Higher than expected inflation in the United States has provided a turn-key for market sentiment. Investor opinion has switched from valuing companies on how much cash they promise to deliver, to valuing current cash flows.
This change in mind-set in the US has spread to all markets and is likely to create a relatively positive longer term outlook for New Zealand equities.
Typically higher US inflation leads to higher US interest rates. We think that the US Federal Reserve will move to raise interest rates in coming months. The correction in technology stocks that began in March is in our opinion likely to continue for those stocks that have poor prospective profitability and are not sector leaders.
A feature of past market corrections is a period of poor market liquidity. Buyers are scared of participating, sellers won’t sell at lower prices. Once markets stabilise and liquidity improves we believe that more traditional valuation parameters will reassert themselves.
The New Zealand equity market has been a big under-performer in the past three years as global technology and growth stocks have moved ahead.
New Zealand companies are valued at about 60 per cent of a comparative global value; when historically they have traded at about an 85 per cent comparative value. From that perspective, because the New Zealand market has avoided much of the speculative excess of some overseas markets we believe that on a 6-12 month view the New Zealand market offers good value.
AXA New Zealand Funds Management has emphasised companies that offer strong growth such as Telecom, INL, Fisher and Paykel,and ANZ Banking Corporation. We also believe that the restructuring of Fletcher Challenge Limited provides a likely release of value for shareholders of existing letter stocks, particularly Fletcher Paper and Fletcher Energy. Among smaller caps, although it may be the case that liquidity is reduced for a period, we are attracted to Tourism Holdings, TranzRail, and Pacific Retail.
Whether invested offshore or in New Zealand, we don’t think that investors should turn their focus from shares that deliver strong earnings growth. Over the long term we believe that companies that provide high return on equity will outperform and investors should continue to be attracted to these companies.
Andrew Bascand is the equities manager for AXA New Zealand
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