The conundrum that faces capital markets

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Fran O'Sullivan sat down at UBS New Zealand for a Roundtable with Nicholas Ross, Christopher Simcock, Andrew Fredericks and David Lane.

Herald: Looking at the big picture internationally, what are the major trends you're seeing and what should we be looking out for from the global capital markets?

Nicholas Ross: The burning issue is the relative health of equity markets in the face of quite sharply rising interest rates. It genuinely is a bit of a conundrum. We are seeing equity markets respond not necessarily negatively but cautiously.

One of the key indicators is a measurement that we track quite closely through our global derivatives desk of "selling versus buying" pressure.
So when we have an up-day in the global equity markets, we tend to find that there are fewer buyers than there are sellers in the down-day. So, from a global equities perspective that gives us a sense that the market is cautious, quite rightly so.

Herald: Staying with this aggressive move upwards in interest rates what does that mean for global equities?

Nicholas Ross:
Obviously Q1 wasn't a great quarter for equities but I don't think we've seen a big sell-off for a couple of reasons. This has got to be one of the most telegraphed and anticipated uplifts in interest rates. If I go back to 1994 or say 1999 there were quite sharp responses from the Fed that came quite quickly, and there were multiple moves, and they shocked markets, whereas this hasn't.

A lot of fund managers have got themselves into duration neutral or short duration positions in anticipation of higher rates, so are in a position to invest cash balances.

There's still an enormous amount of liquidity in the markets which is supporting the health of the markets. Sovereign wealth funds weren't anywhere near as aggressive or prevalent as they are now, 10 or 20 years ago. Hedge and quant funds have attracted huge quantities of FUM (funds under management) and despite some tapering Central Banks are still printing money.

Christopher Simcock: Add to this the growth in the US — there's lots of money being spent and that's stimulatory. Europe is looking better and China is not as bad as we thought it could be. We've been sidetracked with tweets of — "He said "$50b in sanctions, I'll have you by another $50b" and that causes so much volatility. People want to stop being worried about that and it feels as though that has eased a little and we're getting back to the central thesis.

Andrew Fredericks: While volatility's increased, equity markets are grinding higher, and that's the backdrop of strong global growth and company earnings. I think the tailwind of the tax breaks in the US is assisting that as well as global monetary policy still remaining favourable.

Herald: The Kiwi equities market seems to have hit a stall when it comes to new listings.

Christopher Simcock: Unfortunately it's pretty torpid, with the number of listed stocks significantly reduced since 2015. Everyone blames the NZX, but in my view the exchange is not solely to blame. It's just a function of what is happening in the shape of our business economy.

Obviously the IPO process is very onerous but that in itself I don't think is a massive deterrent. If you're a small-to-medium enterprise — let's say a $100m business to $200m business — you've never had as much access to capital as you do now.

Debt financing, equity financing — public and private context. It's a really positive thing and I hope we'll see the fruits of that in 5-10 years time when a lot of these smaller companies that are $50m- $150m can turn into the $500m to $1b corporates that we need to genuinely drive our economy and give us a great number of international export receipts.

Herald: The level of M&A activity has really stepped up but there's a lot of gripes about regulatory uncertainty here, particularly with the Overseas Investment Commission

Christopher Simcock: The process around how OIO works still needs a lot of work to provide proper ground rules. It's around the Commerce Commission as well. A number of our clients in Australia have now taken a back seat in terms of investing in New Zealand.

Christopher Simcock: Unfortunately, we don't see a lot of New Zealand companies thinking big about M&A, having big M&A agendas, and then using capital markets to fund that.

Herald: Why is that?

Nick Ross: There's a low-risk tolerance I think from corporate boards, many NZ companies have suffered from going offshore.

In many sectors in New Zealand, because we are small, you've got as much consolidation as you can get from a regulatory or competitive perspective.

Whereas Australia for example is much larger and more fragmented t's a lot more decentralised. It's a lot more fragmented, so you do see a lot more M&A around consolidation/scale plays. It's hard in our big sectors to see more consolidation for example in telcos and gentailers.

Christopher Simcock: So what you get in Australia and in the US is you get sector consolidation which delivers synergies and it's a traditional M&A corporate finance story.

In NZ what you end up having is a strong performer in a category which will diversify into another industry which they think is relatively close, but still in New Zealand.

Herald: Must be time for another round of MOM then?

David Lane: Ultimately it creates some form of trickle-down effect because if you can expand the top end of the market with these gentailers and Fonterras and get internationally relevant companies on the market, and therefore the capital from offshore, the local fund managers have a bigger pool and investment opportunities and that creates the opportunity for the mid-sized company to have a capital market they can access and hopefully the next Xero or something like that.

Andrew Fredericks: Can I ask you a question Fran? Because I'm sure you spend a lot more time with politicians than I do. Are they worried? By that specifically, is this just a winter of discontent, like Helen Clark had, or business confidence hasn't bounced back? It did a little bounce and it's got worse when it comes to companies' intention to hire and consumer spending.

Fran O'Sullivan: Well, they keep saying the negative business confidence surveys are balanced out by positive individual business intentions. But I would have expected confidence to have firmed by now. Business reaction to the Budget is very important.

It's important to know how the Government's plan will roll out and how it will be funded.

And to me that's the missing chink.

Grant Robertson is a Social Democratic-style Finance Minister. But he is still a relatively unknown quantity.

Unfortunately he is surrounded by colleagues like Shane Jones who makes political capital out of beating up on boards like Air New Zealand and The Warehouse rather than asking to see them first to try to find solutions. Businesses are wary that the regional development fund may be little more than a slush fund. So they need to put some good governance around that.

Then you've got David Parker sounding off about the 1 per cent, and foreign investors. What's really important is that the Government gets the tone right and take business with them.