Sky-high valuations are setting NZ equity markets for a rapid return to earth, according to AMP Capital NZ.
The manager’s latest NZ ‘Insights’ publication notes the 2019 bounce-back from December quarter woes has seen local shares defy investment gravity with an average forward price-to-earnings (PE) ratio of 27.3 times – well above the 10-year norm of 18.3 times.
While the PE expansion was partially supported by record low interest rates NZ equities “remain firmly overvalued” even in the current era of bottom-dwelling bond yields, the paper says.
Based on the AMP Capital analysis of bond yields to NZ share PEs, the local equity market was 21 per cent above “fair value”.
Previous NZ equity valuation extremes – such as in the expensive run-up to the global financial crisis (GFC) and an historically cheap patch in 2011/12 – have tended to revert rapidly once the music stops, the report says.
“Today’s period of over-valuation has been the case for a couple of years now and it too will end quickly when it does end,” the AMP Capital paper says. “The crystal ball does not extend to when or why, but the key will be recognising the trigger when it arrives.”
But the 2019 share price recovery in both Australia and NZ has been lop-sided with the rises weighted to larger companies. In Australia, a JP Morgan analysis dubbed the phenomenon the ‘P Explosion’ after the top 20 per cent most-expensive ASX-listed firms experienced multiple increases of almost 19 PE points during the last year. Over the same period, the bottom 60 per cent of ASX-listed companies suffered share-price stagnation.
“In other words, the most expensive companies have become nosebleed expensive and everyone else has been left behind. This brings back memories of 1999,” the AMP Capital paper says. “New Zealand has experienced the same phenomenon, with the one-year forward PE being 27.3x versus the median of 15.6x. This tells us that there are plenty of attractive valuations still on offer, it’s just that they tend to be in smaller and mid cap companies.”
AMP Capital says the bias to large companies could have been fueled by the growth of index funds, more ‘black box’ quantitative strategies, rising risks for smaller firms in a slowing economy and “ultra-low interest rates favouring mega-multiple growth companies and ultra-expensive defensives”.
“Given current valuation levels, far lower returns should be expected in New Zealand equities than have been experienced in recent years,” the report says.
AMP Capital is also picking global bond yields to stay “lower for longer” in the wake of central bank easing across the world. The $20 billion plus fund manager has pushed out its local fixed income duration slightly in anticipation of Reserve Bank of NZ rate cuts this year while bumping up holdings of “high grade” credit to enhance yield.
“We also maintain our exposure to inflation linked bonds as they remain cheap in an environment of shrinking excess capacity and where the RBNZ appears to favour easier monetary policy to boost economic activity and support a lift in inflation,” the AMP Capital paper says.
The Insights report was authored by AMP Capital NZ managing director, Bevan Graham, and fixed income analyst, Carrick Lucas, as well as Matt Goodson, director of Salt Funds Management. Salt manages a portion of AMP Capital’s local equities portfolio, including the $500 million plus NZ Shares Fund. Harbour Asset Management took over from Salt last December as underlying manager of the $17.6 million AMP Capital Responsible Investment Leaders NZ Shares Fund.