Is the NZ market a pre-cursor for global markets?
For the best part of a decade, New Zealand has been one of the strongest performing equity markets on the globe. Whilst there are many factors that have supported this strength; an emerging capital markets, a commodity super cycle, relative political stability, foreign capital investment and positive net migration to name a few.
However, this local equity market strength appears to have halted in 2021. For the twelve months ending 31st October 2021, the NZX50 Gross index had returned 8.4%. Now this appears a more than adequate return. However, if we look across the Tasman, the ASX200 has returned 28.00% (in NZD) for the same period, and if we look even further afield, in the US, the S&P500 has delivered 30.1% (in NZD).
So why the underperformance in NZ? Some, of these idyllic conditions which kept us at the forefront have faded, and not least lower interest rates. The Reserve Bank of New Zealand has made the decision to be ‘world leading’ (sound familiar?) by embarking on a tightening cycle at the same time the rest of the developed world are committing to keeping their interest rate settings where they are (close to zero).
The RBNZ will point to the resilient economic data as reasoning enough to get underway ahead of the rest of the world, and only time will tell if that is indeed the right decision, but there is no doubt that this has dampened the attractiveness of our market in 2021.
Rising bond yields and persistent inflationary pressures has seen our interest rate sensitive market come under pressure. Much of our domestic equity market is made up of defensive constituents (Power companies, Telcos) that tend to be low growth, but high cashflow dividend paying entities. These types of businesses prefer lower interest rate settings when assessing valuations and sustainability of dividend payments.
So, is the NZ market a pre-cursor for global markets in the coming 18 months? If in fact we were to see easing monetary support (less liquidity in the system and higher interest rates) does this threaten to weigh on financial assets more broadly?
I would have to think so. There are a number of reasons to suggest that global equities’ serene progress over the last 18 months will become somewhat more volatile going forward as earnings growth slows, bond yields rise, and corporates continue to juggle the challenges of disrupted supply chains and elevated input costs. Wall Street’s high exposure to growth stocks also makes it more susceptible to rising real bond yields.
Now this is not to suggest that we abandon global equity markets, but needless to say 2022 will be more about stocks than sectors or styles, in my view. It seems impossible to ignore the potential effect of higher interest rates if and indeed when global central banks embark on their own tightening cycles.
I have written at length before that the path to higher interest rates won’t be an easy one, equity markets will be hoping this is in fact the case.