WHY IS THE NZ SHAREMARKET HITTING NEW HEIGHTS, AND CAN IT GO EVEN HIGHER?
Intended for clients of Craigs Investment Partners only
The local sharemarket, based on the widely quoted NZX 50 index, reached new closing highs during the September quarter, having recovered virtually all the losses from earlier this year.
That sort of headline will cause plenty of head scratching from bystanders, who are also being told we’re in the middle of a major economic crisis, which will see widespread job losses and business failures.
There are several reasons for this dichotomy. For a start, the economic outlook doesn’t look as bad as it did back in March, and the worst-case scenarios we were hearing about during that period now look pessimistic.
The unemployment rate is still likely to go higher, but not nearly as high as some predictions had suggested, while the expected negative impact on the housing market hasn’t eventuated as prices have risen, rather than fallen.
In short, things are still going to challenging for the next year or two, but not nearly as tough as share prices were foretelling at the lows of late March, when prices were down 30 per cent from their peak a month earlier.
Another aspect of the rebound can be explained by the massive response we’ve seen from our central bank and Government.
Strong government response to COVID
The Reserve Bank has thrown the kitchen sink at this, and the bathtub is probably coming next. The OCR has been slashed to rock bottom, while the quantitative easing programme has ensured longer-term interest rates remain equally subdued.
The impact of all this shouldn’t be underestimated. It provides certainty to borrowers, keeps financial markets stable and ensures credit flows to where it needs to. It also dramatically reduces the investment hurdle rate for businesses and lowers the opportunity cost for investors and spenders to almost zero.
This isn’t going to change anytime soon. The threat of deflation is what keeps central bankers awake at night, and while that’s a possibility you can be sure the foot will be firmly on the throttle in terms of stimulus and loose monetary policy.
Even though corporate profits have fallen some 20 per cent on average, investors are valuing those remaining cash flows higher than before, because of just how significantly interest rates have fallen.
A strong performance from some big companies
Another important factor to be aware of is that ‘the market’, as represented by the NZX 50 index, is extremely lopsided.
Think of the NZX 50 like a pizza with 50 slices, but where not all of those are the same size. The bigger companies tend to be over-represented, so when the heavyweights move up or down, they push the index in that same direction regardless of how the others are doing.
For example, Fisher & Paykel Healthcare, a2 Milk, Spark and Chorus have all performed well this year.
These four alone account for more than a third of the NZX 50 index, and their gains have dragged it higher.
Plenty of other companies in the NZX 50 are still down from where they began the year , and the average share price change for all 50 is a modest decline, which makes for a slightly different story.
NZX 50 from 1 January 2020 - 30 September 2020
Another point to be aware of is that the sharemarket is far from a perfect reflection of the economy.
Some of the industries that have been impacted most by recent events are hospitality, tourism, retail and accommodation.
These sectors aren’t well-represented on our sharemarket. The NZX is dominated by more resilient industries that have faced much less disruption, such as electricity companies, property and infrastructure, healthcare and agricultural businesses.
Finally, it’s important to remember that the value of a business is a function of all of its future growth and profits, not simply those over the next one to two years.
Even though the immediate future will be challenging, as we look ahead to the next five, ten or 20 years, many of the quality companies on our market still have excellent prospects and growth options.