“Remember corporations are sitting on clean balance sheets and a fair amount of cash, as are individuals and an enormous amount of money can come into equities which might drive stock prices much higher over the years to come. Thus, thinking that this rally is over may be one of the biggest mistakes investors could make in the next five to 10 years. Note that secular bull runs have encompassed sharp equity market corrections as seen in 1987, but given the lack of broad-based participation mixed with the need to address benchmarks, one should expect any current backups to be relatively mild, barring shocks to the financial system. For now, it seems as if the “pain trade” is still to the upside”.

Tobias Levkovich – Citi Group Equity Strategist

Since my last rather bullish blog on the 25th January, “NZ Market is a long way from Frothy”, the NZ share market has returned a further 5%. The recent quote from Citi Group strategist, Tobias Levkovich, struck home to me how early in this recovery we actually are and how much longer the market can keep grinding higher.

In NZ the Economic data has been very good. Retail sales for the previous quarter grew a robust 2.1% year on year driven by fuel, hardware and new cars. Higher hardware sales are a likely indication that activity in Canterbury is picking up. Housing market activity continues to move upwards, with a further rise in dwelling consents, another increase in the annual rate of house sales and higher average prices. Other data that tend to be forward looking such as business and consumer confidence improved over recent months as have activity indicators for manufacturing and service sectors. So the economy is actually doing quite well with very little drought effects showing up in the numbers.

Recent company results were generally in line with expectations, with 10.3% earnings growth and 4.2% dividend growth. Company comments suggest that despite challenging trading conditions, there are increasing signs of a pick up in activity in NZ, with increased confidence for the year ahead. Companies are also witnessing signs that the NZ building sector is continuing to recover, led by Auckland and Canterbury regions and that consumer spending is also showing modest growth. A strong focus for firms is managing their cost base to improve earnings, taking advantage of low interest rates to re-finance activity and using financial strength to maintain or increase dividend payments. On the whole, outlook comments from management were generally more optimistic than I observed in 2012 and broadly a higher level of confidence in the prospects for the NZ economy going forward.

I believe it is likely the market will continue to be supported by the promising themes from the reporting season and the more favourable economic data. The key is that sustained earnings growth is likely over the next two years and analysts forecasting has become fairly cautious after the last few years. In terms of valuation the local share markets currently appear slightly above fair value on a Price/Earnings basis. Having said this, I expect earnings to be revised upwards over the coming 12 months, and this would mean that markets could hold further upside. Prospective dividend yields are in line with historic averages and dividend pay-outs are increasing, while dividend yields versus bond yields suggest that the market is undervalued. Dividend yields should support valuations until earnings growth recovers further.

In the medium term equities remain attractive and there are plenty of new and exciting opportunities on the horizon this year and over the medium term the NZ equity market can grind much higher in the absence of external shocks.

Mark Warminger

Portfolio Manager