New Zealand's sugar rush bounce back is wearing off, writes Sam Dickie. Photo / Supplied
The NZSE50 has underperformed global markets by almost 15 per cent in 2021, after a whopping 25 per cent out performance over the previous five years. Sam Dickie, senior portfolio manager at Fisher Funds looks at what has caused this underperformance and if it is set to continue.
New Zealand's sharemarket is the worst performing developed market in 2021 – down 4 per cent while global stock markets are up 10 per cent. However, this comes on the heels of a five years of significant out performance.
In the five years to the end of 2020 the NZ market gained a staggering 107 per cent, versus global markets which were up 82 per cent. It is worth digging into the drivers of this performance, and considering what could happen next.
New Zealand was the poster child in the fight against Covid. According to Our World in Data, New Zealand has been 34 times more successful than the rest of the world in defeating Covid. The country's cumulative cases are a mere 2531 or 0.05 per cent of the population, well below the 132,420,000 or 1.7 per cent of the population globally. As a result, New Zealand's economy recovered faster too. We stamped out Covid and re-opened quickly. We spent money locally instead of overseas. And our housing market boomed.
But, New Zealand's sugar rush is wearing off. We are feeling the pinch of the international tourism hole and the NZ economy is now performing worse than expectations. The global economy on the other hand is in the sweet spot we were in last year and continues to perform better than expectations. Global economies are now benefiting from reopening their domestic economies as they vaccinate their populations.
NZ is a more interest rate sensitive market than global equities. This is because the NZX50's weighting in defensive companies is five times that of other global markets. Defensive companies like utilities and property, that often offer higher dividend yields, do relatively well when interest rates are falling.
This was the situation from 2016 to 2020 in New Zealand (when the 10-year bond rate fell from over 3.5 per cent to less than 1.0 per cent). However, these companies do relatively poorly when interest rates are rising. And interest rates have near doubled since late 2020. The NZSE50 has a dividend yield of 2.7 per cent, almost twice the dividend yield of S&P500 at 1.4 per cent, and some investors value this extra yield less in a period of rising interest rates.
The strongest sharemarket performers globally year to date have been cyclical stocks or "reopening plays". Investors have been selling Covid winners and buying Covid losers. They have been buying companies that benefit as economies re-open. NZ is more heavily weighted to defensive companies (utilities and property) than to re-opening plays like oil, banks, airlines and industrial companies that populate many global markets.
The final reasons for the New Zealand market's recent underperformance are idiosyncratic. While the US S&P500 index has 500 companies and the largest single stock weighting is 5 per cent, the NZSE50 has 50 companies and the largest single weighting is 16 per cent. The top 10 companies in the S&P500 make up 26 per cent of the index while the top 10 companies in the NZSE50 make up 60 per cent. So, single companies can materially impact index performance in NZ.
a2 Milk has been one of the worst performers in the NZSE50 year to date. Over the past 12 months or so, there has been too much supply of a2's platinum infant formula product and not enough demand from China. This excess supply has driven down the selling price of the a2 platinum product. So volumes, revenues and profits have been much lower than the market had expected.
This pain was exacerbated by Covid, travel restrictions and lockdowns impacting the flow of product from New Zealand via Australia to China.
Contact Energy and Meridian Energy prices spiked late last year, thanks to strong US investor interest in the renewable energy sector (on the back of President Biden's clean energy reforms). This investor interest in clean energy exchange traded funds (ETFs), like the iShares Global Clean Energy ETF (ICLN), which saw its number of shares swell from 58 million in June to 219 million in January. Meridian Energy and Contact Energy happen to be two of the largest holdings in ICLN due to their large renewable energy operations.
Did ICLN's US investors realise they were buying electricity companies in New Zealand, which will not benefit from Biden's clean energy reforms? We doubt it. But this did not matter, the mechanical buying propelled Meridian Energy and Contact's share prices significantly higher late last year.
This ETF driven buying has unwound this year, dragging down the share prices of Meridian and Contact – and the New Zealand market with it. The methodology of the index underlying the ICLN ETF has changed.
As a result, more companies have been added to the ETF and the allocation to less liquid companies (such as Meridian Energy and Contact Energy) have been reduced to prevent this irrational exuberance happening again. The forced selling of Meridian and Contact shares when the ETF rebalanced its weightings caused significant weakness in their share prices - which retreated over 30 per cent from their peaks.
Explaining historical market movements is the easy part – guessing what comes next is harder. While the recent underperformance of the New Zealand market can be rationalised, the key question is how will it perform relative to others markets in the years ahead? This is much harder to predict! Reopening now seems at least partially priced into global markets. What drives returns from here will be the individual companies and how they fare. We believe, buy exceptionally high-quality companies with long runways for growth, almost irrespective of the economic backdrop.
• Sam Dickie is a senior portfolio manager (New Zealand shares and property and infrastructure) at Fisher Funds
BNZ and Westpac now have the lowest six-month and one-year rates on the market.