This year has been a tough one for investors with returns on equities and bonds being pummelled by inflation and steeply rising interest rates and experts don’t expect next year to suddenly get better.
John Carran, Jarden’s chief economist believes markets will continue to be volatile.
“We have been advising particularly in terms of equities to be a bit on the cautious side. I think that’s largely because there is a risk to earnings going forward and that’s because we are heading to a slowdown period globally and here. To a degree, some of that has been priced in but I don’t think it has been fully priced in yet.
“Earnings expectations do seem to be on the optimistic side at an aggregate level.”
How badly company earnings get hit will depend a lot on how exposed they are to consumers and how much consumers tighten their belts in the rising interest rate environment.
Forsyth Barr analysts this week said the Reserve Bank had done its best to make sure none of us approach 2023 with any illusions of good times ahead.
“Mortgage rates have hit a 10-year high, inflation is expected to remain stubbornly elevated, and the icing on RBNZ’s economic cake is its forecast of four quarters of declining GDP.
”This bleak backdrop will clearly influence 2023 to a large degree.”
But the analysts remain hopeful things could be looking up by the end of next year.
“2023 is 12 months long, and towards the end of the year, we see numerous potential positive inflexion points. Less bad is often good enough for the animal spirits to return and a year-end market rally is not off the table.”
Shane Solly, senior portfolio manager at Harbour Asset Management expects company earnings to continue to track down.
“Most people are expecting that. It’s the degree and where and how. That first half of 2023 is all about how deep, how far the recession is and earnings fall. At that point you hopefully start to see some inflation data that is going through - suggesting the central banks have done enough. Then they go on pause hopefully, and that’s breathing room.”
There are signs that inflation is coming down internationally with the US reporting annual inflation of 7.1 per cent for November down from 9.1 per cent in June.
Carran says the evidence is not quite as convincing for New Zealand yet.
Partly that is a data timing issue. NZ reports its inflation data quarterly whereas other countries report monthly.
“We do have survey data which shows that costs pressures are still pretty high although you could argue they have moderated slightly. But then again inflation expectations have gone up recently.
“It may be we have to wait a bit longer than some other places offshore because of the dynamics of our market particularly given how tight our labour market is. Labour markets are tight everywhere around the world but I think they are particularly tight in New Zealand. That will be a key factor in how long inflation pressures persist.”
While the Government announced more changes to open up immigration this week Forsyth Barr analysts still see it as a big issue for companies, especially those with larger workforces.
“The companies we expect to be most impacted are those with a high proportion of costs linked to salaries, but a relatively low ebitda [earnings before interest, tax, depreciation and amortisation] margin — aged care and technology stocks are at the top of the list. While the aged care sector - Arvida, Oceania Healthcare, Summerset and Ryman - is facing significant employee cost pressures, indications are good that Government funding will improve to help offset cost increases.”
On their technology watch-out list are stocks that have yet to make a profit like ikeGPS, Pacific Edge, Serko and Trade Window.
“All of them have high employee costs - more than 50 per cent of operating expenditure - which makes breaking even that bit harder.”
The analysts also noted that NZX, SkyCity, F&P Healthcare, Napier Port and Argosy Property were also exposed with high employee costs and low ebitda margins.
“Least impacted by rising employee costs are the property companies - Asset Plus, Goodman Property, Investore and Vital Healthcare - with management contracts — labour pressures are an issue the management companies have to deal with.”
Carran believes a recession is a possibility.
“I think the consensus is we will have a significant slowdown and potentially that might manifest itself as a recession but whether it’s a recession in a technical definition it is going to feel like a reasonable slowdown.
“We are starting to see hints of it now in the economy and I think that will be magnified next year as the rapid interest rate increases we have experienced recently have their full effect next year as people roll onto higher interest rates and as they react a bit more to the fall in house prices as well because that traditionally affects people’s ability and confidence to spend as well.”
Forsyth Barr analysts note the outlook for New Zealand also seems to be worse than other countries, particularly Australia and the US and as such it will look to invest in New Zealand companies with international exposure.
“NZ does have a reasonable number of companies with substantial international exposure. We believe many of them will perform better as a consequence. The RBNZ is forecasting four consecutive quarters of negative growth, followed by two quarters of zero growth. A bleak outlook compared to Australia, US or the rest of the world.”
They are picking the likes of Vulcan Steel, Kathmandu and Infratil to perform well given their strong international businesses and tilt towards Australia.
Carran says there are some positives next year.
“We are seeing some encouraging signs on the tourism side. It does seem to be rebounding quicker than many people had thought and we are seeing that through the net migration numbers too. It’s coming back quite quickly so potentially as we get more people in the country obviously that won’t do anything for inflation pressures but it could help generate a bit of growth and help counteract some of those negative spending pressures.”
Forsyth Barr analysts note the key winners to date have been the airlines. But they say the travel recovery will take time, particularly in New Zealand given its long-haul reliance and seasonality.
They suggest airline yields will come under pressure and fall through 2023 because of the tougher economic climate for consumers. But companies like Auckland Airport, SkyCity and Tourism Holdings will continue to improve over the next couple of years.
“While we believe the recovery is more than priced into Auckland Airport, we believe upside potential continues to exist for SkyCity and Tourism Holdings.”
Solly says while the recovery in reopening activity is helpful he is wary about businesses that are too dependent on cyclical strong economic activity.
“We think there is risk around that.”
Growth stocks have been hammered in the past year so Solly is looking to stocks that offer a blend of defensive growth - the likes of Ebos and Infratil - that have structural tailwinds behind them.
“Mainfreight is in the same camp but has been caught up to a degree in the slowdown in activity - that’s driven long term by more secular trends - the move to logistics, move to outsource is not going away.
“Covid has shown us people want and need to understand their inventory management to make sure they are delivering to customers on time.”
Solly says there is still a place for cyclical companies - the likes of the banks and mining companies, which have done well in the past year through the strong economy - they are just a bit more expensive now.
“The pricing of those stocks is reflecting some of that strength. They are still relevant - still worth looking at.”
The other factor next year is the general election.
Carran says that could create volatility - particularly around the New Zealand dollar.
“Elections don’t tend to have a lasting impact on the markets in NZ. It’s more determined by what happens offshore and the fundamentals of the economy. It can cause some volatility around the time or in the lead-up to elections. I don’t think it’s something that longer-term investors will worry [about] too much.”
Typically big deals can take a pause ahead of an election as players wait and see what the result is. A change to a National-led government could give the business community a boost of confidence given it tends to prefer blue to red.
Better in a year
Carran also suggests things could be looking up again towards the end of next year.
“It could be a year of turning points in a way. I think as we go through next year we probably will get a bit more clarity on where the labour market is heading and where inflation is heading and how some of those labour shortages are sorting themselves out. It could potentially be a year of pivots in terms of central banks - our own central bank perhaps easing up on the accelerator in terms of tightening monetary policy and perhaps even hinting at some cuts towards the end of next year or early the following year.
“Things will move on from the current state of everyone worrying about inflation, everyone worrying about the tight job market and coming recession and then they will be looking forward to what’s next. We might see a relatively short cycle hopefully and there will be a bit more optimism emerging from the middle of next year onwards.”
This is the last Stock Takes of the year. We wish you a Merry Christmas and Happy New Year. Stock Takes will return in January.