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Opinion: Are we heading back to 1987?

By Simon Louisson of NZPA

Saturday 5th November 2005

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The sharemarket may not be heading for a 1987-style melt-down but Tyndall fund manager Anthony Quirk believes there's a good chance the economy will find itself in similar straits.

"It's not the most likely scenario, but it's certainly a possibility, and the more (Reserve Bank governor Alan) Bollard talks about having to raise rates to get imbalances out of the system, the more risk there is that we get a situation a bit like post '87." he said.

Quirk reckons Bollard "stepped it up a notch" this week when he issued a fresh stern warning about consumer spending and the runaway housing market.

Bollard told banks, homeowners and international investors they could be in for a sharp shock if New Zealanders are allowed to continue their current borrowing and spending.

He said he was willing to "take further action" on top of the eight interest rate hikes since the start of last year. Bollard will almost certainly raise the official cash rate to 7.25% from 7.0% at the bank's next review on December 8 as he tries to tame the 3.4% annual inflation rate.

Bollard repeated his concerns that homeowners were continuing to spend more than they earn and many were "vulnerable" to interest rate rises, a fall in property prices, or their job prospects worsening.

New Zealanders' love affair with home ownership and borrowing money on their sole financial asset was a recipe for disaster, he said.

He also had a dig at the banks lending people money, international investors who keep buying the New Zealand dollar as well as the Government for its spending promises.

Banks had helped fuel the boom in property values and could suffer because of it. They needed to focus on their long term interests, not just their one year profit growth or market share target, Bollard said.

"The larger banks' shareholding interests, which are intrinsically linked to the health of the New Zealand economy, will not be achieved if they promote loans to people who cannot afford them," Bollard said.

Ann Sherry, chief executive of Westpac Bank, which this week posted a $30 million increase in normalised net profit to $569m, rejected allegations Westpac's lending was unsustainable.

However, she said it was a "supply side" problem.

"The reality is we still have huge demand in this market from consumers, and a huge preference for housing as their primary investment vehicle."

Finally, Bollard took a swipe at politicians for the pre-election promises - that those undertakings could fuel the domestic economy further which could require counter action from the RB.

An early victim was likely to be the "exceptionally high" exchange rate. Its coming decline could be gradual or sudden if global investors had second thoughts about New Zealand as an investment destination.

"Either way, those investors who think that the New Zealand dollar only goes up will be set for disappointment."

Quirk said Bollard already showed last month his readiness to back words with action, when he hiked rates despite the slowing economy.

If unwinding the "imbalances" in the economy -- mainly New Zealand's unsustainable current account deficit - isn't smooth, then the risk of a "hard landing" (recession) increased.

"What we saw in '87, highly geared companies, the paper shufflers, imploding and a lot of investor savings going with that.

"What we have this time is slightly different in the sense that it's consumers that are geared up rather than companies, and they are geared up into the housing market which is what Bollard's on about.

"If that unwinds, that could get pretty ugly, because studies have shown around the world that a housing bubble unwinding is much more dramatic than a sharemarket unwinding."

The classic example was Britain in the 1980s, where a lot of people borrowing 90% to 100% of the value of houses ended with "negative equity" and lost all their savings.

"One thing that suprised a lot of people post '87, was how significant the second and third round effects were. If one company went under, all of a sudden you found another company had exposure, which led to another company having exposure and so on and so forth."

The economy and sharemarket took around five to 10 years to adjust from the 1987 crash.

Quirk said not only are consumers likely to get hurt but other sectors exposed to the property market, such as finance companies, will experience pain.

"If property unwinds, then they could unwind with that, and then it gets uglier and uglier, because you get some depositors, the oldies who have put their savings into these finance companies, and so forth.

"It was what happened post '87 and it was a pretty ugly environment in which to be an investor. Economically as well we had a pretty rough ride."

Economic purists believe Bollard's medicine will be good for us, to purge the inflation disease, Quirk said.

In the US, outgoing Fed chairman Alan Greenspan has been criticised for letting things get out of hand by taking a gradualist approach and keeping a light hand on interest rates.

"Probably, the purists are cheering Bollard on and saying `do a bit more and wipe out the imbalance'. But it could get pretty ugly."

There are two positives compared with '87 - the Government's books are in great shape and most companies' balance sheets are healthy.

If the economy does turn to custard, then the Government can do the Keynesian thing and try and prime it. Such action would put it in further in conflict with the RB and each time the Government attempts to loosen the purse strings, the bank would respond with a monetary policy tightening.

Quirk said if there is a hard landing there is no way the sharemarket will be unscathed.

"If the property downturn is significant, even very sound companies will get affected."

Earnings will be hit hard. High interest rates are never great for equities. The market underwent a 6.5% "correction" in October but has since carried on the merry way of the last four years.

But already a number of companies have issued profit forecast downgrades, most recently Air New Zealand, Carter Holt Harvey, Contact Energy, Tenon and Hellaby Holdings.

Quirk said analysts tended to underestimate how well companies will do on the way up and how badly they are affected in a recession.

Tyndall has gone much more defensive with its investments, lowering its weighting of NZ shares on the expectation that the good times can't continue for ever.

Quirk advises investors to look for stocks with a low valuation, good balance sheet, good dividend yield and whose earnings won't be bounced around too much by a downturn in the economy.

"There is no doubt when the downturn comes, the currency will come down. Look for companies with a currency exposure."

"It's a very interesting juncture that we find ourselves in."

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