MORTGAGE, TRAVEL AND KIWISAVER
How the global financial wobble will hit your back pocket
While New Zealanders were relaxing on Waitangi Day the world was in a panic. Markets were crashing. Well, almost. There was some chaos, some large falls — and then a bounce back that enabled New Zealand markets to skip the worst of it.
The only thing anyone seems sure about is that investors are on edge and more volatility is expected.
So what happened on Wall Street last week? And what does it mean for us here in New Zealand — where we keep getting told the economy is in good shape.
To understand why stock markets are nervous you need to go back to the global financial crisis of 2008.
To paraphrase Mick Crocodile Dundee: This isn’t a crash. That was a crash.
When global investment bank Lehman brothers collapsed in September 2008 the entire financial system froze.
Banks were literally too scared to lend money so short term interest rates spiked.
Central banks like the US Federal Reserve and the Bank of England had to step in to save the day.
They did that by slashing official interest rates to zero and effectively printing trillions of dollars of new money just to get commerce moving again.
Disaster was averted but the financial system was on life support. And it has been on it ever since.
Attempts to unwind these measures and lift rates have been regularly thwarted by things like the oil price slump of 2014 and a persistent lack of any inflation in the global economy.
Meanwhile, all this extra cash has been looking for a home.
With low interest rates making bank deposit returns so meagre, the money has flowed into stock markets and property markets — inflating both to levels that economists find worrying.
The past nine years have been tough for many — with wages stuck in the low inflation doldrums. But if you had money to invest in stocks or property, you have made a killing.
Auckland’s housing boom is well documented but believe it or not our stock exchange has outperformed it.
At its peak last month the local NZX-50 gross index had risen more than 240 per cent from a low in February 2009.
That kind of puts last week’s falls into context. However, we’re not out of the woods yet.
Despite the US Federal Reserve repeatedly signalling and warning that rates will eventually go back to normal — no one has much faith markets can cope with the move when it happens.
And the signs are it will finally happen this year. The US Federal Reserve indicated it is likely to hike rates three times this year, taking the official cash rate to two per cent.
That’s still low by historic standards but stock market investors don’t like it. Some even predict four hikes. Basically, the stronger the US economy gets the more likely they are to lift rates.
Last week’s mini-crash was sparked by unexpectedly strong employment data.
So if you’re worried about markets watch out for good news.
In New Zealand the economy has been stable for longer. We came out of the global financial crisis faster than the US thanks to China and a boom in dairy prices.
So our official interest rates are already at 1.75 per cent and not expected to rise again for about 12 months.
But that has very little bearing on the fortunes of the local stock market. We’re tiny and a big chunk of the money invested in local stocks is from offshore. So we remain very much at the mercy of Wall Street.
There are some pluses to the New Zealand’s equity markets, though.
Although we inevitably follow Wall Street up and down, the local market is dominated by large utility and infrastructure stocks, such as power companies, that have stable businesses, steady profits and offer investors attractive dividend returns.
That has tended to make New Zealand’s market a bit more of a safe haven than many, at least in the past 20 years. And unlike in the US (and this country in 1987) not many New Zealanders invest directly in stocks.
That means the fall in market value doesn’t have such a dramatic impact on consumer confidence and the wider economy.
In New Zealand it’s a house price crash that economist really fear. Most of us are exposed to stocks through KiwiSaver and other retirement funds.
These can still go backwards, which isn’t pleasant, but they are structured to focus on long term returns and — by pooling money with fund managers — investments are diversified across a range of different markets, industries and assets classes. This includes quite a large proportion of cash deposits.
The next few months are expected to be a bit of a roller coaster for equity markets as investors adjust to the changing economic cycle. We are likely to see a few more days with scary graphs and gloomy brokers staring at us from the front page. It is dramatic stuff and fascinating to read about.
Some argue that like bush fires, market meltdowns are part of a natural cycle. Serious investors see them as creating opportunity. They bring values back into line with the real-world profits of companies. They clear out the dead wood.
But like bushfires they sometimes rage out of control.
