Has the local sharemarket turned a corner?

The Reserve Bank’s bumper OCR cut gave the local sharemarket a strong boost earlier this month.

With further reductions expected in the coming months, New Zealand shares could be in for a brighter period.

Having rebounded solidly since the end of June, the local NZX 50 index (which includes dividends) is up 9.1 per cent so far in 2024.

That’s close to the long-term average, and it’s much better than we’ve seen in recent years.

The market eked out a gain of just 2.6 per cent last year, while it declined in both 2021 and 2022.

Before that, it enjoyed a lengthy post-GFC winning streak between 2009 and 2020.

This saw the index rise almost five-fold, or 14.0 per cent per annum, as it strung together 11 positive years out of 12 (the exception being a one per cent decline in 2011).

During this period we outpaced world shares (also including dividends), which returned 11.9 per cent per annum and were up in nine of those 12 years.

In contrast, for these last four years we’ve been an underperformer.

The NZX 50 is still five per cent below its peak from early 2021, and if you strip out dividends share prices are more than 15 per cent below those levels.

Our economy and sharemarket are more sensitive than most to changes in interest rates, for a range of reasons.

In places like the US, mortgage terms of 20 or 30 years are common, insulating many borrowers from rising rates.

We favour much shorter terms, usually one to three years, which ensures we feel the brunt (or benefit) of changing mortgage rates.

This can have an outsized impact on the housing market, which is partly why prices surged during the COVID-era then tumbled more than 18 per cent, the most in more than 40 years.

A high proportion of our wealth is tied up in housing and as a result, slumping prices have a big impact on confidence, spending and overall activity.

Our sharemarket doesn’t mirror the economy particularly well, but it too has struggled against the backdrop of high inflation and tight monetary policy.

The NZX is dominated by sectors like utilities, infrastructure and real estate, which tend to perform better when interest rates are stable or falling, rather than headed higher.

The OCR is now at 4.75 per cent, the lowest in more than 18 months, and it’ll keep going lower.

The Reserve Bank has grown more confident that inflation is under control, while its increasing nervousness about the economy means it wants to get its monetary policy settings to more neutral levels, and quickly.

There is one more meeting to come in 2024, in late November.

Another 50-basis point cut is expected, which would see the OCR end the year at 4.25 per cent, well down from the 15-year high of 5.50 per cent from just a few months ago.

Markets see the easing continuing in 2025, with the OCR expected to be close to its nadir of about three per cent by this time next year.

The usual monetary policy lags will apply, but they might be a little shorter this time around with two thirds of all new fixed mortgage lending in 2024 for terms of one year or less.

Listed companies should see improved earnings as the recession abates and the economy recovers, which bodes well for dividends as well as share prices.

Sharemarkets generally look ahead, which is why prices are responding immediately rather than waiting until the February reporting season for evidence of an improving outlook.

As investors face steadily falling returns from term deposits, we’re also likely to see money flow into other assets, including shares.

Financial markets see the OCR at 3.25 per cent in 12 months’ time.

That implies a six-month deposit rate of slightly below four per cent by then, which means an after-tax return in the mid-twos.

That’s an income drop of more than 30 per cent, compared with the six per cent peak investors were enjoying earlier this year.

New Zealand shares are expected to deliver an annual pre-tax dividend yield of about four per cent in 2025, and dividends should grow steadily as the economy picks up.

Throw in a conservative estimate of a few per cent of (untaxed) annual share price gains, and you can see why many investors will soon view the term deposit hurdle as easy to beat.

The NZX itself upgraded its earnings guidance by than 10 per cent just a few days ago, on the back of improving trading conditions across all its business lines. That could well be a precursor to a much more buoyant period right across the market over the next few years.

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