September 2005 Quarterly Review

The two main issues in the September 2005 quarter were the New Zealand general election and rising oil prices.

NEW ZEALAND GENERAL ELECTION

Table 1: Party Percentage Votes

The election result was a disappointment for business even though National raised its vote from 20.9% in 2002 to 39.1%. Most of the gains were at the expense of the minor parties with Labour’s vote falling only 0.2% to 41.1%.

Prime Minister Helen Clark will have a difficult task maintaining support for her minority Government although, as Table 1 indicates, this has been a requirement of all Prime Ministers since MMP was introduced in 1996.

At this stage there are no reasons to suggest that the election outcome will have any direct impact on the domestic economy or financial markets.

OIL PRICES

Oil prices have been rising steadily since April 2003 with WTI (West Texas Intermediate) increasing from US$26.09 a barrel to US$66.25 a barrel currently.

Table 2: Spot Oil Prices

(US$ per barrel)

Month End Prices

The immediate outlook for prices is heavily dependent on worldwide demand and refining capacity in the hurricane affected Gulf of Mexico.

Although refining output in the Gulf is recovering the demand/supply variables are not encouraging. The US Government estimates that world oil demand will grow by 1.7 million barrels per day in 2005 and 2006 but non-OPEC supply will increase by only 0.7 million barrels a day during the same period.

Saudi Arabia is the only OPEC country with spare capacity but this is mainly heavy crude, which is difficult and expensive to refine.
By comparison the performance of the export sector has been relatively weak. Export volumes rose only 2.9 per cent in the latest twelve months as dairy and forestry volumes declined.

WORLD OUTLOOK

Table 3: GDP Growth

The OECD forecasts were released in June and IMF in September.

The IMF has revised its world economic growth forecast for the 2005 calendar year from 2.6% in its April World Economic Outlook to 2.5% and for 2006 from 3.0% to 2.7%.

It has revised its Australian growth forecast for the current year from 2.6% to 2.2% and from 3.3% to 3.2% for 2006. Australia is expected to perform relatively strongly in 2006.
As far as New Zealand is concerned 2005 GDP growth is now forecast at 2.5% compared with 2.8% in the April forecasts. In 2006 the IMF expects the domestic economy to grow by 2.5% compared with its April forecast of 2.6%.

These New Zealand forecasts are consistent with most other major forecasting groups.

SHAREMARKETS

The September quarter was another positive period for international sharemarkets with the MSCI World Gross Index rising 7.4%. The ASX outperformed the World Index but the NZX under performed by a small margin.

Table 4: Gross Sharemarket Returns (local currencies)

(To September 30, 2005)

Source: MSCI

The New Zealand market has done particularly well over the past three years with a gross return of 74.0% compared with 65.6% for the World Index.

Earlier this year we predicted that the NZX and ASX would achieve gross returns between 10% and 15% in 2005. The NZX rose 11.5% in the first nine months and the ASX 21.2% over the same period.

The ASX should achieve our target forecast, particularly as the Australian economy is expected to pick up next year but the NZX is more difficult to predict. The domestic economy is weakening but the high level of corporate activity and capital repayments suggests that the NZX will achieve a gross return for the year of approximately 15%.

CURRENCY

As Table 5 indicates the NZ dollar has eased slightly against the US dollar and Australian dollar since the beginning of the year but it has risen strongly against the Japanese Yen, Euro and UK Sterling. The overall result is that the Trade Weighted Index (TWI) has increased from 69.0 to 70.1 since the end of 2004.

Table 5: New Zealand Dollar against Major Currencies

The TWI finished the June quarter at 70.6 but fell rapidly to a quarter low of 68.3 on July 14. It bounced back to a third quarter high of 71.0 on September 15 but eased down to 70.1 as at September 30.

With the current account deficit expanding rapidly the New Zealand dollar is expected to ease over the remainder of the year.

FIXED INTEREST

New Zealand has traditionally had higher interest rates than the United States, particularly for short-term borrowings. The gap widened in 2003 and 2004 and is one of the major reasons why the New Zealand dollar performed so strongly against the US dollar.

Table 6: One-Year Government Securities – NZ & USA

The gap has narrowed from 418 basis points in March 2004 to 259 basis points at the end of September.

Higher US interest rates could encourage overseas investors and speculators to leave New Zealand. This would put downward pressure on the dollar.

A drop in the value of the New Zealand dollar will increase inflationary pressure and encourage the Reserve Bank to raise interest rates again. There is also the prospect of further interest rate rises in Australia.

OUTLOOK

The outlook for the world economy remains positive although the major international forecasting groups have revised their predictions downwards. New Zealand is expected to perform better than Australia in 2005 but the situation is expected to reverse next year.

The Australian sharemarket has performed slightly better than the NZX and this trend is predicted to continue until the end of the year.

But the six to twelve month outlook for the ASX and NZX is less encouraging. Valuations are high and there is the prospect of share price weaknesses, even for companies with excellent long-term outlooks.

The New Zealand dollar continues to be the biggest uncertainty. In the last two quarterly reviews we stated that a range between 60 and 65 cents would be the best scenario for the New Zealand economy. At this stage it looks as if the New Zealand dollar will trade at the top end of this range at the end of 2005.

Brian Gaynor