'At some point someone needs to be allowed to lose some money'

Whether share markets have rallied too far, too fast depends a lot on the outlook for interest rates, Harbour Asset Management managing director Andrew Bascand says.

Tuesday, June 16th 2020, 10:43PM 1 Comment

Sharon Zollner

He, ANZ chief economist Sharon Zollner and board chairman Rob Campbell spoke at a CFA Institute webinar on the “dislocation of equity and debt markets with the real economy”.

Zollner outlined the economic challenges ahead for New Zealand.

She said the 5% reduction in the economy as a result of the absence of international tourism would be a “horrendous recession” on its own but it had an additional layer added in the form of the damage done by the lockdown.

She said, while there had been a big sigh of relief as New Zealand moved to level one, there was still wariness which could dent spending and investment.

The Reserve Bank has responded with monetary stimulus, including significant quantitative easing. Zollner said: “The more you intervene in markets the more you break them.

“The uncertainty is enormous. I do suspect equities are pricing all the upside and turning a blind eye to some of the downside scenario. It’s a very risky world out there. Central banks with their monetary morphine have succeeded with compressing all pricing of risk but at some point that needs to rewind.”

But Bascand said it was not so clear cut.

He said anyone thinking about the price of equities would consider the economy and outlook for earnings. How earnings were valued would depend on the level of interest rates, he said.

In the past 12 depressions or recessions, it had taken 10 quarters for earnings to get back to their previous peak.

He said if it was assumed earnings would only get back to 90% of their peak, while bond rates remained lower those equities still looked good value.

“That’s because the fall in interest rate is a greater force than the expected fall in earnings.”

A 20% fall in earnings would make the appeal more marginal, he said. New Zealand’s government debt level was still at a manageable level by international standards.

Zollner said the risk was that the system would become reliant on QE and history had shown that it took more than the second half of a typical cycle to unwind. “The Federal Reserve was making progress but ran out of runway … all this can kicking, we will eventually run out of road.

“At some point someone needs to be allowed to lose some money.”

Inflation was a risk to markets, they said.

Normally, an economic shock would push New Zealand’s dollar down but this time it was holding up internationally, Zollner said, “which is pretty unhelpful. The Reserve Bank will have to keep its foot to the floor for a while yet.”

Tags: Andrew Bascand CFA equities Sharon Zollner