Investment Market Commentary
Current market volatility creates excellent buying opportunities. You should be buying while prices are low and the exchange rate is up rather than waiting until all the good news is out in the marketplace.
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Economic Commentary Courtsey of  February 2006 KEY THEMES FOR 2006> We expect world growth to remain robust during 2006. Despite tighter global monetary policy, bond yields are near record lows and equities near record highs, which provides a supportive backdrop. Indicators for global trade and industrial production continue to look healthy. In addition, trends in employment remain firm and business investment is likely to remain quite strong due to the healthy position of corporates worldwide. > There is likely to be a rebalancing of global growth, with less reliance on US consumers, whose spending will slow with the housing market, offset by stronger demand growth elsewhere. > Headline inflation including energy costs will remain high, although in the short term this has peaked. Core inflation will edge higher because core intermediate prices are accelerating, capacity utilisation is rising, labour markets are strengthening and output gaps are closing. Global manufacturing competition will continue to act as a disinflatonary force. > US Federal Reserve policy has become dependent on economic data, now that that the measured and “predetermined” path has taken its course. We expect the Fed will stop tightening during the year, but not before they reach 5%. The new Chairman Ben Bernanke will want to establish his inflation credentials by not immediately calling a halt after 13 tightenings. > Elsewhere, European and Japanese growth indicators are looking more positive. The export-led recoveries should transition gradually to self-sustained expansions in domestic demand, thereby reinforcing the global trade cycle. > As a result, we should start to see adjustments to monetary and fiscal policy settings. The European Central Bank (ECB) will tighten 2-3 times, while the Bank of Japan will adjust quantitative monetary policy settings, but won’t shift from the zero interest rate policy. The Japanese Ministry of Finance will tighten fiscal policy. > In the UK and Australia, the soft patch may prove relatively short-lived and, as a result, monetary policy may shift from neutral to tightening again. Emerging markets and Chinese growth will remain robust. > Earnings growth is in the process of moderating due to a range of factors including slowing US consumption, rising compensation growth, higher short rates impacting on profitability of financials, and energy costs remaining high. Note, the rate of change in energy price increases will decline, reducing profit growth for the energy sector (on which there has been an increasing reliance for total market earnings growth). > However, moves to protect ROEs (return on equity) and the utilisation of excess cash should help the durability and longevity of the current earnings expansion. Globally, corporate balance sheets remain supportive of business investment and /or returning cash to investors. This is not just US companies; for example, in Europe, corporate leverage is at a 15-year low and free cashflow yield is at a 20-year high. RoE less cost of equity is at a 25-year high. Payout ratios, buybacks and M&A should continue to rise. > In an environment where global monetary policy is being progressively tightened, volatility is likely to rise and lower quality and more speculative assets are likely to underperform. > Key risks include the over-reliance on housing markets for consumers in many countries. Equally, high household debt and twin deficits in the US leave the US economy exposed to funding issues, potentially leading to another downward spiral in the US dollar. Energy security fears will keep energy prices elevated. > New Zealand growth will slow during 2006, although the Reserve Bank of New Zealand (RBNZ) will remain on hold for most of the year. We expect an easing in monetary policy to occur by the end of the year. This will be preceded by a weaker NZ dollar. We expect New Zealand stocks to underperform international equities. Regional Review United StatesAlthough GDP growth in the fourth quarter of 2005 was slower than expected, the first quarter is shaping up to be quite robust. The economy grew just 1.1% (annualised) in the final quarter of last year, leaving growth for the full year at 3.1%. The slower growth resulted from a moderation in household spending, as consumer purchasing power was dented by the surge in energy costs. The picture has improved this quarter as a result of the firming labour market and sharply lower gasoline and natural gas prices. On the back of these developments, consumer confidence jumped to its highest point in 2½ years, as perceptions about the labour market improved substantially. The latest employment report made it very