Steam comes off the stockmarket

A monkey could have made money in the sharemarket over the past couple of years but 2005 is a different story ... a monkey wouldn't have earned himself a banana this year. That's how one market participant sums things up.

The NZSX-50 index posted its first quarterly decline in two years in the March 2005 quarter, falling by 0.8 per cent.

Until the Reserve Bank's March 10 interest rate hike from 6.5 per cent to 6.75 per cent, there was no sign that the heady rise of the previous two years would be interrupted.

That surge took the NZSX-50 gross index up 73.5 per cent from 1870 in March 2003 to a peak of 3245 on March 9.

The Reserve Bank's move was the seventh since January last year and governor Alan Bollard indicated there could be more to come.

Since then, the market has dived in what is known in brokers' terms as a "healthy correction". It is now trading at 3057.63.

 

First NZ Capital strategist Jason Wong said strong earnings during the February reporting season had lifted investor sentiment. But the interest rate hike turned the tide. He said the writing had been on the wall for some time. First NZ made an increasing number of downgrades in the lead-up to the Reserve Bank's decision.

Broking firm Forsyth Barr backs this up, saying the equity market has enjoyed more than three years of stable earnings growth, resulting in a continuous run of earnings and valuation upgrades.

"Looking ahead, we believe the earnings momentum is likely to slow and valuations will come under pressure, particularly those companies with high implied growth rates from domestic-based earnings."

The reason? The domestic economy is slowing and the mix is changing from one of low interest rates and a high currency to a weakening kiwi dollar and higher local interest rates.

The dollar is down 4c from its mid-March high against the greenback - with more weakness possible.

International investors are becoming less interested in parking their cash here. The difference between American interest rates and New Zealand rates is declining, now the US Federal Reserve has indicated it may lift rates faster than expected.

At the same time, New Zealand's growth prospects relative to the rest of the world are easing. Our annual current account deficit, the amount we borrow each year from the rest of the world, was $9.4 billion last year and this worries overseas investors.

Meanwhile, prices of commodities that underpin the economy such as dairy products and meat may be about to come off historic highs.

The brakes are on.

The question for the sharemarket is: will it retrace further to wipe out big chunks of the gains of the past couple of years?

While most market players don't think so, they admit that if economic growth forecasts are trimmed from here, the sharemarket will respond accordingly.

No one will nail their colours to the mast on the year-end level for the index.

The last reporting season (covering interim and full-year December 31 dates) was solid enough, but the softening economic outlook suggests softening company returns are in store.

Good performances were turned in by Sky TV, Mainfreight, Steel & Tube, Freightways and Fletcher Building. On the downside, Abano, Carter Holt Harvey, NGC and Wrightson disappointed.

CHH sent its shares scurrying to an 18-month low after Easter when it warned that its operating profit could be as much as 42 per cent lower than a year earlier. The heavyweight building products company has been hit by the currency and the slowdown in building in Australia and New Zealand.

Similar issues caused carpet-maker Feltex to warn that its June-year profit would be $8 million to $9 million below its earlier forecast at $15 million to $16 million.

 

First NZ's Wong again: "Our GDP projections suggest the economy is on the vergeof underperforming its major trading partners and this lagging economic perform-ance suggests a high chance of local equities underperforming fully hedged globalequities going forward."

Local equities remained expensive despite a correction of about 5 per cent in March.

"Relative to global equities, local equities still look expensive, especially when considered in light of the deterioration in the relative macro outlook," Wong said.

Telecom - which makes up 26 per cent of the NZSX-50 index and, as such, largely dictates market direction - is unlikely to fare too badly. The company hedges against currency and interest rate fluctuations.

Telecom chief financial officer Marko Bogoievski said: "The interest rate side obviously could affect us but we've actually hedged via stringent treasury policies most of our interest rate exposure so it's actually quite difficult for interest rates to impact our earnings in any meaningful way.

"On the foreign exchange side, we're obviously not a big exporter, but we do import and we buy quite a bit of capital expenditure and equipment out of the United States" - so a stronger kiwi helps to keep these bills down.

Bogoievski said Telecom hedged forward about 12 months at an average rate of just below where the kiwi was trading.

"Issues around technology, what competitors are up to and regulation probably dominate our short- and medium-term prospects ahead of macroeconomic concerns."

Forsyth Barr backs this up, saying its equity strategy is moving to a defensive bias best illustrated by the recent move to upgrade Telecom NZ to a buy recommendation.

First NZ Capital said in its weekly report it was changing its model portfolio to be more overweight in Contact Energy (after the share price retracement) and Fletcher Building, which has been oversold because of CHH and Feltex downgrades and was also exposed to less competitive markets.

Many analysts are taking on a defensive bias and moving away from stocks that are sensitive to the economic cycle and those whose earnings are negatively affected by the strong dollar.

Stocks that could suffer are those connected to the building market like Feltex, CHH and Fletcher Building, consumer stocks in the retail sector and those exposed to the currency where currency hedges have run out.

The NZSX will be partially sheltered from any fallout as the sectors that will be hit first and hardest are agriculture and property - neither of which features prominently among listed companies.

NZX chief executive Mark Weldon said: "You would expect the impact to be mixed. Some of our companies are net buyers of overseas goods and then we have some who are more exposed to the price on an export basis."

Other positive signs include the fact that the New Zealand Superannuation Fund held its 7.5 per cent asset allocation to local equities steady when it did its first asset allocation review. The fund's mandate is to get the best returns, not necessarily invest locally, so that must be a sign of confidence in the local market.

Finally, a slowing of sharemarket returns is inevitable but, as this comes from a high base, then the train is not on a collision course yet.

- additional reporting, NZPA