Market Review: New Zealand at an economic and savings cross roads?

By Anthony Quirk

Friday 3rd June 2005

This month's commentary focuses on New Zealand given:

the domestic economy (and sharemarket) appear to be at a cross roads; and
the Budget in May, which has significant implications for future savings levels and for the investment industry in this country.

Let's look at each of these in turn.

1) The New Zealand Economic and Sharemarket Outlook

After what has been a great run it is now hard to be bullish on either the New Zealand economy or sharemarket. The following factors are starting to weigh on both: the high Kiwi dollar, low net migration levels, high oil prices, falling consumer confidence, falling business confidence, a high current account deficit and an easing residential building sector.

Perhaps the most important factor in the outlook is that we seem to have a (currently) hawkish central banker in charge! The Governor of the Reserve Bank in New Zealand (RBNZ), Alan Bollard recently pronounced that he still holds some inflation fears and that a further rise in interest rates is possible.

Frankly, this is a bit hard to fathom in the face of the negative factors listed above. Sure, unemployment is low but this is a lagging not a leading indicator of how an economy is going to perform over the next 6-12 months. That is, the current unemployment rate is not a good predictor for the economy.

Ironically what the RBNZ does with interest rates (and the impact on the yield curve) is actually a much better predictor of the economy. That is, the New Zealand economy slows down when short-term interest rates are higher than long-term bond rates � a so called negative (or inverse) yield curve. This is because short term rates are the basis for floating mortgage rates and also potentially ratchet up the middle part of the yield curve, which is used to set many fixed rate mortgages and corporate borrowing rates.

With a negative yield gap having been in place for some time now the clear implication is that economic growth is going to slow down. This is clearly starting to happen but we would be stunned if the RBNZ did raise rates next week as it certainly has the potential to result in an economic "hard landing" and even a full blown recession.

If this does occur then corporate earnings have the potential to be significantly "crunched". A trickle of companies are already making noises about a poorer earnings outlook but this could become a flood if a hard landing does eventuate.

Generally, sharebroking analysts under estimate the impacts of an economic slow down on corporate profits. They often forecast steady profit increases for most companies through their forecast period, whatever the macro economic environment. Thus, the New Zealand sharemarket does appear vulnerable to earnings shocks at present. The key for successful investing over the next six months may be to avoid the earnings "land mines" that are out there.

Looking longer-term there will be a time to look at companies that will do well from a falling interest rate environment (and lower currency) as well as yield plays. However, it is probably premature to look at this now � unless we do get another rate rise from the RBNZ and an economic "crunch" through the second half of this year.

2) The Budget � some implications for savings, investment product vehicles and the industry

While most New Zealanders found the 2005 Budget to be a total bore, other than the resultant debate about tax cuts, the savings industry was hanging on every word of the Finance Minister. It is certainly the most significant Budget for savings policy in the twenty-plus years I have been involved in the industry with many significant ramifications. The most obvious are:

- the huge impact Kiwisaver could have on products offered and who offers them. It seems likely the potential default providers will be a relatively small list and the fees they offer will be competitive (with more than a little help from the Government!). This should be a 'win" for the customer. However, it will possibly further consolidate the main players in the savings industry, particularly given the need to provide service to what is likely to be a multitude of savers with small balances.

- Kiwisaver has the potential to significantly impact on existing Corporate Super Schemes. While companies have the option to convert to Kiwisaver the reality is that many will not because their existing terms and conditions do not meet the Kiwisaver criteria. Such companies will then have the choice of either continuing to offer their existing scheme and a Kiwisaver version, or closing down their existing scheme in preference to a new Kiwisaver scheme. This cash out potential for existing scheme does mean savings could go down in the short-term, an outcome I'm sure the Government would like to avoid.

- Also introduced was the concept of a capital gains tax on all offshore share investments, whether they are held directly or through a managed fund. This would remove the tax advantage for New Zealand investors using Australian, OEICs, UK listed investment trusts and passive funds, thereby putting all vehicles on the same tax basis.

Related to this is the issue of Australian investments with some calls to exempt these to further integrate investment rules across both countries. I doubt this will be the case as exempting Australia will result in all sorts of boundary issues and potentially incentivise product providers to once again use Australian domiciled funds to avoid or minimise tax.

Removing capital gains tax for New Zealand shares for managed fund vehicles also has the potential to change the nature of many New Zealanders' share portfolios. For tax reasons many currently use a sharebroker to purchase a "buy and hold" portfolio or invest in a passive product. This tax advantage now goes and thus provides greater options for investors to consider in terms of their New Zealand share portfolios.

Given the move to tax all offshore shares (as mentioned above) it also provides an incentive for tax conscious investors to re-consider their split between domestic and offshore shares.

Ensuring individual tax rates apply in savings vehicles. Again, this is a very positive step for many customers of managed funds as it ensures they pay the correct amount of tax � although it does remove the salary sacrifice benefit for 39% tax payers investing in a superannuation fund. Having individual tax rates will provide a major headache to product providers as this requirement, as well as the possible introduction of tax on all offshore shares, will mean significant systems development will be needed to cope.

All in all, a very proactive budget in terms of savings policy by this Government but one that will mean some winners and losers amongst the industry. However, more importantly the consumer should benefit from having the choice of investing in much more efficient managed fund vehicles, from a tax and fee perspective.

To see how the numbers stacked up for various markets around the world in the past month and over the year, visit our Monthly Market Review here

Anthony Quirk is the managing director of Tyndall Investment Management New Zealand Limited (Tyndall).

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