Lower interest rates, V-shaped bounce justify current share prices: Harbour

The S&P/NZX 50 Index has jumped more than 30 per cent since its low point on March 23. Photo / File

There is probably no disconnect between equities markets and the real economy, even after the recent sharp rally, because the fall in interest rates has been a greater force than the expected fall in corporate earnings, said Harbour Asset Management managing director Andrew Bascand.

The S&P/NZX 50 Index has jumped more than 30 per cent since its low point on March 23 and the US S&P 500 Index has made similar gains.

"This is a health crisis so far – it might develop into an economic crisis," Bascand told an online meeting of the CFA Society New Zealand.

But a month or two ago, markets thought the economic impact was going to be a lot worse than it does now, partly because the health crisis isn't as bad as expected, he said.

Rather than the mortality rate from Covid-19 being somewhere between 3 per cent and 4 per cent, it now looks likely to be about 10 times less than that at about 0.4 per cent.

"Markets were pricing in no recovery back in March and April" but the data so far is indicating a partial recovery, Bascand said.

China's economy was the first to go into lockdown, and has been the first to come out, and economic activity there is now back to 90 per cent of where it was pre-Covid.

The Chinese data was a "bit of a shock" because the bounce back has been much bigger than expected, he said.

A 'V' shaped recovery is now looking likely in some sectors. "The issue is that there are a couple of sectors that won't be 'V' shaped recoveries."

For example, Z Energy won't be selling a lot of jet or marine fuel because there won't be many international tourists or cruise ships arriving for some time.

"The valuation of earnings is critically geared to the level of interest rates," so how long the "stimulus economy" lasts and how long interest rates stay very low are key assumptions in valuing equities.

"History is never the most perfect guide to what's happening to earnings, but generally it takes 10 quarters to get back to the previous peak levels" after a recession.

It is quite possible this time it might take 12 quarters, but "the consensus at the moment has us getting back in less than 10 quarters."

Winners and losers

If the economy recovers to about 90 per cent of where it was pre-Covid, even after the more than 30 per cent rally in shares since the low point in March, "the fall in interest rates is a greater force than the expected fall in earnings."

That means the question of which sectors are going to win and which will lose becomes a more important question for investors.

But if central banks lose control of long-term interest rates and inflation takes off, that will become a significant issue for all types of assets, Bascand said.

Harbour Asset Management managing director Andrew Bascand. Photo / Supplied

ANZ Bank chief economist Sharon Zollner told the meeting that NZ has come out of lockdown measures sooner and more thoroughly than the rest of the world, but the recession here is just starting.

Because the tourism industry and its spill-over impacts won't be returning to normal any time soon, that means about 5 per cent of the economy won't be bouncing back.

But domestic tourism, which accounts for about 40 per cent of the total, will also take a hit because people tend not to spend on anything non-essential during economic downturns.

"It's discretionary spending so, if we're going into recession and high unemployment, people will prune their spending."

Tourists from Australia normally account for about a quarter of international tourists "but Australia is also facing a fairly nasty recession," Zollner said.

Because Australia hasn't had the same success as NZ in eliminating the virus, and it's still unclear whether it will be able to achieve that, the likelihood of a trans-Tasman bubble remains in doubt.

"You don't want to jeopardise 95 per cent of your economy in order to throw a lifeline to 5 per cent of it," Zollner said.

Soaring dollar

She is expecting unemployment will peak at about 10 per cent, somewhat worse than the 7 per cent peak after the GFC, and between a 10 per cent and 15 per cent fall in house prices, although that's in the context of house prices having risen nearly 10 per cent in the last 12 months.

"We were very late to the money-printing economy" and the extent of it is likely to grow from the $60 billion currently envisaged to about $90b, but "they will eventually hit some limits – the more you intervene in markets, the more you break them," Zollner said.

A big problem for the Reserve Bank is the soaring NZ dollar – it is trading above 65 US cents now after breaking below 56 cents in March – because usually in recessions the currency falls and provides a cushion under export earnings.

"That's pretty unhelpful and it does mean the Reserve Bank is going to have to keep their feet flat to the floor."

Rob Campbell, who chairs casino operator SkyCity Entertainment Group, Tourism Holdings and Summerset Group, said it isn't going to be easy for businesses.

"At the moment, the overwhelming atmosphere around most board tables is weathering the situation and trying to make some judgements about the next six to 12 months" and trying not to be overly concerned with things such as what share prices are doing.

ANZ Bank chief economist Sharon Zollner. Photo / Dean Purcell

Boards are looking at their balance sheets and cash "harder than they probably have ever done before," and are "trying to make realistic calculations about what they can achieve in the next six to 12 months."

Because of the degree of uncertainty, companies are going to be very cautious about investment and employment decisions.

"Being over-optimistic about the speed of the recovery would be dangerous."

But he rejected suggestions that there will be lasting changes to how people behave.

"One hears all these things about how the world's going to totally reset. It's a bit of a New Year's resolution theory."

The natural tendency of businesses is to first stabilise and then to try and get back some growth momentum, "but you're inevitably more cautious than you were before."

A large part of Tourism Holdings' business is offshore and it has experienced a sharp bounce-back in demand for motor homes in the United States, but international tourism to NZ stopped.

While domestic tourism may help, "we're not going to get out of this by buying ice creams from each other and going for drives on the weekend. It's a long haul for tourism."