Opinion: Greg Fleming - AMP Capital
The announcement of the New Zealand First party’s decision to join the Labour party in coalition government with Green Party support has ended almost a month of uncertainty, and results in a verdict in favour of change, rather than allowing for cautious continuity.
In markets, uncertainty is usually rewarded with bouts of volatility, which spikes up and then gradually subsides as participants take on board the new reality and begin to re-position their portfolios. Change allows investors both to take advantage of newly-revealed investment opportunities, and to limit the impact of latent risks.
Now that the broad shape of the new New Zealand Government is known, investors holding New Zealand assets will need to re-examine some of their assumptions about domestic economic policy and direction, many of which have been taken for granted during the last decade.
2016-2017: Not “The Establishment’s” year here, or abroad
The New Zealand outcome is the latest wavelet in what we described at the start of this year as a rising tide of impatience with the established order, and the probability that dissatisfied elements around the world would wield more influence in the political economy than has been the recent norm (see our macro themes and investment E’s articles in: Taking Stock #18 Summer 2017). The UK Conservatives, the US Democrats, the German Christian Democrats and even NZ’s National Party have suffered electoral setbacks above and beyond what was expected, given the reasonable – if not stunning – economic performance of their economies.
The leader of New Zealand First, Winston Peters, deployed pre-election billboards throughout the country headed up with the question “Had enough?” followed by a list of social and economic issues. In delivering to Opposition parties the capacity to remove the existing National-led Government, it appears that voters in aggregate were less satisfied than an apparently healthy domestic economy would suggest. In announcing his party’s decision last night, Mr Peters introduced a warning tone about impending economic threats to New Zealand and to economies we depend on.
The dark tone which he adopted surprised some commentators, but it should not be missed that concern about the post-GFC global reliance on low interest rates, monetary authorities providing stimulus even well-outside recession conditions, rapid asset price inflation, implied taxpayer guarantees for risky lending and ever-rising globalization in goods and services trading, underpin the political swing against ‘the Establishment’ and liberal economic expertise that is becoming apparent (in fits and starts) in many jurisdictions. This observation applies to Jeremy Corbyn’s rise in the UK, Emmanuel Macron’s in France, Donald Trump’s in the USA, and to lesser-known ‘radical amateur’ movements in the emerging markets.
One lesson is that investors should not under-estimate the degree of disenchantment, and should appreciate that the incoming New Zealand Government is not wedded to the conventional economic consensus, and may well experiment more profoundly with alternatives than some have expected. While movements elected on a platform for change often become pragmatic once in political office, there is good reason to expect that the incoming New Zealand Government will be keen to experiment and resist compromising it’s agenda to alter the country for as long as is politically possible. Vital issues like tax and regulatory changes remain to be clarified, and we will follow up with our thoughts as policy details emerge in weeks to come.
Outlook for assets
So, what effect could the incoming Government have on investment asset prices? How are our portfolios at AMP Capital positioned to benefit?
The New Zealand dollar (NZD) reacted with a fall of around 2% on major cross-rates. While this is a sharp offshore move, it hardly compares to the 10%+ drop in the UK pound against the US dollar last June after the Brexit referendum result. A weaker NZD is desired by both New Zealand First and by the Reserve Bank of New Zealand (RBNZ), although the RBNZ may not wish that to come via a change to the Policy Targets Agreement with the Government. Much will depend on who is appointed as the new central bank Governor early next year. It seems unlikely that the ‘Singapore model’ of a managed floating exchange rate that Mr. Peters has suggested we emulate would be viable here, at least until New Zealand’s foreign exchange reserves are much higher than their current level of 10% of GDP. Nevertheless, it is reasonable to expect the climate to deteriorate for ‘carry traders’ who borrow in lower yielding currencies to benefit from higher New Zealand short-term interest rates, thus pushing up the currency. The new regime appears notably impatient of such financial market practices, and condemns their impact on the real economy. In sum, the array of factors now pointing to a lower NZD have strengthened. However, in the medium-term, greater fiscal stimulus and more inflation-tolerant or wage-supporting policies would be likely to provide the basis for the NZD to strengthen again. In this regard, upcoming US policy announcements also have a crucial role to play, because they could push the US dollar higher and limit the scope for a major NZD recovery.
At AMP Capital, our international investments are broadly positioned to benefit from a phase of weakness in the New Zealand dollar, which we have anticipated this year, and we will retain this bias.
The New Zealand government bond market has been a good performer in recent years, as the departing Government has been fiscally fairly conservative, the New Zealand country risk premium has fallen, the RBNZ has remained accommodative while inflation has been low, and the global ‘hunt for yield’ has attracted some international funds (though, real yield hunters tend to favour dividend-paying New Zealand equities).
Depending on the degree to which new policy announcements either increase government debt or increase the New Zealand country risk premium by affecting credit rating trajectories, we are likely to see bond yields moving up. Our ratio of government debt to GDP is low compared with most of our developed market peers, but is set to increase by perhaps 3% by 2021/2022. If the new policy thrust allows for more inflation risk, markets will be inclined to reflect this in pushing New Zealand bond prices gradually lower and yields higher in the next few years. Wage inflation is now more likely though collective agreements in health, teaching and elsewhere. The rapid build of affordable housing programmes will push up construction wages, and tensions with skills-based immigration quotas will need to be resolved. However, the long maturities in the New Zealand government bond market are still mainly determined by shifts in US bond yields.
AMP Capital funds are cautiously positioned on New Zealand government bonds, and increases in yields here would be buffered for investors by our comparatively defensive and credit-quality focused portfolio orientation.
The New Zealand share market has been among the strongest developed market performers year-to-date, with a rally of 18%. Unless there is a sharp rise in interest rates (low probability) it is likely to retain a good part of those gains. Underlying demand for New Zealand equities is strong, both because of domestic retirement savings and international support driven by yield and diversification. While the market is expensive by most historical measures, a change in political direction is more likely to lead to a change in market leadership, than to an outright correction.
Companies operating in the export arena and in tourism should benefit from a lower NZD. Education reform is highly likely, and the impact on private educational providers has become less certain, but more differentiation will be key and quality should prevail. Exporters with high China exposure could be at an elevated risk if any antagonism develops over immigration restrictions, though that would depend on whether diplomacy can forestall untoward consequences.
Infrastructure build is a key policy platform of the incoming Government. Companies with construction and infrastructure (telecom/IT/utilities) are likely recipients of greater contract spending. Public-private partnerships (PPP) may also develop further, if pragmatism about getting results prevails over ideological objections to the PPP model.
Healthcare and elderly care companies are potentially major beneficiaries from higher social spending and a focus on older citizens’ needs. Experiments with new funding models are probable and will create opportunities for investors alert to the ‘ageing demographic’ theme.
AMP Capital funds are diversified across the New Zealand share market, with a bias towards the less-expensive companies and the sectors mentioned above that rely on longer-term fundamental shifts in demand and in the drivers of profitability.
Finally, our investment strategy this year has been alert to political change risks above others, and has thus held high cash balances in most diversified funds. We are satisfied that this is the correct positioning for the current environment of transition in economic priorities.
If value emerges in domestic markets as the result of any bout of concern, and a sell-off in listed assets ensues, our relatively defensive positioning will allow us to re-establish active positions in assets which are broadly rather expensive at current levels. Long-term investment opportunities are often revealed only when an established system is disrupted and an imperfectly-understood alternative gets underway, and we are alert to ways of gaining exposure to any changes that will contribute to our investors’ long-term wealth building while keeping vulnerability to asset price risks in check.
Source: AMP Capital