The end of the golden weather?

Last month's commentary was about ‘the calm before the storm’. Those storm force winds certainly buffeted the New Zealand sharemarket during March!

Monday, April 11th 2005, 7:41AM

by The Landlord

As mentioned last month, inflation fears are becoming more prevalent, certainly as far as the Reserve Bank of New Zealand (RBNZ) is concerned. This led to another interest rate rise in March, which spooked the domestic equity markets, as did lower than expected December quarter GDP growth and a ballooning of the balance of payments deficit.

Accentuating the domestic sharemarket sell-off was the weakening New Zealand dollar. While this is helpful for our exporters it certainly isn't to unhedged offshore investors who own New Zealand shares. Many decided to take some money out of New Zealand, happy to take the profits of the past few years and concerned that any further fall in the kiwi would erode those gains.

While the above events would not normally result in a dramatic fall, the New Zealand equity market was ripe for a sell-off. As highlighted two months ago, in one of my commentaries, the domestic equity market was at 10 year highs, in terms of its P/E relative to global equity markets. Thus, we were due for a correction and this is a healthy part of any adjustment process.

A concern would be if the current correction becomes a rout. This is not likely, as many New Zealand shares are now priced at more reasonable levels, with many having fallen more than 10% over the past ten days. Thus, value is now easier to find, although the market is still not cheap. So the loss of confidence in the domestic sharemarket could result in an over-sold situation in the coming months. This will potentially provide some buying opportunities but will need to be assessed on a stock-by-stock basis.

On the interest rate side, my view is that the RBNZ should now go on ‘hold’ mode for much of the remainder of the year, to ensure it gives sufficient time for its significant rate rises of the past year to feed through. The only factor that might change this would be a collapse in the kiwi dollar, which would further accentuate the existing inflation pressures on the economy. While this is possible, it is unlikely as, even with recent rate rises in the States, New Zealand interest rates remain some of the most attractive yields in the developed world.

If a significant fall did eventuate, the RBNZ response would be likely to be relatively swift with the resultant rate rise/s then underpinning the kiwi. So, a relatively high kiwi dollar looks set to be with us for some time. Eventually (although it continues to be delayed) we will enter a cycle of interest rate declines which may contribute to an easing in the kiwi. When this does occur, shares will look very attractive given the high yields some provide and the boost some exporters will get from a lower currency. However, as always, it is extremely difficult to predict the timing of when this might occur.

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