Gareth Morgan, director of Gareth Morgan Investments
Globally, interest rates continue to fall as economic recovery in the expensive economies of the industrialised world – remains meek, and inflation slowly ebbs. This fall in rates can be put squarely down to the inability of the world’s most expensive economies to resume the pace they’ve averaged over the last 25 years. The 1980s formula of running on empty via the rapid expansion of debt no longer applies, and there’s little left but the hard graft of replenishing capital stores through thrift.
Still the market expectation is economic recovery will soon break out all over and the boost to share values so far driven mainly by interest rate falls will be bolstered by earnings surges. Another year passes, economic growth disappoints so interest rates fall again. Share prices surge in response to the rate falls. But the same forces delivering lower inflation and growth, can also undermine corporate earnings. Nobody believes the economic recovery-based earnings surge originally priced into share valuations won’t arrive.
Why should earnings rise? For most economies the reality of international capital market deregulation has at last arrived – a decade after the event maybe but nevertheless it’s here. That reality is capital is now free to move where it likes, so siting plants in the expensive economies of Western Europe and Japan is no longer necessary. Capital loves cheap land and labour to work with and, subject to falling victim to the odd political disturbance or two, those conditions are now enjoyable in abundance elsewhere in the world. Why should capital stay sited in the expensive economies trying to compete in global markets with those cost disadvantages?
So where in the spectrum does NZ sit? Thanks to the deregulatory moves of the late 1980s it spans the divide between the thriving emerging economies and those atrophying under the weight of over-valued currencies. The reward of reform is being reaped in part by asset price appreciation. Parts of NZ Inc. will thrive but large parts of its corporate state are as competitively sick as their European and Japanese contemporaries. Inappropriate management structures and weak commodity markets are the primary causes.
Meanwhile New Zealanders increasingly replenishing personal wealth through thrift, have to decide which investment horses to back. The idea that our own sharemarket is on a sustained across-the-board recovery is naive. As well as the success stories there will be big earnings disappointments and shareholder loyalty will not pay off in those cases. The pricing of some assets is clearly running ahead of earnings capabilities and already the sharemarket has lost some of the discriminatory pricing indicative of an informed investor clientele. Ramping value simply on the back of global interest rate falls is no more valid now than it was in 1986. On that occasion a rise in interest rates shook sense into world markets. On this occasion slow recognition of unsatisfactory earnings performance is the threat. A slow world economy means our commodity sellers will struggle – who’d believe that in light of current market valuation of their assets?