May 24, 2014
Brian Gaynor
There have been a number of recent comments that the New Zealand sharemarket is overvalued, just as it was in the mid-1980s. One of the arguments supporting this is that there are a huge number of new listings in the pipeline, a sure sign that a market is overvalued.
There are a large number of potential IPOs — maybe as many as 20 to 30 — but this is well short of 1985, 1986 and 1987 when there were 32, 50 and 65 IPOs respectively. These mid-1980s IPOs were particularly low quality with Michael Hill International the only one of the 147 new listings to have survived on the NZX in its original form.
A better way to look at investment markets is to assess whether local investors are over or under-invested. This can give us some indication whether the sharemarket, residential property or other asset classes are over-valued or under-valued.
The accompanying data on household (individual) financial assets is derived from Reserve Bank of New Zealand statistics. The December 1986 figures are just prior to the 1987 sharemarket crash and December 2006 was shortly before the global financial crisis.
The December 1986 figures give a clear indication that domestic investors were over-exposed to the NZX as they had $18 billion, or 26.5 per cent of their total financial assets, allocated to direct domestic equities. In addition they were exposed to the NZX through superannuation and managed funds, which had a much higher percentage of their portfolios invested in NZX companies than now.
In the 27 years since then householders have reduced their exposure to direct domestic equities from 26.5 per cent of total financial assets to just 9.3 per cent.
New Zealand households have become incredibly conservative as far as financial assets are concerned since the 1987 sharemarket crash.
This is illustrated by the following figures:
Total risk assets, which includes both direct domestic and overseas equities, have fallen from 28.5 per cent of financial assets to just 11.9 per cent over the 27-year period.
Income assets, which include fixed interest assets and bank and non-bank deposits, have risen from 37.6 per cent of total financial assets to a staggering 56.5 per cent over the same period.
Meanwhile life insurance has fallen from 10.9 per cent to just 2.2 per cent while managed funds and superannuation has risen from 22.9 per cent to 29.4 per cent since December 1986. The superannuation figures have been boosted by the introduction of KiwiSaver in 2007.
New Zealand householders are extremely conservative as far as financial assets are concerned and this is confirmed by Morningstar’s KiwiSaver figures which show that 55.6 per cent of these funds were invested in cash and bonds at the end of March. These KiwiSaver figures are completely consistent with the mix of total household financial assets.
However, New Zealand households take a high risk approach towards non-financial assets, especially residential property.
At the end of 1986 domestic householders owned $81 billion worth of residential property and had bank and non-bank loans of just $10.2 billion according to Reserve Bank statistics.
By December 2013 total housing value had surged to an estimated $720 billion and household bank and non-bank loans to $202.4 billion. The latter figure excludes student loans of $13.6 billion.
Thus, the following developments have occurred over the past 27 years: The total value of residential housing has increased 8.9-fold whereas the value of all companies listed on the NZX has increased just 1.9 times.
The country’s residential property is now worth 8.8 times the NZX compared with 1.9 times at the end of 1986.
Total household financial assets have increased by $197.3 billion since the end of 1986 while household borrowings have risen $192.2 billion over the same period.
In other words, domestic householders have an extremely conservative approach towards financial assets but adopt a highly leveraged strategy towards residential property. This is based on the premise that land is in short supply in New Zealand and land and property values will continue to rise year after year.
The figures emphasise the important role the Australian-owned banks play in New Zealand because they supply most of the mortgage debt and hold a substantial proportion of the $129 billion of household deposits.
In light of the huge increase in domestic residential property values over the past three decades — total residential property values have risen from just $53 billion at the end of 1983 to an estimated $720 billion 30 years later — it is not surprising that the OECD considers our residential property market to be over-valued relative to other western countries.
According to figures released this week, New Zealand has the highest price-to-rent ratio in the OECD as far as residential property is concerned, followed by Canada and Norway. We have the second highest price-to-income ratio after Belgium and are followed by Canada, Australia and France.
The cheapest houses are in Japan, Germany, Ireland and Portugal. All of these countries, with the exception of Germany, have had residential property crashes in recent years.
There is no question that we have invested far too much in residential property compared with other assets, particularly the NZX. For example the total value of the two major US sharemarkets — the New York Stock Exchange and Nasdaq — is greater than the total value of the country’s residential property.
In Australia total residential property is worth 3.1 times the ASX whereas New Zealand housing is worth 8.8 times the NZX.
This is not an argument that the New Zealand housing market is over-valued and is going to crash. It is also not an argument that the NZX is under-valued.
However, the figures do indicate that New Zealand continues to have a non-diversified economy with too much emphasis on housing, dairying and China.
The outlook for the domestic economy looks great at present because the strong migration inflow is boosting house prices, dairying remains strong even though prices have eased and exports to China are booming.
However, should any of these factors turn negative then the economic outlook will change dramatically. A sharp contraction in house prices will have a major impact on domestic activity as we have over-invested in this sector.
The downturn would be particularly severe if a housing downturn coincided with a slump in dairy prices and a significant slowdown in the Chinese economy.
That is why the big increase in IPOs should be viewed as a positive development, rather than a negative one, because it will help diversify the economy away from housing, dairy and China and also encourage households to have a less conservative and more diversified financial asset portfolios.
?This column is often asked about the longest-listed NZX companies. The clear answer to this is Sanford, which first listed on the NZX in 1904. Only nine other companies joined the NZX before 1970 and remain listed. These are; Hallenstein Glasson (first listed in 1947), Mercer Group (1959), Ebos (1960), Abano Healthcare (1962), New Zealand Refining (1962), