June 2009 Quarterly Review
GLOBAL ECONOMY
Global economic activity weakened during the early part of 2009 with sharp falls in GDP in major Western economies. However, Chinese activity has remained strong. More recent economic data suggests activity is stabilising or getting worse less quickly. Consumer and business confidence indices have improved, helped by significant fiscal and monetary policy stimulus.
A key outcome of slowing growth has been rapidly rising unemployment rates (US currently 9.4%) and consumer savings rates. Governments in the US, China, Japan, Australia and NZ have introduced significant fiscal stimulus packages equivalent to 5%, 8%, 5%, 6% and 5% of GDP respectively.
AUSTRALASIAN ECONOMY
New Zealand economic conditions remain weak with a continued reduction in GDP, albeit much less severe than many major economies. Domestic demand remains subdued with lower interest rates and lower tax rates leading to an increase in the savings rate (which remains negative).
There have been some positive signs with the level of housing sales in New Zealand improving, supported by positive net migration numbers. Unemployment to date has been relatively benign but is expected to grow from current levels.
The Australian economy continued to grow in the first quarter of 2009, avoiding a technical recession, as a result of a sharp drop in imports. Business and consumer confidence in Australia has rebounded strongly. Retail sales have benefited from the Australian Government’s stimulus packages. The unemployment rate of 5.7% has been relatively subdued and shows the resilience of the Australian economy.
SHAREMARKETS
Equity markets rebounded strongly over the quarter – with commodity related sectors and emerging markets performing strongly. This has more than offset a poor start to the year with the MSCI World Share Index up 6.8% (in US dollar terms) for the past six months, although it is still down 29.0% (in US dollars) for the year ending 30 June.
The Australian market rebounded strongly during the quarter, as did NZ Equities, which rose 7.9% (NZX50 Gross Index) over the same period. Earnings news generally remains mixed with some companies doing well but many giving little guidance or confidence in the future.
The NZX 50 is trading on a FY09 P/E of 15.0 and a gross dividend yield of 7.4%. The Australian Equity market is trading close to fair value after being very cheap. Most of the Australian equity rally has been a rerating in P/E multiples rather than earnings growth.
FIXED INTEREST
The New Zealand yield curve has steepened over the quarter following moves by the RBNZ to cut the cash rate by a total of 50bp’s to 2.5% during the quarter. Longer term rates rose toward the end of the quarter following the overseas lead and the RBNZ’s decision to remain on hold. Global bond markets have been more volatile than usual as markets have adjusted to higher levels of government bonds being issued.
CURRENCY
The $NZ strengthened during the quarter following general weakness in the $US. The $NZ also benefited from improved risk appetite and strengthening commodity prices. The $A has outperformed due to continued robust growth and demand from Asia.
ECONOMIC OUTLOOK
Policy measures have to date been successful in helping improve confidence and stabilise economic growth in many countries. However, the ability of governments to maintain large levels of fiscal stimulus given their own deteriorating balance sheets is limited.
High degrees of consumer leverage and rising unemployment will constrain economic growth in the medium-term. Whilst it appears we may have reached a bottom there are still downside risks. Moreover, we do not expect growth to rebound sharply once it has stabilised. Emerging market countries will be the key to any strong recovery and we are monitoring China closely.
Given the current fiscal position in New Zealand and that interest rates are already low the economy will not get the same boost going forward. The sharp rise in the value of the $NZ will not help exporters, particular as many commodity prices, such as dairy have not risen accordingly. The main positive growth driver will be strong growth from Asia increasing demand for exports and tourism but this remains uncertain.
Our base case is for low growth for New Zealand over 2009. Risks have become more evenly balanced. However, downside risks remain given the possibility of rising unemployment, continued falls in house prices and New Zealanders high level of debt relative to incomes.
MARKET OUTLOOK
Following recent rallies in markets equity valuations are now fair. However, the outlook for international equity markets is subdued and following the strong rerating of equities further gains are likely to be reliant upon earnings growth, which will be difficult given the economic backdrop. Emerging markets are likely to be the greatest source of growth given high government and consumer debt levels in developed economies.
With NZ and global growth likely to remain subdued inflation pressure should remain muted. This allows the RBNZ to keep rates low for a relatively long period – with rates not likely to rise until the second half of 2010. NZ bonds are unlikely to generate significant future capital gains but investment grade bond yields look attractive in a low growth, low inflation and low cash rate environment. On the global bond side there is likely to be a continuation of relatively high volatility but high yields in investment grade bonds compensates for this.
The risks for the $NZ are balanced given the very weak state of the US and Japanese economies. However, given New Zealand’s large current account deficit the $NZ remains vulnerable to any increase in risk aversion. A strong $NZ is also likely to hurt growth prospects – particularly if key export prices remain weak. The $A continues to look the best currency given strong growth in Asia and China in particular which remains a key export market.
