Your Quarterly E-Zine
Edition 11 • December 2019

This website contains the latest edition of Forsyth Barr Focus, a quarterly on-line magazine written by senior members of Forsyth Barr's investment team.

If you experience any difficulty in accessing Forsyth Barr Focus,
please call 0800 367 227, or e-Mail for assistance.



With the New Zealand sharemarket (S&P/NZX50) having gained over 14% year to date, many investors are keen to understand the reasons behind this growth and the risks around the current momentum being sustained.

Our starting point is that unless there is an external shock to market sentiment, investors should continue to expect at least modest positive returns.

Two domestic factors which have the potential to increase market uncertainty are the upcoming General Election, which may or may not see a change in government, and a slowdown in the housing market.

We are not concerned about the first of these factors, as all political parties are promising greater fiscal stimulus and spending on housing and infrastructure. This should stabilise any potential decline in the construction sector and extend the earnings cycle for companies reliant on construction sector earnings growth. Similarly the housing slowdown that is occurring has plenty of fat in prices and this should dampen any negative impacts.

Addressing valuation concerns, we have seen plenty of reports suggesting that the New Zealand sharemarket is expensive. Our own analysts’ bottom-up expected-total-returns suggest effectively no returns over the next twelve months. We also know that New Zealand shares look expensive relative to international equities.

However, this relative premium to international markets is not new. In fact, over the last 10 to 12 years, the New Zealand sharemarket has usually traded at a premium to international markets. It did so before the Global Financial Crisis, with this trend also particularly evident over the last five years, since the partial privatisation of NZ electricity generators. These listings effectively increased the proportion of lower risk companies to over 50% of the market

NZ Equity Market PE premium history

We believe the price to earning (PE) premium has been in effect driven by the lowering of the volatility of the New Zealand sharemarket earnings relative to the world. As interest rates have fallen, this has made New Zealand company earnings more attractive to investors. While interest rates remain low (even if slightly higher), the New Zealand sharemarket should maintain this premium.

What about company earnings; are these at risk?

We have had a period of phenomenal returns from New Zealand shares and over the last five years the local sharemarket’s capital value has risen by around 65%. The good news is that earnings have explained most of this increase, while the rest has come from an expansion of price to earnings ratios (PEs).

How sustainable PEs are now, depends on actual earnings growth, looking forward. With no-one making any money out the booming construction sector and operating leverage just not coming through there are fears that we are currently in a “profitless cycle”. However, it’s important to remember that corporate earnings growth over the last 5 years has averaged 7.2% and growth expectations over the next two years average 5.5%. In other words, if share prices simply maintain their current levels, investors will still receive around 4.5% p.a. returns, through dividends.

In summary, from a top-down perspective, we believe that the current sharemarket growth cycle should be an extended one. This is supported by our positive view on migration, as well as greater fiscal spending arising from election promises. Regardless of what government is elected, more spending on services, housing and infrastructure is integral to the policies of all political parties. This should support the Reserve Bank’s 3.0% GDP growth forecast and (by inference) corporate earnings growth of around 5%.

What we need to focus on is therefore not New Zealand centric risks, but what could de-rail strengthening, synchronised, global economic growth. The bigger risk may be if global growth exceeds our expectations and interest rates rise faster than we currently expect.

Brian Stewart
Senior Analyst, Strategy