Ihave been covering stock markets for almost 20 years and, to be honest, I quite enjoy a good market meltdown. To a point, of course — I don’t like seeing my KiwiSaver returns go backwards and I certainly worry about market negativity spilling over to the real economy. Recessions and job losses are not exciting, they’re depressing.
But most times that isn’t where a market meltdown leads — touch wood. That was the case last week. Wall Street took a dive on Tuesday as New Zealanders were chilling out for Waitangi Day and has been on a rocky ride ever since. It was no Black Tuesday (Markets plunged 22 per cent on one day in 1987).
But even moderate falls and corrections are dramatic events.
They always feel like they have come out of the blue. Even if — as was the case with last week’s turmoil — every man and his dog has predicted we’re due for a fall.
It’s not rocket science. For almost nine years equity markets have benefitted from the low interest rates put in place to save the world from the last financial crisis.
Finally, as the US economy starts to see good growth, the rates are being lifted back to normal settings.
As rates rise cash investments like bank deposits and bonds look more appealing.
So naturally some investors exit the stockmarket for less risky options.
Higher interest rates will also raise costs and dampen profits for shares in businesses that carry a lot of debt.
Everyone can see markets are extremely highly valued and prices are due to correct.
As the whole process has been slow and well-flagged by the US Federal Reserve you’d think it would be orderly.
But markets just never seem to act in an orderly way. I blame people.
Let’s face it humans are famously prone to excesses of fear and greed.
When markets fall sharply the first question financial journalists always get is: should we be panicking yet?
The answer is always: no.
You should never panic, even if your house is on fire. Even if there’s a zombie apocalypse.
Panicking doesn’t help. Rick Grimes didn’t stay alive for eight series of The Walking Dead by panicking every time the zombies broke through the perimeter fence.
To be fair, what most people really want to know is how bad things are in historic context.
That isn’t necessarily obvious when turbulence hits. Markets don’t always crash in one day as they did in 1987 and 1929.
There was a morning in 2008 when Lehman Brothers collapsed and it felt like
the global economy
Markets just never seem to act in an orderly way. I blame people. Let’s face it humans are famously prone to excesses of fear and greed.
was really going to seize up.
But the global financial crisis was well advanced by then and had unfolded with a series of market falls across months.
So we don’t know how this cycle will play out.
Fundamentally, it’s an improving global economy driving the turmoil so a recession caused by a share crash makes no sense.
If market falls are bad enough to damage economic growth we should see central banks back away from rate rises.
That happened in 2015 and 2016 — markets effectively spat the dummy.
This time there’s a belief that the US Federal Reserve has the bit between its teeth.
Hmm, we’ll see.
The other question we get asked is: How will this affect me?
Are you highly leveraged trader? No? Good, so there’s probably not too much to sweat about for now.
It is possible your KiwiSaver balance will fall. But the odds are you’re in one of two kinds of KiwiSaver funds.
If you take an active interest in your savings and have a more aggressive fund you should know you have just benefited from one of the biggest equity booms in recent history. You should stay focused on long-term growth and shortterm falls shouldn’t bother you.
Or you might be the kind who doesn’t pay much attention and is still stuck in a conservative KiwiSaver default fund. That means a larger chunk of your money is already in cash investments. You won’t be hit hard by a crash.
You should have been worrying about the boom. You’ve missed out on thousands of dollars of returns.
Ultimately, there is a possibility a crash could reveal some previously unknown weakness in the financial system, which spills into the real world.
In the GFC the trading of home mortgage debt as financial products was exposed as woefully risky.
Billionaire investor Warren Buffet once said: “Only when the tide goes out do you discover who has been swimming naked.” Here’s hoping we’re all a bit smarter this time around.
I wouldn’t count on it, but neither do I see a change market conditions as inherently bad.
There are aspects of the New Zealand economy worth worrying about — our overvalued, highly leveraged property market remains top of the list.
If interest rates were to soar, we’d have serious problems.
But the rest of the economy is in pretty good shape.
Most of us are at least one step removed from the reality of equity market crashes.
That makes it a little bit easier to sit back and enjoy the drama.