Where The New Zealand Markets Currently Sit In The Global Economy

05 January 2010

2009 will go down in history as one of the most remarkable years on record for markets around the world, including New Zealand.

The year began where 2008 finished, with the world facing financial Armageddon, but ended with investors enjoying a year of generally reasonable returns, after such an awful 2008.

Market tensions eased in March and sentiment improved. After hitting a low of 676 points on March 9, a level not seen since 1997, the S&P 500 began to recover strongly, eventually ending the year (with one trading day to go as I write this) 67% above this low point.

In New Zealand our market followed global markets upwards. Using the NZSE index, which does not include dividends, the NZ market hit an 11-year low in early March, but has since gained 34% from this low.

While markets have recovered strongly, they remain far below their 2007 peaks. The New Zealand market needs to deliver a 34% gain to get back to its 2007 high point.

Much to the frustration of exporters and investors with overseas investments, the NZ Dollar roared over 2009. Against the US Dollar it gained 50%, rising from US$0.50 to US$0.75 during the year.

The fortunes of our currency have clearly been tied to investor sentiment. Over 2008 during the global financial crisis, investors evacuated the NZ Dollar in favour of safe havens like the US Dollar. The Kiwi fell from a high of US$0.81 to a low of US0.50 over 2008. As fortunes turned and investor sentiment improved, so has the NZ Dollar.

Not all of the increase in our currency is simply exuberance from bullish overseas investors. Some of the strength in the NZ Dollar is probably deserved given our economic fundamentals are actually better placed than those of many of our major trading partners. Nevertheless, our currency has looked stretched, and some weakness was seen later in the year.

The trend for interest rates over 2009 was upwards. Government bond yields in the secondary market rose by around 100 basis points over the year.

The Official Cash Rate (OCR) started the year at 5% but was promptly slashed by 1.5% in January by the Reserve Bank, who followed this up with further 0.5% cuts in March and April. The Bank has left this rate unchanged at 2.5% since this time, and this is where it has ended the year.

Latest Indications from the RBNZ are that it will start increasing the OCR in June next year, although this will depend on the strength of the recovery, and the latest GDP growth data released just before Christmas for the September quarter was sluggish with growth of just 0.2%, half the Reserve Banks own forecast of 0.4%.

With risks and positives delicately poised, investors will be hoping that some of 2009s positive karma will rub off on 2010. One of the main risks facing investors is that markets are no longer cheap. Both the New Zealand and Australian markets are trading on PE ratios above their long-run averages.

Another risk is that many central banks, including our own, have signalled that the period of very low official cash rates is coming to an end. Traditionally, share and bond markets have struggled in the face of rising interest rates.

We also believe that the global economic recovery is fragile and high debt levels still pose a serious threat to the sustainability of the recovery.

Balancing these risks, are a number of positive factors that could underpin a continuation of the rally in share prices over 2010, albeit at a more subdued pace than witnessed over 2009. First, is the fact that the recovery in the global economy has been much faster and stronger than most predicted.

The strong growth seen in China and in other Asian countries has been remarkable and adds to the positive picture as a growing Asia may help nullify the impact of lower growth in the United States and Europe.

In respect to New Zealand, another factor that should not be overlooked is the potential for material policy changes in areas of tax, government spending and regulation that could be implemented by the government over 2010. Such changes have the potential to enhance productivity in New Zealand and both equity and bond markets could react positively to any policy improvements in these areas.

Inflation risks are such that over the long-term investment portfolios should have a meaningful orientation towards growth assets, but with only tepid valuation support, and serious risks still lurking across many economies, a considered approach to investing cash is warranted.