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Market Review: The end of the golden weather?

By Anthony Quirk

Friday 8th April 2005

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This market summary is provided by Tyndall Investment Management New Zealand Limited (Tyndall). 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

Last month's commentary was about ‘the calm before the storm’. Those storm force winds certainly buffeted the New Zealand sharemarket during March!

As mentioned last month, inflation fears are becoming more prevalent, certainly as far as the Reserve Bank of New Zealand (RBNZ) is concerned. This led to another interest rate rise in March, which spooked the domestic equity markets, as did lower than expected December quarter GDP growth and a ballooning of the balance of payments deficit.

Accentuating the domestic sharemarket sell-off was the weakening New Zealand dollar. While this is helpful for our exporters it certainly isn't to unhedged offshore investors who own New Zealand shares. Many decided to take some money out of New Zealand, happy to take the profits of the past few years and concerned that any further fall in the kiwi would erode those gains.

While the above events would not normally result in a dramatic fall, the New Zealand equity market was ripe for a sell-off. As highlighted two months ago, in one of my commentaries, the domestic equity market was at 10 year highs, in terms of its P/E relative to global equity markets. Thus, we were due for a correction and this is a healthy part of any adjustment process.

A concern would be if the current correction becomes a rout. This is not likely, as many New Zealand shares are now priced at more reasonable levels, with many having fallen more than 10% over the past ten days. Thus, value is now easier to find, although the market is still not cheap. So the loss of confidence in the domestic sharemarket could result in an over-sold situation in the coming months. This will potentially provide some buying opportunities but will need to be assessed on a stock-by-stock basis.

On the interest rate side, my view is that the RBNZ should now go on ‘hold’ mode for much of the remainder of the year, to ensure it gives sufficient time for its significant rate rises of the past year to feed through. The only factor that might change this would be a collapse in the kiwi dollar, which would further accentuate the existing inflation pressures on the economy. While this is possible, it is unlikely as, even with recent rate rises in the States, New Zealand interest rates remain some of the most attractive yields in the developed world.

If a significant fall did eventuate, the RBNZ response would be likely to be relatively swift with the resultant rate rise/s then underpinning the kiwi. So, a relatively high kiwi dollar looks set to be with us for some time. Eventually (although it continues to be delayed) we will enter a cycle of interest rate declines which may contribute to an easing in the kiwi. When this does occur, shares will look very attractive given the high yields some provide and the boost some exporters will get from a lower currency. However, as always, it is extremely difficult to predict the timing of when this might occur.

The United States Federal Reserve recently voiced fresh concerns about inflation, with an above expectations CPI announcement during March not helping the situation. However, in stark contrast to this country, the resultant fall in bond and stock prices in the US was relatively muted, although the US sharemarket is currently trading close to its lows for the year.

As interest rates go higher in the US, the so called ‘carry trade’ (borrowing at relatively low short-term rates and investing in longer dated securities) may start to unwind. There is a good chance that this adjustment will not be smooth. This could mean that the recent volatility of the New Zealand sharemarket could be 'exported’ elsewhere around the globe.

I mentioned last month that I had seen one respected commentator forecasting an oil price returning to mid-US$20 a barrel. This was countered in March by a Goldman Sachs forecast which stated that oil has the potential to reach US$135 a barrel! This arose from their forecast of continued strong demand for oil from China and the US. It is also the level that Goldman Sachs believes oil potentially needs to reach, in order to significantly change consumer petrol buying behaviour in the US, where petrol is still relatively cheap and large cars and SUV's prevalent.

Of course, these scenarios have potentially hugely divergent outcomes for the world economy. If the Goldman Sachs forecast occurred it would probably see a repeat of the early 1970s oil shock period, which resulted in a recession for the global economy, stagflation (high inflation with low or no growth) and a blood bath for sharemarkets. There appears to be considerable speculative positions around oil going higher and one other commentator likened it to the NASDAQ bubble with some potential for it to burst.

Away from the US, prospects in Japan and Germany are improving slowly. This is not because of a better macro-economic environment but is more driven from the bottom up, with many companies making considerable changes to how they operate in order to increase efficiencies. An example of this is Japanese unit labour costs, which fell by 2.2% for the 2004 year - the largest decline of its type since 1985.

While some of the benefits of this are hidden as their domestic economies struggle, it potentially creates a better platform for growth. This could lead both countries to making better contributions to global growth levels, after having left that to the US in the 90s and, more recently, China.

In terms of China, recent data has confirmed its growth profile remains strong, with its industrial output, already at high levels, rising by 16.9% (compared to a year earlier) in early 2005. It, therefore seems unlikely that the country will experience an economic ‘hard landing’ in the short-term. Moreover, its long-term growth potential remains intact, although there will undoubtedly be the odd economic ‘hiccup’ along the way.

In summary, the relative calm of markets has been disturbed in New Zealand and one feels there may be some storm clouds brewing on the horizon for global markets, leading to lower returns in 2005 than last year for most markets.

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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