clear that the labour market continues to tighten, as non-farm payrolls rose 193,000 in January and pushed the 3-month moving average to an even higher 229,000. In addition, average hourly earnings increased 0.4%, to be up 3.3% for the year. Household spending firmed from a soft base as holiday shopping ended on a strong note and auto sales clearly accelerated towards the end of the quarter. In fact, retail sales grew very strongly in January, up 2.3%. While this is partly weather related, it makes it likely that consumption will move back above 3% in the first quarter of this year. Over the year ahead, the US economy will be subject to two opposing forces, the net result of which should be a mild slowdown in growth. > A slowing housing market and a slowdown in mortgage equity withdrawal will act as a dampener on consumers’ ability to spend. Current housing data indicate that the market has peaked, although housing starts rebounded in January to record levels. > Offsetting this, the labour market remains robust and balance sheets are still very strong. There will continue to be an element of CEO caution, but there are strong underpinnings for continued business investment growth. Recent statements and minutes from the Federal Reserve indicate that the Committee thinks they have some more tightening to do, but probably not a lot more; we still see 5% as the likely target. With the negative output gap almost closed by the end of this year, ongoing demand growth will probably lead to rising inflationary pressure in 2006. Statements from the Fed indicate it is getting closer to a neutral stance, and future moves will be dependent on data releases rather than the outcome of a predetermined path. In addition, with a new chairman at the helm, there will undoubtedly be a period of increased uncertainty. EuropeFourth quarter GDP in Europe was a little disappointing, increasing by just 0.3%. Although the details have yet to be released, weaker consumption as a result of higher energy prices was probably the culprit, as indicated by disappointing retail sales in Germany and France. Despite this, the European Monetary Union (EMU) zone is entering 2006 with the best momentum in many years. Encouragingly, the odds seem to be in favour of the economy embarking on a self-sustaining recovery. This is largely a result of export-led growth increasingly spilling over into a recovery in domestic demand, as indicated by: > Increasing signs that the worst of corporate restructuring is over, as investment spending has embarked on an accelerating trend; > A visible improvement in employment intentions in various business surveys over the past few months; > Consumers’ unemployment fears well below the average seen since the series began in 1985; and > Domestic financial conditions remaining stimulative. In particular, the German IFO business confidence index surged in January, right across the manufacturing, retail, construction and wholesale sectors, which can be seen as evidence the recovery continues to spill over to the more domestically oriented sectors. Although there have been signs of improvement in the German labour market, the unemployment rate remains at 11.2%. In France however, unemployment declined further from its 10.2% peak in May 2005 to 9.5% in December. These developments lay the foundation for a pick-up in consumer spending later in the year, as employment growth will see an increase in real disposable income growth as well as a further increase in consumer confidence, which may well cause consumers to decrease their precautionary savings. Finally, higher energy prices pushed up EMU headline inflation again, from 2.2% to 2.4% (year on year) in January. Meanwhile, the ECB is signalling a probable rate hike in March (the second so far in this tightening phase), but is still not expecting to tighten at every meeting, as the Fed did. UKFurther positive signs are evident in the UK economy following the 25 basis point (bp) rate cut last August. Mortgage approvals are running at levels not seen since early 2004, and the housing market appears to have turned the corner in terms of both activity and prices. An improvement in the retail sales data also suggests that increased confidence in the property market could be encouraging people to shop again. Consumers might also be benefiting from stronger wages; pay settlements are rising at the strongest pace since 1998. It is increasingly likely that the Bank of England will move to a tightening bias in 2006, rather than vote for more rate cuts. JapanJapanese data continues to be very encouraging. The latest labour market statistics raised hopes that the external dependence of the economy is fading as the unemployment rate dropped another 0.2% to 4.4% in December, and the ratio of job offers to applicants returned to equilibrium in December for the first time since September 1992. On the back of this, growth in employees’ income, including regular wages