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A Tale of Two Economies

27.08.2015

It was the best of times, it was the worst of times… at least according to your average economist. But which average economist are we supposed to believe?

For those that missed the rigmarole this week, we saw the worst of times, with the Dow Jones Industrial Average (perhaps the most irrelevant, but still oft-quoted index in the world) dropping 500 points on consecutive days for the first time ever. This was coupled with substantial drops on the Shanghai Index. 

When trying to figure out what happened to world share markets this week, we have to decipher a tale of two economies. One is finally getting back on its feet, the other is trying gamely to maintain its momentum.

The impetus for the recent rout on share markets came from poor data out of China, starting with the surprise devaluation of the Yuan on the 11th of August. The Chinese economy has carried global growth on its back over the last few years. The momentum their economy built up is finally starting to wane. Fears are that the rest of the world can’t do enough to pick up the slack.

The US economy, representing approximately a fifth of worldwide GDP, is expected to take up much of this slack. Most of the recent US data suggests exactly that, with consumer confidence strong, new home sales high and growth expectations still in the 2.5 to 3 percent range.

Strong data out of the US gave the US Federal Reserve more ammunition as they looked at the possibility of increasing interest rates for the first time since the Global Financial Crisis. However, data sets can never be looked at in isolation, and the Fed will now be questioning whether the much predicted September rate rise is the right thing to do. Holding off on a rate rise in the short term will lend support to the share market.

So what does all this palaver mean for New Zealand investors and companies listed on the NZX? The answer is less than most in the media would have you believe.

There is no doubt that positive news on all fronts is preferable, but in the real world there is always something negative to point to, and when fear pervades the marketplace it is this negative news that dominates.

New Zealand investors have probably heard very little about the great results from the likes of Ebos Group, Metlifecare, Skellerup and Genesis Energy this week. It is the results released by these companies that should be of most interest to New Zealand investors. In the long run, company performance shines through, not the level of the Dow Jones, or the price of fish in shanghai. If an investor owns part of a well run, cash flow positive company, with a strong balance sheet then day to day market movements matter very little.

In fact savvy investors approach scenarios like we have seen this week as a golden opportunity to buy stock whilst they are on sale. The share market is perhaps the only place where human psychology dictates that when prices go down they do not want to buy, and conversely, when prices go up, so does demand.

The market turmoil we are seeing is a timely reminder of the importance of asset allocation for investors. Those with a properly diversified portfolio that includes defensive assets such as fixed interest will outperform when markets suffer a pull back. Investors uncomfortable with the recent volatility we are seeing would be advised to reconsider their asset allocation, as they may be taking on more risk than appropriate (anyone losing sleep in light of recent events are perhaps over-exposed to equity and may sleep tighter with more defensive assets).

Properly diversified portfolios will also have an element of international exposure. Positions with unhedged currency will find that the NZD will often fall when international markets fall, meaning that unhedged equity assets in international markets have a sort of natural hedge built in.

What we’ve seen on the markets over the last week may not be the worst of times just yet. Markets are likely to remain vulnerable in the short term.

However, NZ investors with a long term focus shouldn’t get caught up in the hype of short term bumps in the road. Those companies that produce things people want or need, that are not overladen with debt, and have the right people in charge will ride out the storm and thrive when summer weather returns.

Whether this is the worst of times is debatable, but what we do know is that the best of times are still ahead of us.

*Written by Grant Davies, Investment Advisor at Hamilton Hindin Greene Limited. This article represents general information provided by Hamilton Hindin Greene. It does not constitute investment advice. Disclosure documents are available by request and free of charge through www.hhg.co.nz.

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Add a comment1 Comment

Reply Warwick Blair | August 31st, 2015 at 2:23pm
A well balanced timely article written from a sound perspective. Well done, Grant.

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