Comment: Why NZ's sharemarket is racing ahead of Australia

COMMENT:

As far as rivalries go down under, it doesn't get much bigger than New Zealand vs Australia. However, while bragging rights have been shared relatively evenly across our major shared sporting codes over the years, the story is somewhat different in terms of stock market performances (at first glance anyway).

Over the past decade while the NZ50 has gained around 275 per cent, our Antipodean neighbours' ASX200 has risen by just 75 per cent.

However, before we start with another round of high fives (we love beating the Aussies don't we), we are actually talking apples and oranges. Many commentators extolling the performance of our 'rock-star' market, but over the years have frequently omitted the fact that the NZ50 is an 'accumulation' index – it effectively includes dividends. The typically quoted ASX200 is a 'capital' one and does not. Factoring in dividends, the equivalent accumulation benchmark over the Tasman has kept pace reasonably well, rising around 260 per cent over the same timeframe.

This would seem to make intuitive sense with the Australian stock market just as high yielding, an economy arguably more diverse and a better performer. Australia has in fact epitomised being the lucky country, as far as recessions go, having not had one for almost three decades – whereas NZ saw one in the aftermath of the GFC.

Enough of the history lesson, and as most people know driving using the rear-view mirror is generally when trouble starts to happen. But, a number of recently emerging tailwinds for the Australian stock market bolsters the case for kiwi investors, if not completely packing their bags, at least increasing portfolio exposure across the Tasman.

The ASX200 has recently come within a whisker of the all-time highs last seen in late 2007, with an initial spark provided by a market friendly 'surprise' election result. This has seen the avoidance of Labor's proposed policies, such as an overhaul of negative gearing and changing the treatment of excess franking credits (Aussie retirees effectively get cut a cheque for any they don't use).

Enthusiasm has been stoked further by the Reserve Bank of Australia, which, having been on hold for 2 ½ years, has cut rates in quick succession to a record low of 1 per cent. This appears to have already boosted a 'correcting' property market – auction clearance rates have been on the rise, and Sydney/Melbourne house prices recently recorded their first monthly rise in a couple of years.

Of course, our own RBNZ has also been in the (global) easing mode, and there is a better than even chance they will cut rates at the next OCR in early August.

The problem I have however with the New Zealand central bank's current strategy is that it appears to be very much a Jekyll and Hyde one.

On one hand the central bank is looking to stimulate the economy through a lower cash rate, whereas on the other, planned increases in bank capital requirements (to insulate against a once in 200 year event!) will choke off credit at precisely the wrong time in the cycle, and potentially rub out the stimulatory impacts. This is also in contrast with the regulator in Australia (APRA) which in the past week has reduced the levels of capital it planned to ask banks to set aside.

I suspect the RBNZ will cave to increasing pressure (ANZ for instance has already 'threatened' to pull back from its operations here), but the problem is that the final decision is not expected until December, which could provide a lingering source of uncertainty (perhaps for the economy and market) till then. The consequences if put through could be dire, and particularly for the likes of our key dairy industry, which is already feeling the squeeze.

Whereas over in Australia, the government, central bank and regulators all seem to be very much on the same page. The recent uptick in the property market there has also come as the prudential regulator has relaxed a key lending constraint, while the government has also committed a very legitimate first Homebuyers' scheme. This is also helping the banking sector to 'move' on from the grilling and remediation fallout of last year's Royal Commission.

Scott Morrison's Australian government is also looking to effectively 'keep the party going' by rolling out tax cuts and sustained infrastructure spending (around $100 billion over the next decade). In our opinion, the government is on the 'right track' here; even if they are taking a leaf out of Donald Trump's book.

Despite this, Australia is also forecasting a return to a budget surplus in 2019/20, owing in no small part of a resurgent resource sector - iron ore prices recently hit a 5-year high, while the likes of A$ gold is at record levels thanks to a weak currency. There is also plenty of 'wiggle room' in the government forecasts – iron ore for instance is pegged at US$55 for March 2020, more than 50 per cent below levels currently.

A big question for Australia, perhaps, remains the outcome of current trade frictions, with China the country's biggest trading partner. While yet to be resolved, it looks however that this may also be a 'lucky' outcome, with the US getting ready to 'deal,' so Donald Trump can move on and focus on the 2020 elections.

Back to our comparison, on a valuation basis the ASX200 also looks relatively more appealing, with a PE of 17x versus the NZ50's 19x. The average yield on offer at 5.4 per cent, is almost a full percentage point higher than here.

Looking further ahead, could our two markets actually become one down the track? I was somewhat surprised to learn recently that the Australia constitution provides for New Zealand to 'become' an Aussie state should it so choose.

Perish the thought, but the case for combining our equity markets may make some sense. A thought for another day!

- Greg Smith is the Head of Research at Fat Prophets, an independent research and funds management house.