and bonuses, improved further in November and December. Not surprisingly, this triggered a rise in workers’ household expenditure of 3.2% (year on year). The improved domestic demand conditions have also been reflected in the gradual strengthening of the Shokochukin small firm sentiment index, which continues to point to GDP growth of around 3%. On top of all this, the external sector has actually become less of a risk to the Japanese cycle in recent months, as export growth surged last year, helping industrial output growth to its best quarterly rise in 2 years. Furthermore, the Bank of Japan (BoJ) Loan Officer Survey showed the strongest loan demand from both the corporate and large non-manufacturing firm sectors in the survey’s five-year history. The survey cites capital spending as a key factor behind loan demand. Currently, inflation is barely in positive territory: the core CPI rose 0.1% (year on year) in December. However, the BoJ expects inflation to end 2006 in positive territory, given most measures of the Japanese output gap suggest that slack in the economy has been removed over the last three years. As a result, the BoJ has started to signal to markets that a gradual tightening of its ultra-loose monetary policy is in the offing for 2006. However, it is not that simple as the Government has plans for further fiscal tightening this year, and has been putting a lot of pressure on the BoJ not to adjust interest rates too soon. As a result, the Bank is likely to stick with its zero interest rate policy for all of 2006, although adjustments will be made to the excess quantitative easing currently in place. ChinaChina continued to grow at a 9.5% pace in 2005 and also reassessed its GDP to be 16% higher than previously estimated, pushing it ahead of Italy, France, and possibly the UK. China accounted for roughly 30% of the increase in global growth in 2005. Signs are that growth is again accelerating, e.g. commodity imports and money supply growth are rising. Much of this new growth is being domestically generated and is necessary if 15 million jobs are to be created each year. Near-term constraints on growth have eased, with inflation falling to 1.3% (year on year), while the current account surplus has widened to 7% of GDP. As a result, forecasts for 2006 have been revised up by some analysts to be in the vicinity of 10%. Australia2006 should be a better year than 2005 for Australia, with GDP growth improving to 3.4% (from 2.5% for 2005). The business investment pipeline is swelling, with much of the new spending directed at mining and infrastructure, laying the foundation for an export rebound. However, consumers should be under pressure if house prices keep falling. Corporate spending is taking over from households and home construction as the main drivers of GDP growth. In fact, investments and exports should be the principal drivers of economic growth in 2006. Firms responding to the latest official investment survey doubled expected growth in spending in the year ended June 2006 to 12%. Household wealth should decline in real terms if house prices stay on a flat-to-down trend. Having made no headway in getting their finances in order, this should ensure consumer spending remains sluggish over the next couple of years. The public sector should remain a stimulus to the economy, with further income tax relief a distinct possibility. State and territory governments in particular have made huge spending commitments to improve essential infrastructure and outdated transport links. New ZealandNZ macroeconomic data continued to be consistent with a slowing growth environment. In the quarterly survey of business opinion business, confidence fell to a net -61% in the December quarter, in line with the net -62% reported in the National Bank consumer confidence survey released before Christmas. The December 2005 quarter Household Labour Force Survey also showed an easing of the employment growth seen in recent quarters, with a quarterly decrease of 0.1% and an annual increase of 1.5%. However, the unemployment rate actually fell over the quarter, because Q3 unemployment was revised upwards from 3.4% to 3.7%, and the labour force participation rate eased from the record high of 68.1% to 67.8% in Q4. Wage pressures mean the labour market will need to weaken further before the Reserve Bank (RBNZ or the Bank) can relax. Private sector salary and ordinary-time wage rates increased 2.9% (year on year) in Q4. Median and mean increases of surveyed private sector salary and wage rates rose 4.0% and 4.8% respectively, in Q4. Retail sales continued to weaken, primarily the result of falling motor vehicle sales, which suggests that consumers are cutting back on big-ticket items. With price effects removed, total retail activity fell 0.7% in Q4 (+3.1% for the year). Retail activity for the core retailing group increased 1.1% over the quarter (+5.6% for the year). The number of dwelling consents