Interesting times as economic risks subside

The US election result has an impact on NZ equities, rates and currency, writes James Grigor.

The positive market response, and continued moderate tone from President-elect Trump, suggest downside economic risks in the immediate aftermath of the US election have subsided.

What does an election in the US mean for New Zealand equities? The S&P/NZX 50 has fallen 9.1 per cent since its record high in September. But despite this drawdown, New Zealand equities continue to trade at historically high valuation levels.

Positive growth means higher interest rates

Uncertainty remains, but the potential increase in US growth expectations from some of Trump’s policies has led to a move higher in long term US interest rates. In New Zealand, long term interest rates are correlated to the US and have also increased. This is despite our short term Official Cash Rate (OCR) being cut to just 1.75 per cent earlier this month.

Since the US election, the US 10-year bond rate has increased almost 50 basis points (or half a per cent) since the US election to approximately 2.35 per cent.

The New Zealand 10-year bond rate meanwhile, has increased 40 basis points to around 3.10 per cent over the same period.

Higher interest rates are negative for NZ equities.

Long term interest rates could increase further. This is putting pressure on New Zealand equities for two reasons.

Firstly, the low interest rate environment has increased the demand for, and price of, interest rate sensitive stocks.

Increased interest rates put the valuation of these stocks at risk, through potential higher cost of funding and inflationary pressures not seen in this latest economic cycle.

Secondly, expectations for higher interest rates in the US weakens the NZ dollar. This is causing the high levels of foreign investors in New Zealand equities to reduce their NZ investments to avoid losses.

So what is our verdict?

Our view is that long term interest rates will continue to normalise, i.e increase. This will put further pressure on New Zealand equities. We would look to reduce exposure to interest rate sensitive stocks, such as those that pay a high dividend like Meridian Energy or listed property companies, and increase exposure to cyclical stocks which exhibit growth, or stocks which have US exposure such as Mainfreight or Fisher and Paykel Healthcare.

The views expressed in this article are those of Hobson Wealth Partners Limited, an NZX Firm. The disclosure statement is available free on 0800 742 737.