Share market review
Over the past 12-months most share markets have produced positive returns with only the Japanese Nikkei index producing a negative return in local currency. The remainder have produced low single digit positive performance except for the NZX and ASX which have produced attractive double digit returns.
As shown above the NZX50 has had a solid 12-month performance. This rally has occurred on the back of slowing local and global markets, which has led to falling local interest rates, and an increased level of foreign ownership (53.7%). These two factors have driven the NZX50 to record high price to earnings (P/E) levels, with the NZX50 now trading at a record 30.1X.
As the global economies have continued to slow, we have seen a steady reduction in NZ Gross Domestic Product (GDP) from 3.1% y.o.y in June 2017 to 2.1% y.o.y June 2019. NZ GDP may slow further into the end of 2019 unless we see a meaningful turnaround from our trading partners.
NZ economy & interest rates
Reserve Bank Governor Adrian Orr cut the NZ Official Cash Rate (OCR) by 0.50% to a new record low of 1.00% on the 7th August. This was unexpected, but markets continue to price in one further rate cut before the end of the year.
Even post this surprising rate cut NZ Business Confidence continues to suggest that NZ companies are becoming much more pessimistic about the future direction of the economy and are now moving to levels we have not seen since the Global Financial Crisis.
The table below shows the level of household debt in NZ has increased to c.164% as a percentage of disposable income. This OCR rate cut has now been passed onto borrowers in the form of lower mortgage rates with the two-year rate dropping to a record low 3.35% p.a. (HSBC). Due to falling interest rates (on the back of unprecedented quantitative easing and OCR rate cuts) the debt servicing costs have fallen from a high of c.13.5% in 2008 to a low of c.6.5% over the same period. This is likely to lead borrowers to feel more comfortable taking on higher levels of debt which in turn is likely to be stimulatory for the NZ property market.
Over the past 12-months to the period ending August 2019 NZ property prices were up 2.10% but continuing to slow. As shown in the table above there are strong regional differences with Auckland house prices continuing to side down 2.6% y.o.y.
Will falling interest rates lead to a turn in the property prices? We feel it is possible we will see greater support for Auckland house prices on the back of falling interest rates as consumers feel more comfortable borrowing. This is potentially only going to be a short to medium term stimulus and will potentially only lead to a greater negative impact to borrowers when interest rates do finally rise again.
World economies continue to slow
The global Purchasing Manager Indices (PMI), which is a measure of growth (above 50) or contraction (below 50) in markets peaked in late 2017. Back then global economic growth felt very positive, and rising inflation was a very real risk. This led the US Fed to continue to increase their cash rate and reduce their quantitative easing to stabilise inflationary pressures in what felt like a high growth environment.
Fast forward to today and we now have the US cutting interest rates on the back of global PMI indicators moving into contraction territory, except the US. This means the risk of a global recession is rising again with Absolute Strategies Research now putting the chance of a global recession at 54%.
As shown below Quantitative Tightening (QT), or the removal of stimulus has come to an end with the forecasted net total QE now moving from negative US$20 billion per month to US$60 billion per month by the end of 2020. Deutsche Bank is now even forecasting the potential for QE4 from the US next year.
We have now had a decade of quantitative easing with arguably the only outcome being record high asset prices leading to the rising inequality with the largest gap ever between the “haves” and “have nots“. This in turn is leading to the strong rise in populous political parties globally, and the advent of excellent acronyms such as Brexit and Frexit.
So, what will this round of QE achieve? Possibly nothing other than higher asset values and higher global debt levels. Given this the next stimulus lever that the governments will likely pull is “fiscal stimulus” which will mean governments borrow a higher level of funds from the markets to provide funding for tax cuts, and much needed infrastructure projects. Fiscal stimulus is likely to have a greater impact on the wider population and may be enough to fire the global growth engine again.
The Trump effect
Robert Mueller testified in front of congress and more importantly television where the Democrats were hoping the movie was going to be better than the book. It wasn’t the case in this instance, with Mueller not drifting away from the written report. However, there was one small crack in the armour, when he acknowledged (then back-tracked later) that the only reason he didn’t indict Trump was due to standing guidelines from the Justice Department’s “Office of Legal Counsel” that a sitting president cannot be indicted. Following on from this, he agreed that Trump could be indicted after leaving office and this is where it gets very interesting.
If Trump is elected for a second term, the statute of limitations essentially means he may not be able to be prosecuted as he would continue to be a sitting president. There have been reports that Trump had privately suggested he did not have the desire to run for a second term. Now, he is in the unique scenario of needing to win the next election, or potentially face prosecution (and jailtime) for obstruction of justice charges.
To complicate matters even further, Democratic majority State California, has recently passed a bill requiring presidential candidates to release their tax returns. Other Democratic states are following suit. The Trump team has already filed a lawsuit challenging this law. We still don’t know why he is so secretive of his tax returns. Some indicate due to carrying forward losses he hasn’t paid taxes for large parts of the last twenty years. Others suggest he is just not as wealthy as he says he is, an ego driven motive to withhold his returns. Conspiracy theorists suggest there are Russian loans. Document leaks suggest the former may be accurate.
Approximate 30-35% of voting Americans are hard-core “Trumpers”. He once famously said “I could stand in the middle of Fifth Avenue and shoot somebody and wouldn’t lose any voters!”. He appears to be right. Donald Trump is undertaking a new form of political manoeuvring seen in some parts of the investment world – called ‘day trading’. Small but frequent short-term plays, rather than a longer-term approach. With the news of a formal impeachment investigation being announced, we’ve already seen some extreme comments coming from President Trump. Such as his insinuation that the whistle-blower, and those who provided them the information should be tried for treason and executed. We are in for a roller coaster ride of ‘shock and awe’ politics from an incumbent president seeking re-election!
The Democrats have undertaken multiple rounds of debates, with 20 candidates slowly being whittled down, with the lead candidate currently being Elizabeth Warren who wrote The Presidential Conflicts of Interest Act. The Democrats need a strong candidate but risk alienating the ‘closet Trumpers’ who won’t say aloud they’re voting Trump but will be extremely difficult to win over by the potentially “over-leaning left” Democrats. There is a real risk of over-compensating which the Republicans are already taking advantage of.
Why does all this matter?
Firstly – Trump is ‘market friendly’ – for the most part (let’s just put aside the trade war for the meantime). When he was elected, markets unexpectedly climbed and have largely continued to do so since. A Trump loss may be disastrous for markets, and a self-described socialist such as Bernie Sanders winning the presidential race could be doubly disastrous for the US market – and possibly global markets.
Trump’s inability to put top-down measures in place to counter Russian meddling in the elections have emboldened Russia (as well as China and Iran) to enhance their own misinformation campaigns. Italy is currently investigating a Government official (a close aide to their deputy Prime Minister), having met with several Russian businessmen recently.
In summary, we are in for a wild ride which is unlikely to be like anything we have seen before. There is real potential that this presidential race will be one for the ages but will also have a significant impact on the economic outlook of the US over the coming decade.