NZ Equities
Outlook for 2004 and the year that was
Wednesday, February 4th 2004, 10:55AM
In order to gain some perspective on what we might expect from the New Zealand equity market in 2004, we need to take a quick look back into 2003.
In a global sense, 2003 started poorly beginning with the war in Iraq, followed by a worldwide SARS health scare centred in the Asian region. However, by the end of the June quarter, international markets had recovered significantly and this trend continued through to the end of the year. Meanwhile, investors in New Zealand shares were well rewarded in 2003. The NZSX 50 index increased by 25.6% for the year ending 31 December 2003 and was again one of the best performing equity markets (when measured in NZ dollar terms) in the world. Looking at it from a NZ dollar perspective helps investors realise the significance of the currency movement last year, particularly the NZ/US dollar rate. While the US market (S&P 500 index) increased by 26.4% in US dollar terms, when converted back to NZ dollars that return was reduced to a mere 1.1%.
This strong performance by the NZ equity market mostly reflects the undervaluation at the end of 2002 and a continued strong profit growth of around 8 to 10% in 2003. In addition strong economic fundamentals, high dividend yields and good corporate governance meant NZ companies fared better than many of their offshore peers. What proved particularly encouraging was that the market was generally strong across the board and was not inflated by a handful of stellar performers. In fact, among the NZSX 50 index stocks, only six saw a gross negative performance in 2003, and most of these were in the retail sector.
Fair Value
Looking ahead at what we can expect from the NZ sharemarket in 2004, our strategic view is that the local equity market is now fair value, if not slightly overvalued. The key this year will be finding and unlocking value in individual companies, while remaining focused on the local operating environment.
While business confidence has been restrained by the rising dollar, consumers will have come into the new year full of confidence. Employment is high, incomes have been rising steadily - as have house prices – and interest rates are now less likely to rise in the short term. There are also enough currency pressures to keep interest rates relatively low for the rest of the year. The question is – what issues might impact on equity markets to knock this confidence?
There are a number of risks that may or may not eventuate in 2004. For one, the Reserve Bank of New Zealand (RBNZ) forecasts a decline in net immigration to an annual rate of 20,000 by early 2005. A decline in migration figures will have a knock-on effect on housing demand and could easily take the heat out of the residential property market, especially in Auckland. By implication, this would also affect the residential construction industry and general levels of household activity.
Flying Kiwi
A second consideration is the overvalued New Zealand dollar. Over the last few years the strong Kiwi dollar (or, more accurately, the bearish US dollar) has been negatively impacting on the primary sector and exporters in general. However there is an upside in that it is also helping control inflation, preserve a low interest rate environment and maintain a stable GDP growth rate of around 3.5%.
The possibility that the US dollar will reverse its trend is a key issue facing the NZ market and economy in 2004. At the moment currency is doing a lot of the work for RBNZ governor Alan Bollard. Inflation is being kept at bay, due in most part to the cheapness of imported goods. However if the value of the NZ dollar drops significantly, the RBNZ may be forced to raise interest rates earlier rather than later in the year - or raise more aggressively - thus adversely affecting the local equity market.
Another factor that may weigh on the NZ equity market this year is the expected upturn in global growth. A strong global economy will help NZ export volumes to recover while domestic demand begins to moderate after a busy 2003. This is not all necessarily good news for the NZ economy as offshore investment dollars will seek better value globally. Meanwhile we expect local economic growth to slow sharply in the second half of the year with a flow-on effect on earnings, however, in the short term, momentum around corporate earnings growth remains strong.
So What’s New?
At the time of writing, Pumpkin Patch looks to be the only new listing of any significance on the horizon. Given the lack of supply of new listings, the amount of cash inflow from capital returns and the investment of the government super fund throughout the year, there should be a focus on more liquid stocks as well as those quality stocks that have strong franchises, earnings momentum and growing dividend yields. Cash flows generated in 2003 may also lead to increased corporate activity.
While it will be difficult to repeat the stellar performance of 2003, reasonably strong returns are expected from the NZ equity market this coming year, driven by solid earnings and stable long-term interest rates. It may be a case of the year of two halves, as the market looks towards an increasingly weaker environment later in the year or early 2005. Given this view as at January, expectations of low double digit returns for the 2004 calendar year would not be unrealistic.
Andrew South is the chief investment officer at BT Funds Management
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