement

The pandemic and the recent relaxation of restrictions continue to reverberate through the global economy and cloud the outlook. For insight into what may lie ahead, Jarden investment strategist and economist John Carran shared his thoughts, at the time of writing on 18 November 2022.

Through the haze, we see potential improvements in inflation but also see the global economy flirting with recession. In this environment, financial markets may waver in the near-term. Longer-term, prospects for share markets and bonds still look promising. The most glaring consequence of the pandemic, and the responses to it of governments and central banks, has been rapidly rising prices.

Clogged supply chains and the war in Ukraine, combined with rampant consumer spending, have caused prices for energy, food, and goods to rocket up globally. Record low interest rates boosted house prices and led to higher housing-related costs. Despite the immediate headwinds for New Zealand’s economy, household finances are in reasonable shape, with many having built their savings over the pandemic.

This could provide some buffer to tougher conditions ahead.  With global supply chain pressures now easing and commodity prices falling, inflationary pressures may soon ease. Cooling housing markets in New Zealand and elsewhere are also expected to gradually moderate inflation. However, prices in consumer services tend to be stickier. Therefore, although total inflation is expected to continue edging down, there will likely be a significant remnant that will linger for longer.

How long high inflation lasts is also likely to be influenced by pressures in the labour market and how fast wages grow. This will impact the pace of consumer spending and the degree to which businesses pass higher wage costs on to their customers. This is a key risk for central banks in their quest to get on top of high inflation. While heated labour markets may cool somewhat in the first half of 2023 as labour market churn settles down, it may take a spell of higher unemployment to settle wage growth to a more sustainable rate. Although there are reasons to expect inflation pressures to ease a little in the near-term, the US Federal Reserve (the Fed) and other central banks are unlikely to slow the pace of interest rate increases this year.

Central banks presently consider the risks of not doing enough to control inflation are worse than the risks of doing too much. However, by mid-2023, we expect many developed economies to show signs of slowing, including labour market cooling, and core inflation shifting down. This will likely be enough for the Fed and other central banks to halt their interest rate rises. Interest rate rises tend to influence economies with a considerable lag, so recent rapid rate increases should take their full effect through 2023. The more central banks raise interest rates in the near-term, the more likely it is that economies will enter recession next year and possibly through to 2024.

Therefore, it’s also possible that the general economic uncertainty, which has caused share and bond market volatility this year, may persist for a while longer. On the other hand, share valuations have materially declined this year, which means the potential return from shares in the longer term could be favourable. With interest rates now higher than they have been for at least a decade, bonds could similarly offer improved investment yields.

In New Zealand, we are facing similar inflationary and economic pressures to many other countries. The coming year could be challenging as recent interest rate rises start to bite. Many people that locked in low interest rates on one- and two-year fixed mortgages will soon be rolling onto much higher rates.

With the local housing market already feeling the effects of higher interest rates on mortgages and house prices falling almost 13 per cent from their peak at the end of last year, New Zealanders’ confidence and ability to spend could be adversely affected. Despite the immediate headwinds for New Zealand’s economy, household finances are in reasonable shape, with many having built their savings over the pandemic. This could provide some buffer to tougher conditions ahead. In this less certain environment, we often work with clients to diversify their investments in a way that meets their goals and timeframes. This can help with navigating the route ahead in a way that suits your individual circumstances.