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Post Election Market Update – It’s Still an Interest Rate Story

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Unfortunately, we have not seen a new government bounce for the New Zealand share market as interest rates continue to dominate the narrative when it comes to share market performance.

For those uninitiated, the meteoric rise in interest rates over the last couple of years impacts the performance of the share market in a number of ways.

The easiest way to visualise this is asking yourself, “would I invest in a company with little or no earnings growth (i.e. the dividend won’t grow) that has a dividend yield of 5% p.a.”

A few years ago, when interest rates were one to two percent, many investors would have been happy to make this investment. Now, you can get the same return, or better in fixed interest or on-call in cash, so most investors would baulk at the idea of buying the theoretical company above.

If the average investor wouldn’t buy this company at 5% p.a. the market price will adjust the share price to a level where the average investor would buy this company. This adjustment has already occurred in global markets, with share prices dropping as alternative investments have become more attractive.

In response to this pain, the NZX50 is currently trading at similar levels to that seen in late 2019, meaning the market has achieved no return for four years.

There is a flip side to that pain; investors looking for income have far more options available to them.

Before we explore investment options, it’s worth revisiting how we got here.

Thinking back to when COVID kicked off in 2020, and the worldwide response (from an economic perspective), one could be forgiven for thinking that the Reserve Bank of New Zealand made some drastic cuts to interest rates in order to help stimulate the economy. However, heading into COVID, the Official Cash Rate was already at an historic low of 1%.

Rates were cut even further, down to 0.25% at it’s low (currently 5.5%). For the most part, it was worldwide government stimulus that really supercharged the world’s economy. This stimulus created the excess spending that eventually led to inflation, that subsequently saw the rise in interest rates that is the focus of this commentary.

As the old saying goes, no pain, no gain. Well, we’ve had the pain, so where is the gain?

The gain for investors is the relatively high returns available on relatively low risk bonds and cash. New bond issues with a term of 6-7 years are now being priced at 6 to 7% per annum. The interest rate we offer on NZD cash for our clients in our managed portfolio service is currently 5.25% p.a.

We believe now to be an opportune time for investors to begin locking in some of these longer-term interest rates.

We appear to be at, or very close to, the top of the current interest rate cycle. Whilst no one is expecting rates to drop to the pre-covid levels, the market is suggesting that the rate rises to-date have been enough to put the inflation genie back in the bottle.

The most recent NZ inflation figure came in below expectations. Whilst not all data points agree, there have been enough positive signs around inflation to see rates flatline, and even drift slightly downwards in the last few weeks.

This is a positive news for the NZ share market.

To circle back to the beginning of this article, rate rises have been the main driver of the recent under-performance of the NZ market. If that headwind is reduced to a gentle breeze, or even transitions to a tailwind, then the market straitjacket will be removed, and we can get back to focusing on company fundamentals rather than macro (big picture) trends.

Looking at the fundamentals, there is more value to be had on the NZ market than there has been for years. Some companies & sectors in particular have been oversold in our opinion, although whether they’re appropriate for you will depend on your circumstance, and appetite for risk.

As they say, it is always darkest before the dawn, and we believe a well-diversified portfolio combining local and global equities (shares) with fixed interest (yielding in the 6-7% region) will do well in the long term.

They never ring a bell for the bottom of the market, but you’re certainly better off buying when the market has dropped, than waiting to buy in when the market has recovered.

We will soon have a new government in place, complemented by stable or perhaps declining interest rates.

The world will continue to turn, consumers will continue to want the latest gadget, people will still need power and a place to live, retirees will still need care facilities, and companies will continue to make profits and pay dividends.

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