Rise and rise of the NZ market

Chris Timms.
Chris Timms.
The New Zealand financial market has had a stellar run, falling less than tother markets during the volatility early in the year and rebounding more sharply since then. Business editor Dene Mackenzie talks to Craigs Investment Partners broker Chris Timms about why the NZX50 is trading close to record highs.

Existing investors should review positions in New Zealand equities and take profits where necessary, Craigs Investment Partners broker Chris Timms said.

New investors should be patient and selective, using periods of weakness to add to positions while remaining focused on high-quality companies with growth options and sustainable, rather than simply the highest, dividends.

The local economy remained in better shape than many others around the world.

The currency was in a relative sweet spot, interest rates were at record lows, the corporate sector was strong and dividend yields remained highly attractive, he said.

‘‘We expect the New Zealand market to remain more resilient than others in the face of higher volatility. However, we must acknowledge it is trading at higher valuations, leaving much less room for strong capital growth relative to what we have seen during recent years.''

When reviewing the performance of the NZX50, Mr Timms said it must be remembered it was a gross index, which meant cash dividends were included when its returns were calculated.

All other major headline indices were capital indices, which meant they tracked share price movements only and ignored dividend payments.

That made some sense as dividends were much higher in New Zealand than other markets and they represented the vast majority of returns. It also meant the NZX50 had something of an unfair advantage over other indices, he said.

The make-up of the NZX 50 happened to suit the current environment. In recent years, the weakest sectors globally had been related to commodities, such as materials and energy, as well as the financial sector.

The NZX50 had a combined exposure of just 14% to those types of companies, well below 46% for Australia and 43% for the United Kingdom, two of the weaker markets in the last 12 months.

Gross dividend yields in the local market were still impressive and continued to attract investors. The NZX50 gross dividend yield was 6%, including imputation credits, and had been stable at that level since 2010, Mr Timms said.

Meanwhile, the term deposit rate had steadily fallen from 4% to 5% to 3.2% this week.

‘‘Consequently, the yield premium offered by the local equity market is around 2.8%. This is well above the average of 2% from the last five years and enticing enough to fuel investor demand.''

Finally, companies on the local markets had delivered robust, steady earnings growth in recent years and were expected to do so again in 2016 and 2017.

Of the companies in the NZX50, median earnings growth for the last financial year was 8.8% and this was forecast to be 7.3% and 7.5% respectively over the next two years.

Earnings growth in other markets had been patchy, largely because energy and materials companies had dragged the average down, Mr Timms said.

Earnings growth was forecast to rebound to double-digit levels in the US, Australia and the UK next year. However, it was premised on some of those more cyclical sectors experiencing a recovery. Investors were sceptical of a recovery and preferred more defensive plays.

On some measures, most notably the current price-earnings (PE) ratio, the local market looked expensive, he said. The current PE of 20x was close to the highest it had been and was well above the average of the last 20 years of 14.8x.

‘‘In a very small market like ours, these historic comparisons are less useful. New companies that change the make-up of the market have a much greater impact than they do internationally where there is much more depth.''

In recent years, New Zealand had experienced the emergence of a lot of technology companies such as Xero, Orion Health, Wynyard and Vista. Those companies were high growth and all traded at high PE ratios.

The generation-retailer electricity companies Meridian, Genesis and Mighty River Power also had an impact. Because depreciation of assets was often greater than the cost of maintenance, the gentailers appeared to have high PE ratios, despite strong cash flows. The sector also had an average PE of 22x, nearly 50% above the 20-year average for the market.

Looking ahead, Mr Timms said many asset classes looked expensive, largely due to very low interest rates across the world.

Term deposits were at their lowest levels since the 1960s and there was little sign of any uplift in rates in the foreseeable future.

‘‘We can see quite clearly local shares still appear attractive on a relative basis for investors looking for income. This dynamic could see the local market well supported for some time yet.''

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