rose 21% in December, with the ex-apartment figure rising by 4%. For the December quarter, the number of dwelling consents fell by 13% (total) or was flat, excluding apartments. While the number of consents recovered in the second half of 2005, house sales – a leading indicator – suggests some fallback early in 2006. The latest REINZ housing market data also shows a mild slowing is underway: house sales were down 4% in January (seasonally adjusted) for the second month in a row, and down 10% year on year. The important days-to-sell measure also moved out to 31 from 29 days (seasonally adjusted). There is increasing evidence that CPI inflation may have peaked. New Zealand’s CPI increased by 0.7% in the December quarter (up 3.2% year on year). Other measures, such as the weighted median and our estimate of core inflation, showed that inflation pressures were no longer rising. With the weak economic data during December/January and CPI inflation running below the RBNZ’s forecast, the Bank left the official cash rate unchanged at 7.25%, as widely expected. The Bank maintained a tightening bias, although incrementally there was another slight softening in the tone. The Bank admitted it did not expect to raise the OCR further in this cycle, but this possibility could not be ruled out until it saw clear evidence of a sustained weakening in domestic demand. The Bank continued to try and ‘hose down’ expectations of easier policy by commenting that an early decline in interest rates would risk reigniting spending and inflation pressures. INVESTMENT MARKETSInternational sharesGlobal sharemarkets continued to rally in January, with the MSCI World index advancing another 3.2% (3.9% in NZD terms). The momentum continued on from the rally that began last October as market sentiment improved and seasonal New Year fund inflows added to liquidity. Most of the advance occurred in the first half of the month before some high-profile companies announced disappointing Q4 earnings results. A sharp correction in Japan also contributed to the volatility, due to a damaging investigation into fraudulent practices at listed internet company, Livedoor. However, the market recouped most of these losses, as more companies delivered positive earnings results. Latin America significantly outperformed the broader market, advancing 13.7% during the month, Japan (+4.2%) was the next best-performing region, but in general all the major regions performed well, with Europe adding 3.8% and North America gaining 3%. New Zealand sharesThe NZSX50 fell 0.6% in January, significantly underperforming global markets, which had a strong start to the year. The slowing growth environment in New Zealand impacted on performance. The best-performing stocks during the month were Australian dual-listed companies, reflecting underlying Australian market performance boosted by a decline in the NZD/AUD cross-rate. Notable corporate news included Telecom’s intention to write down its Australian investment AAPT by A$700 million, and Rank Group closed its $2.50 offer for Carter Holt Harvey, only to announce it would launch a second bid in February at $2.75. International fixed interestGlobal bond yields rose during the month in all regions as economic data showed a pick-up in growth in Q1. In the US, there is growing concern that the Fed won’t stop hiking rates at 4.50%, and there is now a growing swell of opinion that the Fed Funds rate may climb as high, or even higher, than 5.00%. It currently sits at 4.50%. New Zealand fixed interestThe New Zealand bond market returned 0.31% for the month of January, underperforming Cash, which returned 0.68% over the same period. The RBNZ, as expected, kept the Official Cash Rate (OCR) stable at 7.25% at its 26 January review, hinting it may not need to increase rates further in this cycle. However, it did warn that the market should not look to price any policy easings into its forward expectations, and continued to talk tough on inflation. During January, New Zealand 10-year bonds pushed higher in yield, principally on the back of similar moves in the US and Australia. CurrencyThe NZD/USD traded in a 2-cent range over January, ending the month at its low of 0.6810. Again, strong Uridashi issuance (see ING Focus on page 7) initially led to a stronger NZD. However, some sobering comments by RBNZ Governor Alan Bollard about the risks associated with investing in New Zealand led the NZ dollar lower by month end. Phlip Houghton-Brown
– Strategy Manager
Disclaimer: This publication has been prepared for the general information of ING New Zealand employees and selected financial advisers. While all care has been taken in the preparation of the commentary, ING (NZ) Limited gives no warranty as to the accuracy of the information, and takes no responsibility for any errors or omissions. We recommend you discuss your personal situation with a Creating Wealth Adviser
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