April Market Update


  1. Government Bonds
  2. Central Banks
  3. US Share Market Rally
  4. Australian Property Update
  5. NZ Property Market Update

A world of new lows

Market indicators are now suggesting that the world is slowing faster than most Central Banks had expected, and the chance of interest rates moving higher in 2019 has reduced from approximately 50/50 to now be almost zero percent.

As suggested in previous commentary the European Central Bank, US Federal Reserve and other central banks in the developed world have signalled they wish to continue to support lower interest rates for longer and this has led to the inversion of several “yield curves”, including New Zealand’s.

It has also led to the German 10-year government bond moving back into negative territory for the first time since July 2017. New Zealand’s 10-year bond rate has also moved to the record low of 1.74% gross p.a.

Both local and global central banks have reversed their tightening biases with:

  • The US Fed removing the likelihood of any cash rate rises in 2019 and stopping their quantitative tightening programme sooner than expected;
  • The ECB has removed the chance of cash rate rises in 2019, and has continued the quantitative easing beyond its previously expected end date;
  • The RBA & RBNZ have both indicated that the next move in cash rates is likely to be lower on current data.

So why all the pessimism? The world economies are growing well aren’t they?

What is causing the central banks to loosen their purse strings?

Starting closer to home New Zealand’s Gross Domestic Product (GDP) growth rate has been slowing over the most recent quarters but is still growing at about 2.3% y.o.y. New Zealand’s unemployment rate remains at low levels and we have an inflation rate of just under the Reserve Banks target of 2% p.a. So, what is causing them to suggest rates will move lower to stimulate the economy further?

The Reserve Bank’s cautious view is largely due to most developed global economies slowing faster than financial markets had expected over the past 6-months. Given New Zealand is an export nation we can expect this slow down to flow through to our economy. Indeed, we are already seeing business confidence levels reduce in New Zealand.

As discussed New Zealand’s major trading partners (China, Australia, United States, and Europe) have all been slowing over the past 6-months. The charts above show the German & Chinese PMI index. A result below 50 means that the economy is contracting and may be heading for a recession.

Comparing the two charts we note that the recent slowdown in growth in Germany is almost directly correlated to the slow down in China. As at early April 19 China has reported its latest numbers and as shown there has been a major spike up in their PMI data, back well above 50. We will be watching to see if Germany has a similar turn around in their next reported PMI data.

There can be little doubt that the debt heavy world has struggled with rising interest rates. We will have to wait and see if the new unexpected stimulus, and removal of tightening by the US Federal Reserve will push the equity markets to a new high, or if the share market investors will become more cautious on the back of the worsening economic data.

US share markets rally

The US share markets have all had a very strong start with the main indices up between 9% and 15% since the start of January 2019. This bounce came off the back of a severe 20% drop that occurred from October 2018 through to end of December 2018.

Anecdotal evidence suggests that this recent rally is not driven by investors flooding back into the market to “buy the dip”, with most professional investors still holding large allocations in cash and bonds. There has also not been any change in the consensus view that the US economy continues to slow alongside the rest of the world.

So, what is driving this rally? A big part of the share market support is coming from the US companies themselves. American companies that are flush with profits from their tax cuts, and low interest rates are buying back their own shares at record high levels with over US$800 billion worth of share buybacks being forecast for 2019.

Share buy backs have become the preferred manner for giving profits back to US investors, as opposed to paying dividends. The reason for this unsurprisingly is that it is more tax effective to increase the share price which creates a deferable tax liability, versus dividends which create an immediate tax liability for US tax payers.

So, in a world where share values are being driven higher by the companies own net profits, what happens when US companies’ profits slow, and there is no support from the professional investors? You don’t have to look far to see what happened when US companies dramatically reduced their buy backs in 2007 and 2008.

Australian property update

As discussed in previous monthly commentaries, we have been watching the Australian residential property market for some time now. March figures were not available at the time of writing this report, however house prices in Sydney and Melbourne fell another 1% in February – the 17th consecutive month of declines for the Australian property market!

As of the end of February, Sydney and Melbourne house prices have now fallen 13.8% and 9.6% from their respective peaks. For Sydney this is the worst fall since the 1980’s – however many pundits are predicting it will get much worse before it gets better. AMP Capital is tipping peak to trough falls of 25% in Sydney & Melbourne, while UBS is also picking 25% with a rising risk of 30% declines.

What are the reasons for these material declines? VantagePoint Asset Management produced an excellent research note where they highlighted a few factors – with the 3 main reasons being:

Interest-only loans

Only a few years ago there was a massive amount of interest-only loans being written by the major banks (one bank had half of all their mortgage book in interest only loans) as borrowers could not afford mortgages where they had to repay some of their principal (strange concept I know!).

The regulators finally cottoned on to this and limited the number of such loans the banks could write. This now means a staggering $120 billion per year for the next three years of interest only loans will mature, and most will need to be reset and P&I (principal + interest) which is estimated to add circa 35% to mortgage borrowing costs

Discontinuance of Chinese funded house purchases

This is largely due to tightened Chinese capital controls (transferring funds out of mainland China) and Australian Capital Controls (greater focus on Anti-Money Laundering rules, proving Source of Funds etc)

Australian Royal Commission

One of the major outcomes of Commission was the finding the banks had not been applying responsible lending standards (refer to the interest only loan debacle). Many banks were not even bothering to check if borrowers had the spare income available to service loans – they simply applied a generic (and massively understated) household expenditure.

This has led to the forced tightening of lending standard, and dramatic reduction in the availability of credit to potential borrowers.

Whilst there are material differences between the Australian and NZ property markets (and historic lending practices) there are also some striking similarities. Anecdotally, we hear that credit is much harder to access here in New Zealand, and whilst we have seen nothing like the price declines over the ditch, it is worth noting Auckland’s median price has fallen from its peak – watch this space!

NZ property market update

House price increases around New Zealand continue to slow into 2019 with growth across the country of 3.1% y.o.y. Auckland house prices are now down 2% over the previous 12-months ending February 2019, while Wellington house prices continued to rise at 11% y.o.y.

One area where New Zealand may be protected from the Australian housing market slow-down is the difference in lending behaviours between the two countries. New Zealand banks have just under 10% of total lending over an 80% Loan to Value Ratio (LVR) versus Australia’s 22%. Also New Zealand banks have less investment borrowings (c.19%) than Australia’s 30%.

We continue to monitor the New Zealand property market closely with a high level of concern around borrower’s ability to repay debt if interest rates do move higher. However, in a world where interest rates are testing new record lows we can expect to see some support for the property market via increased lending.