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Opinion: Sharemarket performance as bleak as the weather

By Simon Louisson of NZPA

Friday 21st July 2006

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The sharemarket's performance this week was about as bleak as the weather.

The top 50 index slumped 3.5%. There were a host of reasons for the fall - inflation hit a 16-year high, petrol prices rocketed higher, the Middle East conflagration turned ugly and ANZ National bank hiked two-year fixed mortgages in what is expected to be a round of rate rises.

Monday's June quarter inflation data sent the bond and money markets into a quiver. The quarterly rise of 1.5% was significantly worse than economists' predictions and the worst result in 16 years. The annual rate shot up to 4%, even higher than the gloomy Reserve Bank forecast.

Bank bill yields went north. Despite Reserve Bank governor Alan Bollard having clearly signalled the end of the tightening phase that began last year, the bond market nervously priced in a 15% chance of another rate rise.

With the economy nearly flat on its back, most economists don't believe Bollard is yet ready to hike again. But even if he doesn't, the loosening phase previously expected to begin in early 2007 has been delayed again.

As well the stagflation word - an extended period of high inflation and low economic growth - has been raised again.

"The longer interest rates remain high, the greater the impact on consumer spending and the housing sector," said Mark Brighouse, chief investment officer at fund manager Arcus Investments. "We could face a period of lacklustre economic growth at the same time as inflation remains high."

First NZ Capital sharebroker Malcolm Davie said his firm believed there would not be another rate rise. "We contend there is enough tightening in the system. As it is, we won't see a rate cut this year as many have suggested. The CPI data has delayed the day of any loosening of monetary policy."

However, he agrees the interest rate environment has affected shares.

"Interest rate rises never make comfortable bedfellows with equity markets," Davie said.

Guy Elliffe, head of equities at fund manager AMP Capital Investors said equity markets had been relatively sanguine about company earnings risks in a stodgy economy - perhaps too sanguine.

"Generally, markets are too complacent about the risks of the domestic sector of the economy. It comes back to oil prices, interest rates and the outlook for employment. We just see pressures on the economy.

"Some of the earnings of some of the domestic companies might be more vulnerable than people have been anticipating."

Most analysts believe international influences are at least as important as domestic factors. Geopolitical events in the Middle East and oil prices has heightened nervousness on Wall Street despite robust domestic growth and Fed chairman Ben Bernanke signalling the US tightening phase has nearly run its course.

Elliffe said the earnings season in US hadn't gone as well as some had anticipated.

"The global environment is still uncertain."

He said the coming reporting season starting at the end of this month would be more interesting than usual.

Under the exchange's continuous disclosure rules, there was reasonable confidence profit expectations would be met.

"If a few of the major companies come out and disappoint, that will hit the market all right," said Elliffe.

Guidance companies provide for the rest of the year would be the major point of interest.

The next week or two was going to be the time for companies to "fess up" and warn of lower profits ahead.

Analysis of pricing intentions and cost data in NZIER's Quarterly Survey of Business Opinion showed margin pressures clearly emerging, said Elliffe.

This is why he believes markets are too complacent about earnings pressure, especially for domestic companies, and why he is nervous about the earnings guidance for the second half of the year.

Davie said investors had generally priced in the economic slowdown, but how accurately would not be determined until the June quarter results were posted.

The wild card underpinning New Zealand stocks was takeover activity. There were truck-loads of cash looking for a home, particularly Australian cash, said Davie.

"The outlook is clouded by the slowing domestic economy - it's unavoidable - but we must always remember the world is awash with cash and every time we see a sharp fall in the likes of Fletcher Building or Freightways, we see buying coming in on the fear that you might see a takeover."

So while companies' earnings per share may be slowing, that effect on share values may be counteracted by the expectations of more takeover activity along the lines of Waste Management and Gullivers Travels.

"There's plenty of potential for corporate activity in this market."

Elliffe agrees.

"If you talk about the earnings outlook, things look pretty fully priced and a little bit risky to us. Then again, there is just a tremendous amount of money sloshing around looking for a home. We think that's going to support equity prices generally."

Given the sharemarket is supposed to be forward looking, is there a chance it will anticipate an economic recovery from what is predicted to be a rapid easing in monetary policy when it finally comes? Not according to Davie.

"I think we have a protracted period of sub-optimal growth ahead."

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