March 2007 Quarterly Review

OVERVIEW

The world economy has become increasingly dependent on the strong performances of the Chinese and Indian economies. The latest OECD Composite Leading Indicators suggests that some moderation in OECD area economic expansion lies ahead but the world’s two most populated countries should continue to boom.

As long as China and India remain buoyant the outlook for the global economy is positive.

Table 1: OECD Composite Leading Indicators

NEW ZEALAND ECONOMY

The New Zealand economy grew by 1.5% in 2006 compared with 2.2% in 2005 and 4.5% in 2004.

Table 2: NZ GDP Growth

(Seasonally adjusted quarterly change versus previous quarter)

The economy bottomed out in the second half of 2005 and growth was steady but slow in 2006. Most economic forecasting groups expect domestic economic activity to pick up slightly over the remainder of 2007 with forecast growth for the calendar year predicted to be slightly above 2%.

There is considerable uncertainty regarding these forecasts because the rural sector remains depressed except dairying. The high New Zealand dollar is having a negative impact on exporters and the 0.25% increase in the Reserve Bank’s OCR rate, to 7.5%, on 8 March should dampen domestic demand.

On the other hand the residential housing market remains remarkably buoyant with the national median sale price hitting another record high in February and total unit sales 18.0% ahead of the same month in 2006. The housing market is being fuelled by the strong growth in mortgage lending, which rose 14.3% in the twelve months to February 2007.

NEW ZEALAND DOLLAR

Investment returns for the year ended 31 March 2007 were strongly influenced by the performance of the New Zealand dollar. Investments in US$ and Yen assets were adversely affected by the large appreciation of the Kiwi against these currencies.

In the March quarter the performance of Australian share portfolios benefited from the 1.1% depreciation of the NZ dollar against the Australian dollar.

Table 3: New Zealand Dollar against Major Currencies 

The future performance of the Kiwi is difficult to predict because it is being influenced by two contrasting features, the country’s huge current account deficit and the international carry trade.

The large current account deficit, which now stands at 9.0% of GDP, suggests that the currency should weaken but international investors are taking advantage of New Zealand’s high interest rates by borrowing in low interest countries and purchasing fixed interest securities in this country.

ANZ National Bank, Bank of New Zealand and Westpac have the following New Zealand dollar forecasts for the end of the year;

Table 4: New Zealand Dollar Forecasts

Actual – as at Forecasts for 31 December 2007

ANZ National is the most positive as it anticipates an 11.6% decline in the NZ$/US$ rate by year end and the Trade Weighted Index (TWI) to fall by 10.6%. Westpac has a more negative view as it expects the Kiwi to rise by nearly 2.0% against the Australian dollar by year end and the TWI to decline by only 2.4%.

FIXED INTEREST

New Zealand interest rates have traditionally been higher than most other western countries. The gap widened between the end of 2000 and the beginning of 2006 and this has created a strong demand for New Zealand income securities and pushed up the Kiwi.

The interest rate gap eased in 2006, particularly with the United States (see Table 5), but has began to widen again in recent months. This has been a major contributor to the firmer NZ dollar over the past six to nine months.

Table 5: 30 Day Bank Bill Yields – New Zealand & United States

New Zealand continues to have a negatively shaped yield curve with short-term interest rates higher than long-term rates. As a result the returns from cash exceeded the returns from long-date securities during the March 2007 quarter.

The Reserve Bank will continue to maintain high interest rates until household borrowing growth eases and there are clear signs that the residential housing market is running out of steam. When these developments become clear we will begin to raise client’s exposure to the long-dated securities, particularly top rated corporate bonds that are backed by strong balance sheets and good cash flow.  

SHAREMARKETS

Global sharemarkets had a relatively subdued March quarter, mainly due to the slump in the Shanghai Stock Exchange at the end of February.  The MSCI World Gross Index rose 2.2 per cent in the March quarter and the MSCI Emerging Markets Gross Index increased by 2.3 per cent.

The NZX has lagged, when measured on a MSCI basis, but the ASX was one of the best performing markets in the March quarter and the twelve months ended 31 March 2007.

Table 6: Gross Sharemarket Returns in Local Currencies

(Periods ended 31 March 2007)

Source: MSCI

The best performing S&P/ASX 200 stocks during the March quarter were Leighton Holdings 68.0%, Fortescue Metals 52.1% and Aquarius Platinum 46.7%. The worst performing were Bendigo Mining minus 48.7%, Timbercorp minus 38.7% and Perilya minus 32.1%.

As far as the NZX is concerned the best performing companies during the March quarter were Michael Hill International 36.8%, Air New Zealand 34.1% and Rakon 33.2%. The worst performing were Hellaby Holdings minus 21.2%, Restaurant Brands minus 18.2% and Sky Network Television minus 15.8%.

The historic price/earnings ratio of the NZX50 Index (excluding investment companies) has expanded from 16.4 as at 31 March 2005 to 18.0 two years later and the prospective price/earnings ratio has risen from 15.4 to 17.5 over the same period.

OUTLOOK

The outlook for the global economy remains positive, mainly due to the strong performances of the Chinese and Indian economies.

The NZX has underperformed in recent months because of lower GDP growth, mixed corporate earnings, the high NZ dollar and a reduction in the number of takeover offers.

We expect the domestic economy and NZX to continue to underperform in the months ahead but the prospects for the Australian economy and ASX are more encouraging.

The main issue facing investors is the NZ dollar. The dollar will remain high as long as the Reserve Bank continues to adopt an aggressive monetary policy stance. In this environment New Zealand and Australian assets should continue to offer the best returns.

Investment returns have been more modest over the past three months although Milford Asset Management clients have benefit from a relatively high exposure to Australia and New Zealand. We expect corporate activity to boost the Australian and New Zealand sharemarkets in the months ahead but it will be challenging to achieve double-digit returns on an annualised basis.