Writing a positive commentary about July is a bit challenging, especially when August has started with a lot of turbulence.

Let’s break down what’s been going on:

1. Japan: After maintaining near-zero interest rates for 15 years, the Bank of Japan (BOJ) finally raised rates on August 1 by a mere 0.15-0.25%. This action led to an unwinding of the “carry trade,” where investors borrow in JPY to invest in Japanese stocks. On August 5, the Nikkei experienced its worst day since 1987, dropping close to 25% from the July highs. The volatility index (VIX) spiked to 67, indicating panic, a level only seen during the Global Financial Crisis (GFC), the COVID-19 crash, and now.
   
2. US Growth: A weak jobs report in the US last week raised concerns about a potential recession in 2025 if the Federal Reserve (FED) does not cut rates quickly enough to prevent a slowdown. Consequently, the Nasdaq was down over 12% from its highs on July 11.
   
3. AI Stocks: After stellar performance in 2024, AI stocks have retreated due to valuation concerns and fears that AI spending may slow. NVIDIA (NVDA) had fallen 26% from its highs on July 11, while the SOX (semiconductor index) was off over 25%, though many names rallied off their lows.
4. Middle East Unrest: Concerns over a wider conflict in the Middle East are negatively impacting risk sentiment.

What Actions Are We Taking?

1. Pre sell-off:

• International funds have been reducing exposure to AI names and Japanese stocks.
• Regular discussions about valuation concerns have led to a smaller weight in NVDA.
• We increased weight in interest rate-sensitive names and reduced weight in larger caps within diversified funds.
• We didn’t deploy the strategic reserve of cash.

2. Post sell-off actions:

• The recent market move is believed to be primarily due to the unwinding of the carry trade, and the major damage is likely over.
• Selective buying in Japanese stocks and oversold tech names with good earnings reports.
• Tactical deployment of cash in small-cap funds.

3. We continually monitor the data:

• US growth and interest rates are critical, with the Japan news expected to pass.
• Continuous monitoring of data to assess any further economic deterioration. So far, there is little evidence of severe issues.
• Anticipation that the FED will take action to stabilize the situation, with the Jackson Hole symposium scheduled for August 22-24.
• Current data and earnings reports suggest that while the economy is slowing, it is not facing a major crisis.
• No signs of a COVID shock, earnings shock, inflation shock, rates shock, banking crisis, or other major issues.
• Most markets are flat or down for the year, with valuations outside the major tech stocks returning to reasonable levels.

4. We’re keeping a close eye on the Middle East:

• Monitoring oil prices closely. Unless there are significant movements, the impact outside the region is expected to be limited.

In Summary My Thoughts On The Last Week Are:

1. Don’t panic:

• Volatility is normal and is a regular part of the investment team’s operations. Think of them like emergency doctors. 
• We reduced exposure to Japan and tech stocks during July.
• We are taking advantage of oversold opportunities.
• The funds maintain a strategic reserve of cash for situations like this, which will be deployed tactically.
• Many funds were at 2024 highs or all-time highs just days ago, so there is no cause for alarm.
• Interest rate cuts are anticipated, with central banks having significant stimulus tools available if needed.
• This is not seen as the beginning of a new equity bear market like in 2022.

2. No change to our strategy:

• Valuations for small caps remain very cheap, with some markets still below their February 2020 levels.
• Lower interest rates are beneficial for small caps, property, infrastructure, and fixed income, and generally stimulate stocks and assets. A possible 200bp of cuts in the next 12 months could be seen.
• Large-cap funds remain underweight in the most expensive parts of the market, particularly megacap tech. However, despite these headwinds, there are several bright spots at Pie. We’ve consistently emphasised that as inflation falls and interest rates decline, certain parts of the market can thrive. This insight prompted us to launch our Fixed Income Fund and Property & Infrastructure Fund at the end of last year, anticipating the opportunity presented by falling rates.

For those unfamiliar with why these products perform well during a declining interest rate environment, let’s dive in:

Fixed Income Fund:

• Imagine a bond as a term deposit that pays a fixed interest rate over a specific period.
• Suppose you purchase a 5-year New Zealand Government bond for $100, which pays $5 annually (5% interest).
• If interest rates suddenly drop after your purchase, the bond’s value may rise to, say, $105 because 5% becomes attractive compared to the new 4% rate.
• Consequently, you not only collect the $5 yield but also benefit from the $5 capital gain, resulting in a 10% return in the first year.
• Currently, with falling interest rates, our Fixed Income Bond fund captures both yield and capital gains from rising bond values.

Property & Infrastructure:

When it comes to Property & Infrastructure, there are three reasons why they do well when rates fall.

1. These companies often pay dividend yields, which become more appealing when interest rates decline.
2. Additionally, they rely heavily on debt for construction. As debt costs decrease, their profits rise.
3. Lower interest rates stimulate the market, leading to increased activity and higher property and infrastructure asset values.

Oh, and I nearly forgot to mention that small caps do well in a falling rate environment. Our Australasian Emerging Companies Fund was up 6.5% in July, taking that fund to an all-time high.

Coming back to that economic slowdown, this is not due to COVID, the GFC, or an inflation scare. Instead, it’s a market adjusting to slower growth and lower interest rates – a normal and healthy correction.

Remember, if you have further questions or need clarification, feel free to reach out via email or give our team a call. There’s no such thing as a silly question—finance can be complex!

Annual Report and Climate Statements

The Pie Funds Management Scheme Annual Report is now available. This document outlines important information about our funds for the year to 31 March 2024. The Climate Statements represent significant progress by us in our journey of understanding and managing climate related risks and opportunities and integrating them into our risk management processes . The Annual report and Climate statements are available on the Pie Funds website, under Investor Documents then Scheme Documents. You can request a copy free of charge, which you will receive within 15 working days, by emailing [email protected].

Alternatively, you can find these three documents online:

• Pie Funds Scheme Annual Report
• Pie KiwiSaver Scheme Annual Report
• Pie Climate Statements

Thank you again for your support. If you have any questions, please don’t hesitate to email me on [email protected]

Warm regards,
Mike Taylor
Founder & Chief Investment Officer

Information is current as at 31 July 2024. Pie Funds Management Limited is the manager and issuer of the funds in the Pie Funds Management Scheme and Pie KiwiSaver Scheme (the Schemes). Any advice is given by Pie Funds Management Limited and is general only. Our advice relates only to the specific financial products mentioned and does not account for personal circumstances or financial goals. Please see a financial adviser for tailored advice. You may have to pay product or other fees, like brokerage, if you act on any advice. As manager of the Schemes’ investment funds, we receive fees determined by your balance and we benefit financially if you invest in our products. We manage this conflict of interest via an internal compliance framework designed to help us meet our duties to you. For information about how we can help you, our duties and complaint process and how disputes can be resolved, or to see our product disclosure statement, please visit www.piefunds.co.nz. Please let us know if you would like a hard copy of this disclosure information. Past performance is not a guarantee of future returns. Returns can be negative as well as positive and returns over different periods may vary.