New Zealand’s investment community appears cautiously optimistic about the prospects for the sharemarket this year, although they warn that the first half could continue to be tough for investors.
Last year the S&P/NZX50 index fell 12 per cent, with just 13 of the 50 member stocks finishing in the green. That came on top of 2021, when the index fell by 2.5 per cent.
Mohandeep Singh, senior research analyst at Craigs Investment Partners, says that while markets do bounce back, it would be naive to think this year will see a huge rebound.
“Historically you do get these rebounds but I think it is going to be - the first half of the year is going to be - a pretty tough slog because the hangover of all the risks of last year hasn’t gone away yet.
“You’ve still got the geopolitical stuff, still got inflation being pretty ugly. We haven’t seen too many positive prints on that and you have still got central banks - not just ours but everywhere - still going, this time we are really going to stamp this out. We are not going to capitulate halfway through the hiking cycle.”
But Singh says it’s not all doom and gloom and central banks are closer to the end of the hiking cycle than the beginning, inflation appears to be peaking and market valuations have come back to a more reasonable level.
The average price-to-earnings ratio of NZ companies has dropped from 30 times at the start of 2022 to around 22 times.
“While this isn’t necessarily a ‘bargain basement’ valuation, it does sit well below the 25 times average of the market over the past five years.”
The reporting season kicks off in the middle of next month, and Singh expects some companies will be flagging downside risks to their earnings.
“All the interest rate rises haven’t been for nothing, they are starting to hit consumers as those mortgage rates flow through.”
The country’s largest retail group - The Warehouse - has already received ratings downgrades from Forsyth Barr and Jarden after a slow Christmas trading period.
Singh says companies that are influenced by discretionary spending could find it tough.
“I know it has been a tough year for everyone in the sharemarket but you look at those discretionary names - whether it’s The Warehouse, Kathmandu (KMD Brands), SkyCity - I know there are nuances there for each of them ... but investors are already looking at that and going ‘geez, I’m paying more on my own mortgage, which means I have got less money to spend’ and those are the places that are probably the first people stop spending money at.”
But fortunately, says Singh, there are a lot of other companies on the NZ market which aren’t linked to discretionary spending, such as the telco and electricity sectors, where most consumers will keep paying up.
“They don’t have that earnings risk as much as some of those others. What they do have is the point of difference they had a year ago, 18 months ago, is not as attractive - term deposit rates 18 months, two years ago were pretty dire. The dividend yield you got on defensive companies like the electricity companies, Spark and Chorus was pretty attractive relative to what you could get in the bank. Now that difference has tightened up quite a bit.”
“The reality is the ‘risk-free return’ on a term deposit is much closer to what a dividend yield is on some of those defensive names.”
That meant those stocks faced greater valuation risk, he said. But regardless of that, Singh still believes sectors like the electricity companies will do well because of the ongoing drive to reduce emissions and move to renewable energy sources rather than fossil fuels.
“You are going to see lots of electrification so demand for that sector is still pretty good, which means they will grow their dividends.”
But he said the situation meant there would be challenges on both sides of the spectrum in the first half of the year: earnings risk and valuation risk.
Singh is picking that the market will do better in the second half of the year.
“Markets typically move ahead of the data.” He points out that the official cash rate is forecast to peak in the early 5 per cent range by mid-year.
“Once you are there you have got a reasonably stable position because you know they are not going too much higher than that - if anything they are coming down in time. And then that has got to wash through the economy as well which takes a bit of time.
“I think the data will still be ugly because you will see those soft recessionary numbers coming through ... the data has a lag.”
He expects the market to look through the interest rates but says investors will likely remain nervous and be focused on businesses with a good track record.
”In recent history, we have seen pretty much everything on the sharemarket go up. That rising tide lifted all ships whereas through this next period, there will be a lot of focus on fundamentals again.
“It will be harder to get people to take their money out of their pockets and put it into the market because of what you have seen in the last 18 months - human behaviour means they will be nervous - they are not going to just throw it at anything. They will be looking for good quality companies with reasonable demand. I’m cautiously optimistic about the second half.”
Matt Peek, Fisher Funds NZ equities portfolio manager, says the starting point for the NZ market is much more favourable for long-term returns than it was a year ago.
“You’ve had valuations come back a long way - often to below historical averages where we haven’t been for a long time and sentiment is far more mixed. A lot of people are worried about how shares might perform and how the economy might go - all this talk about recession. Some of those things are positive. The starting point is much more favourable for long-term returns than it was a year ago.”
But he says there are a couple of caveats to that.
“You want to avoid earnings risk that might come about through business performance being worse than expected - that’s the major caveat, although in some cases it feels like share prices have already reacted to factor some of that in.”
While valuations have come down, Peek says defensive stocks have held up well and were the best performers last year.
“It would surprise me if it was the same this year because all those companies that people don’t perceive to have much earnings risk have traded on premium valuations, especially relative to everything else.
“So while they might not carry the same earnings risk, you are paying a premium for that lack of earnings risk.”
He believes growth companies, which have been out of favour, could be some of the best performers this year, pointing at a2 Milk and Fisher & Paykel Healthcare which surprised on the upside at the tail-end of 2022.
“There was almost a consensus pessimism with the likes of a2 and Fisher & Paykel Healthcare where people thought the business was going to go bad and the share price reacted and the multiple came down and then actually they didn’t need even need to really outperform but just deliver in line or near enough.”
Richard Stubbs, a partner at Castle Point Funds, says his optimism is driven by how downbeat the general consensus is.
“It’s mainly because of how bearish just about everyone is about the economy and markets.
“When everyone believes one thing, markets usually do the other and that’s because that thing that everyone believes is already priced in.”
He says that doesn’t mean there might not be some major black swan event this year.
“There are definitely some risks out there. The Ukraine war could escalate, there’s a bit of erratic behaviour from the Chinese Premier and there is always the risk with this dramatic rate rise period that has gone on that some unforeseen contagion occurs and you never really know where that comes from.”
Still, he says it is remarkable how resilient the economy has been.
“We essentially had a crash in the technology companies last year and crypto - the Nasdaq finished the year over 30 per cent down. We have had house prices drop more quickly than they did during the GFC.”
He believes the crash could throw up some investment opportunities in the tech sector.
“Companies will disappear undoubtedly, but really good companies will get dragged down with them, and have been in fact. Amazon and Google were the risers of the decade, if not century, after the dotcom crash and I think there are some genuine opportunities in that sector.”
Devon Funds head of retail Greg Smith believes 2023 will be a better year than last year. “That’s not to say the first half might not be a little bit challenging. We have got a lot of people coming onto those higher mortgage rates. So we think discretionary expenditure, that remains pressurised, particularly in the first half and maybe most of the year.”
But he says there are some positives such as China reopening that could bolster certain stocks.
“China opening up is going to help supply chains. All those supply chains got really blocked during Covid, China is only just coming out of lockdown so that should help.”
Smith said a2 would likely be breathing a sigh of relief, although figures out this week on China’s population drop would be a headwind.
“Companies like Auckland Airport could also benefit from China reopening ... and tourism stocks as well.”
Smith noted that even though Briscoe Group was a consumer stock, it was also a big importer.
“It’s going to be helpful to those companies, even though consumer discretionary spending will still be under pressure.”
OPINION: You never know when bad luck might strike.