During the latter part of May, global equity markets have seen a growing level of volatility due in part to investor expectations the United States Federal Reserve Bank may start to pull back from its massive stimulus programme – quantitative easing. This has led to a strengthening in the US dollar and a rise in treasury yields in the United States. In response, some of the “fast” international money has been reducing NZ holdings in fear the currency will weaken further. Large companies such as Telecom, Fletcher Building, Skycity, Chorus and Auckland Airport have taken the brunt of the selling.
Domestically, during May the equity market has been faced with funding a number of deals. With Mighty River Power, MetLife Care, DNZ Property, Summerset, Xero, Ebos and SLI, the local market has been faced with funding around $650m of placements. So all in all considering international and domestic positioning the 2.2% downward market move in May is not too bad.
The question in many minds currently is should investors be selling at these levels or is a circa 5% pull back from the recent highs, due to international and local short term selling, an attractive entry point? A comparison to the market peak in 2007 is a fair place to start.
The NZ market appears to be in solid shape compared to 2007 and more reasonably valued. The capital index which excludes dividends is about 20 percent below its 2007 peak. Back in May 2007 the NZ50 gross index (including dividends) was trading on a PE ratio of around 17x compared to 16x today, about 7% lower now, although the composition of the NZ 50 Index is quite a bit different now with more of a growth bias, through companies like Diligent, Xero, A2Corp and Trademe, so theoretically the market would tend to have a higher P/E.
Another stark contrast is the NZ economy is growing at the moment and expected to continue to grow. In May there was further growth in retail sales, a boost in the terms of trade on a rebound in dairy prices together with a sharp decline in the March quarter unemployment rate. The Canterbury rebuild will also add to GDP growth. So there is an acceleration of economic growth rather than a roll over like we witnessed following the 2007 high.
Company earnings are expected to grow by 10% this year and 10% next year. Looking at the results from the latest reporting season these expectations are rational as companies are growing around this level despite the economy still being in the early stages of recovery. It doesn’t appear earnings expectations are out of kilter with reality like they were in 2007.
Yield will also continue to play a leading role in the NZ equity market for the foreseeable future. In 2007 stocks were yielding on average 4.9% compared to 5.7% today and bank deposit rates were at 7.5%. An investor would need to deposit money for 5 years to get just 5% yield in the bank today. This is leading to new yield seekers entering the equity market and this is helping to underpin valuations. On a dividend yield basis the market is 16% below the 2007 peak. There is currently around $113bn deposited with the banks in NZ, which is 50% higher than in 2007.
According to Reserve Bank data, New Zealand investors have about $49bn invested in the equity market, this is circa 9% lower than in 2007 despite the growth of KiwiSaver. It doesn’t therefore appear the market is behaving irrationally or is in bubble territory, in fact quite the opposite when one considers all the facts.
Disclosure: Milford Funds Ltd on behalf of clients owns shares in all companies mentioned in this article