Page 18 - Taking Stock 22 Summer 2019

DREAM RUN STRAINING CREDULITY The New Zealand economy has certainly been healthy, and we continue to expect low recession risk at home and abroad. Nevertheless, a variety of domestic assets are now ‘priced for perfection’ – in other words, their valuations are so high that only a sustained period of ideal economic conditions would justify how expensive they have become. Here are a few examples: > The P/E ratio on New Zealand shares has reached extremes not seen in the last two decades. > NZ equities outperformed their global counterparts by a cumulative 30% over the last three years. > NZ government bond yields have lost their historical ‘country risk premium’ above US yields; for instance the NZ 10 year Government bond yield is currently below its US equivalent. > Residential property prices remain close to record multiples compared to buyers’ incomes. > Listed property assets are at an all-time high, having gained 11% in 2018 compared to 6% for the NZ equity market – an unusually-large 5% outperformance gap. The key New Zealand asset that is no longer overvalued is the currency. The NZD/USD exchange rate has now returned to fair value levels at just above 68 US cents. That means we do not expect a marked fall in the NZ dollar (NZD) in 2019, as was expected in 2018. However, should the NZD recommence a declining trajectory, it would likely be due to a softer domestic economic outlook leading to expectations of lower policy interest rates; or due to a price shock in our key commodity exports or in China. While Government tax coffers remain in good shape, the scal horizon could deteriorate if spending increases too much. This could be the result of state-sector wage increases, economic development programme, or the inevitable reduction in consumer spending that would follow any worse-than-expected news on the housing market or the employment situation. 18