The tipping point may have come three months before the NZX 50 reached its peak. Within two weeks of the UK's European Union membership referendum, or Brexit, on June 23, the yield on the US 10-year Treasury bond had bottomed out at about 1.32 per cent. It has since surged about 1.2 percentage points, gaining added impetus from Donald Trump's US presidential election victory, which may herald big borrowing, big spending and inflationary fiscal policies in the US.
Added to that has been a growing conviction that many central banks are near the end of their programmes of extraordinary monetary stimulus and that interest rates can only rise from here. The Reserve Bank is expected to start raising interest rates toward the end of 2017, although it will lag behind the Federal Reserve, which has flagged three hikes. That's a situation governor Graeme Wheeler should be happy with because it should mean the Fed does some of the heavy lifting the RBNZ needs to drive down the kiwi.
New Zealand's stock market has been a popular destination for offshore investors chasing yield while interest rates have been so low, but that propelled stock prices well above fair value on the basis of their fundamentals alone. For example, Nikko Asset Management senior portfolio manager James Lindsay says prices of property company stocks got about 18 per cent above the value of net tangible assets. Since the market correction, that has come back to a more reasonable 1-to-2 percent above NTA, he says.
"Is the yield trade over? I don't necessarily think so," Lindsay said. "It might unwind as some investors head for the door. But yield stocks have come back to levels where they look respectable". The NZX 50's performance this year "is still a reasonably respectable outcome".
The New Zealand story is far from shabby. The economy grew 1.1 per cent in the third quarter and now has the extra leg of rising dairy prices. Construction is on a tear in the face of record inbound migration and many businesses tied to tourism have enjoyed the benefits of record visitor numbers. Campervan rental company Tourism Holdings has gained 63 per cent this year, the best performance on the NZX 50.
But the shift up in interest rates and speculation of more stimulatory US fiscal policy under Trump have caused what some commentators call the "great rotation" - out of bonds into equities, and within stock markets, out of defensive, income-paying stocks into cyclicals - those that benefit when an economy picks up. Deutsche Bank's chief international economist Torsten Sløk estimated this week that US$3 trillion had been reallocated out of bonds and into stocks since the US election last month, according to Bloomberg.
Shane Solly, a director at Harbour Asset Management, said investors that historically invested in lower risk bonds to generate income "were forced to move up the risk curve as fixed interest rates fell to levels that meant return targets could not be achieved."
"In many cases they moved capital into higher income yielding but relatively lower-risk defensive stocks," Solly said. "This capital flow pushed the valuations of some defensive stocks to abnormally high levels. The recent short sharp increase in long-term bond yields from very low levels, has seen some of this valuation bubble deflate."
Banks are currently offering an average 3.51 per cent interest on a two-year term deposit, up from 3.3 per cent in early November. The yield on 10-year New Zealand government bonds, more closely correlated to US Treasuries, has surged almost 70 basis points in the same period to about 3.48 percent, returning to levels last seen at the start of the year.
The kiwi dollar has also fallen back toward levels it was last at 12 months ago, having gained to as high as 74.94 US cents in early September. The trade-weighted index was recently at 76.99, down from as high as 79.30 last month but is still up more than 4 per cent on the year, reflecting strong gains against the British pound, the euro and to a lesser extent the Australian dollar. The economy of New Zealand's nearest neighbour shrank 0.5 per cent in the third quarter, while the local economy accelerated.
Currency strategists say the kiwi's actually proved resilient given the Reserve Bank cut interest rates three times during the year and routinely griped about it being too strong. Still, the New Zealand dollar is more likely to fall further.
"You would have thought we should be lower than where we started the year, especially on the back of rising US yields," said Sheldon Slabbert, a trader at CMC Markets. "It's still to be played out. The groundwork has probably been done for next year, when we'll potentially have a weaker kiwi."
Slabbert said there are risks to the outlook, although they're almost all offshore. A deterioration in the trading relationship between the US and China could be a "black swan" event for Beijing, as it looks over an economy marked by "ghost cities" and infrastructure such as train networks that don't cover their own costs. China has been selling US Treasuries to raise some funds while its own bond market "has been getting a pasting," he said. Flow-on effects could be Chinese capital controls sapping demand for offshore assets including Auckland's property market.
"It's probably again a case of New Zealand being almost collateral damage to what's happening in the big economies - Europe, China and the US," Slabbert said. "A majority of the flow in kiwi is speculative. We need to be able to give them a respectable yield."
