New Zealand - Safe Haven Or Value Trap?

Includes: AUNZ, ENZL
by: Econ Grapher

New Zealand has attracted significant bond flows in recent months as the island nation's status as a safe-haven, or relatively-safe-haven, has been galvanized by Euro worries. But where is New Zealand's economy headed? And does the country deserve this 'relatively-safe-haven' status? And of course, what does this mean for New Zealand's share market - which for most people will be expressed as the ENZL exchange traded fund?

The timing of this article is not random; in the past couple of weeks we've had the Reserve Bank of New Zealand's (RBNZ) regular monetary policy statement, Q1 GDP data, current account data, and just last month was the annual budget. So let's now review these key macro indicators.

Monetary Policy Statement

The RBNZ held the OCR unchanged, and curbed any hopes of a rate cut by upping its inflation forecasts and maintaining a view of a continued improvement in economic growth over the next couple of years. The RBNZ did pull it's 90-day bill rate path in a little, with an implied rate hike coming around June 2013. The RBNZ made repeated reference to the Euro crisis as a key downside risk for the economy through the commodity price and bank funding cost channels. All in all the tone could be described as cautiously optimistic, particularly on the likely boost to come from the Canterbury earthquake rebuild.

Q1 Gross Domestic Product

Statistics New Zealand reported Q1 GDP up 1.1% QoQ on a production basis (0.8% on an expenditure basis). This figure was well above consensus expectations, but much of the strength came from inventory building (basically the flip-side of the December quarter), with core final demand components relatively subdued (Private consumption flat, government consumption a small positive, and Investment positive), while net exports were a significant detractor as commodity prices eased off. Overall it was a good result, but not as good as the headline figure suggests; full year GDP is likely to be around 2-3% this year and around 3% next year.

Current Account

The current account deficit deteriorated to -4.8% of GDP in the year to March 2012. This marks a turnaround in the balance as the economy has improved. New Zealand runs a more or less permanent structural current account deficit due to its banking sector being majority owned by Australian banks. The only thing that will improve this is a strong pick-up in the trade balance; possibly aided by a long overdue drop in the New Zealand dollar (NZD).

Budget 2012

Overall the budget affirmed the Government's desire to return to fiscal surplus, and therefore affirmed a negative fiscal impulse (see graph) in the near term. However the budget struck a good balance between allowing for growth and striving for fiscal sustainability. The Government also noted in the budget that much of the circa $10 billion budget for the Canterbury rebuild will be spent in the next two years, and also affirmed its intention of conducting share sales and IPOs of key state owned enterprises (largely energy companies).

So where does that leave the outlook for New Zealand investment markets? The first place to look is the share market. For many international investors, the simplest entry would be using the ENZL exchange traded fund. The chart below shows the performance of ENZL against the benchmark NZX50 index. Some of the variation can be explained by currency movement and the different components (ENZL replicates the MSCI New Zealand Investable Market Index, which is concentrated on the larger names in the NZX 50).

According to Yahoo Finance, the average PE ratio of ENZL's holdings is 14.5, with an average price to book of 1.3 and price to sales at 0.9, with ENZL having a historical yield of 6.34%. For some investors this would look like an interesting value opportunity. However the New Zealand market does tend to trade on lower valuations, with companies generally paying higher dividend yields than in places like the US. This probably contributes to the fact that NZ equities have a lower beta or correlation with global equities; often under-performing in an up market, and holding ground in a down market.

As for the New Zealand dollar (which used to have an ETF by the name of BNZ that is now a part of AUNZ), the story is similar to the interest rate picture. As you may have concluded from the quick run-through on the economic outlook, New Zealand is in a relatively sound fiscal and economic situation, and as such deserves or at least attracts 'relatively-safe-haven' flows during the risk-off moments. But the NZD is strongly influenced by interest rates and commodity prices, so during risk-off periods, New Zealand interest rates tend to rally, while the NZD will usually sell-off.

In summary, New Zealand offers a relatively unique set of features. The government is stable with a strong rule of law, low levels of corruption, high transparency and low costs of doing business. The equity market historically offers a relatively high yield, while the fixed income market currently benefits from 'relative-safe-haven' status.

The key sensitivities for the economic outlook in New Zealand rely, externally on the course of the Euro crisis and the path of the Australian and Chinese economies, while internally rely on the health of the strengthening property market and the pace of the earthquake rebuild in Canterbury. Provided the global situation doesn't markedly deteriorate, New Zealand's economic prospects for the next couple of years should be relatively good.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.