The New Zealand general election later this month promises to be a close contest. The winds of change are in the air as the Labour party has jumped in the polls following Jacinda Ardern’s appointment as the party leader. But polling data is still showing large swings between Labour and National.

Change creates uncertainty

A Labour led coalition government would end the near decade long dominance of the National party and potentially bring significant policy change.

Changes in government policy influence the economy both directly and indirectly. For example, raising the minimum wage will deliver wage growth – this is a direct and predictable impact. Wage growth could push inflation higher and increase the likelihood of rising interest rates, but it could also push unemployment higher if companies don’t feel they can afford the higher wage bill. These impacts are indirect and much less predictable. Even harder to predict is the impact policies may have on confidence, spending and investment, which are arguably more important for the economic outlook. The upshot is changes in government policy creates uncertainty.

In general, share markets do not perform well in periods of higher uncertainty. It is difficult to ascertain whether election uncertainty has started to creep into the performance of the New Zealand share market yet, but the NZ50 index underperformed most global markets in the three weeks from 25 August to 08 September when Labour was leaping up the polls. This is despite generally solid company earnings updates over the August reporting season and continued strong economic data.

The risk to the performance of the New Zealand share market is exacerbated by the substantial rise in foreign ownership over the last few years. According to local investment house Forsyth Barr, ownership of New Zealand shares by offshore institutional investors has increased from 30% to almost 50% over the last 5 years.

Percentage of foreign ownership of NZ50 share market index

Index data free float adjusted. Source: Forsyth Barr analysis, Bloomberg, Statistics NZ

This increase in foreign ownership has been driven by New Zealand’s high economic growth and political stability relative to other developed countries. Should the political environment become less stable and the economic outlook less certain, this may reduce the demand from offshore investors that has supported our local equity market for the last few years.

Policy specifics: tax, housing and inflation

In general, both major parties have tabled policies that are relatively moderate and fiscally responsible. Unlike the 2013 general election, when the Labour-Greens policy to create a single wholesale buyer of electricity sent the share prices of the listed electricity companies plummeting, there is no major policy that will directly impact a particular company or sector.

A National led coalition will deliver relatively little change. Changes to the income tax thresholds (an effective tax cut) will help household budgets and support spending and confidence. This should be broadly beneficial to cyclical companies. Additional first home buyer grants and refreshed urban planning laws should support the construction of new homes. In conjunction with the promised infrastructure spending, this should be beneficial to the construction sector.

Assessing the outcome of a Labour led coalition is a little more complex. The commitment to build 100,000 homes, removal of urban growth boundaries, plus additional infrastructure commitments should also be supportive to the construction sector. But the policy to ban sales of existing dwellings to offshore purchasers, increasing tax on investors via the extension of the bright line test, and the threat of a capital gains tax on housing could also reduce the demand for housing, at least in the short term.

Labour’s policy to raise the minimum wage and reduce net migration by 20,000-30,000, focussed on low skilled workers, will drive wage growth and could stimulate inflation over the longer-term. In theory, this should lead to higher interest rates and a strong New Zealand dollar, which is beneficial to importers and negative for exporters. However, rising house prices and high immigration have been important tailwinds to New Zealand’s economic growth in the last few years. Policies that impact immigration (noting National are also proposed to reduce immigration, albeit more moderately) and house prices could impact economic growth and supress currency strength.

A pre-election promise is not guaranteed

President Trump’s inability to pass pre-election promises into legislation is an extreme example of the difficulties of enacting policy commitments. An election win does not guarantee policy change and this means more uncertainty for longer, which can result in market volatility.

Importantly, the underlying New Zealand economy is still very strong and likely resilient. For active investors, market volatility can present as many opportunities as threats.