Harbour Commentary: The soft patch is behind us

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Harbour Asset Management has published its market commentary for July outlining its investment strategy.

Tuesday, July 12th 2011, 5:13PM

Australasian Strategy - A stronger outlook

Disruptive structural forces still provide medium-term risks for investment returns. In particular, the balance between debt deflation on the one hand and commodity-monetary-led inflation on the other, highlights the tension in markets. 

The Chinese transition from an investment-led economy to a consumption-driven economy also weighs on investor minds. However, equity markets have recently recovered as more positive cyclical forces remind investors that the earnings outlook remains positive for many sectors.

The fact is that the global path of activity is becoming less correlated, and activity within economies is also dispersed. The US is seeing better growth momentum in manufacturing. China would appear to be near the end of a tightening cycle, while European business confidence is still weakening. However, on balance, we think that markets have become too bearish on growth prospects.

Most signals suggest that the past three months have been characterised by supply disruptions stemming from the Japanese earthquake, a slowdown in inventory accumulation in China, as policy tightened, and a growth pause as higher oil prices and consumer apprehension in Europe led to lower final demand1.

Most of these influences have now passed, and recent economic data and earnings announcements have provided some positive surprises. The most significant signals in coming months may be:

• The path of copper prices - industrial metals seem to have firmed despite a significant reduction in Chinese business confidence
• The track of US employment 
• A lift in transport stocks, signaling stronger global trading volumes
• The path of Chinese monetary policy; namely a cessation of rate rises with more strain taken by the Renminbi

We acknowledge that the economic outlook remains clouded by ‘unsurpassable' peripheral European debt, by the lagged impact of tightening policies in emerging markets, and by inflation pressures and the end of US quantitative easing. These factors may combine to expose the over-valuation of bonds.

Although we give these latter issues a great deal of considered thought, our investment stance backs a US economic recovery leading to a strengthening demand for goods in genera, thus leading more broadly to a jobs recovery in the US. We think that commodity demand will also lift as social housing investment in China renews base metal demand. 

Many of our investment tilts in our Australasian portfolio are towards businesses that will benefit from stronger global demand such as Brambles, Computershare, Mainfreight, and global commodity companies like BHP-Billiton and Oil Search.

This portfolio stance reflects our negative take on domestic demand conditions in Australia, where falling house prices and a moderation in employment and credit growth, suggest further weakness in non-resource based activity.

In New Zealand it is all coming together

In New Zealand the rise in both consumer and business confidence contrasts significantly with developments in Australia. The rise in New Zealand business confidence partly stems from a pick-up in farm investment. This in turn reflects both the lagged impact of higher agricultural prices and a good growing season. The trickledown effect to growth in the regions in New Zealand has been assisted by low interest rates, in contrast to the higher interest rates across the Tasman.

Lower interest rates may also have sparked a steadying in the building market with some signs of renewed demand for residential sections and higher house sales.

 

Perhaps more significant has been the pick-up in consumer confidence3 and the lift in broader business confidence, which is still pointing to GDP growth of above 4% in the year ahead. If that eventuates, we are probably less than 12 months away from a broad based earnings recovery.

Consistent with these indicators we have recently visited a number of NZ listed companies. While management tends to be conservative in forward-looking statements, relative to six months ago, most New Zealand focused businesses were more optimistic about sales in the period ahead. That said, a number expressed caution about the timing of any rebound in Canterbury and the impact of a high exchange rate on translated earnings.

In an investment sense, a six-month delay in the rebuilding outcomes for Christchurch matter little for most companies. Clearly, analysts have reduced profit forecasts for companies like Fletcher Building for 2012 to reflect the further delays in the rebuilding process. Ironically, the Government's package for 5100 houses in the Red Zone may actually accelerate people moving outside the region and place further growth pressure on other regions in New Zealand.

Stronger New Zealand growth prospects, together with some lift in pricing intentions may bring forward rate rises by the RBNZ to December this year. Higher interest rate expectations are also supportive of the New Zealand dollar, which has lifted against both the US and Australian dollars in recent weeks. The higher dollar has hit earnings expectations for our export companies, including Fisher & Paykel Healthcare, Rakon and Delegats, and our overseas earning companies like Nuplex, Mainfreight and, to a lesser extent, Fletcher Building.

In this context, New Zealand companies might see better earnings prospects. Recent earnings upgrades for Sky Network TV, Sky Entertainment and Auckland International Airport among our larger companies typify improving expectations in the domestic economy. It is hard to see these positive prospects diminishing in the near term.

A final word of warning; as growth returns, interest rate expectations are likely to rise. Whilst we do not, as yet, expect a return of the 1994 experience; we have become more cautious on the outlook for bond yields. For example, our Harbour NZ Core Fixed Income Fund had duration of 2.8 years compared with that of that their benchmark of 3.3 years - placing this strategy a half year short. A rise in bond yields could have negative implication for values in both the property and utility sectors and for equity markets more generally, although we would expect in most circumstances equities to continue to out-perform bonds.

We look forward to reporting further portfolio matters in August.

Read Harbour's research reports here: http://www.harbourasset.co.nz/haml/News.html 

IMPORTANT NOTICE AND DISCLAIMER

 The New Zealand Equities Commentary is provided for general information purposes only. The information is given in good faith and has been prepared from published information and other sources believed to be reliable, accurate and complete at the time of preparation but its accuracy and completeness is not guaranteed. Information and any analysis, opinions or views contained herein reflect a judgement at the date of publication and are subject to change without notice. To the extent that any such information, analysis, opinions or views constitute advice, they do not take into account any person's particular financial situation or goals and, accordingly, do not constitute personalised advice under the Financial Advisers Act 2008, nor do they constitute  advice of a legal, tax, accounting or other nature to any persons. Investment in funds managed by Harbour Asset Management Limited can only be made using the Investment Statement, which should be read carefully before an investment decision is made. The price, value and income derived from investments may fluctuate in that values can go down as well as up and investors may get back less than originally invested. Where an investment is denominated in a foreign currency, changes in rates of exchange may have an adverse effect on the value, price or income of the investment. Reference to taxation or the impact of taxation does not constitute tax advice. The rules on and bases of taxation can change. The value of any tax reliefs will depend on your circumstances. You should consult your tax adviser in order to understand the impact of investment decisions on your tax position. No person guarantees repayment of any capital or payment of any returns on capital invested in the funds. Actual performance will be affected by fund charges. Past performance is not indicative of future results, and no representation or warranty, express or implied, is made regarding future performance. To the maximum extent permitted by law, no liability or responsibility is accepted for any loss or damage, direct or consequential, arising from or in connection with this presentation or its contents.  

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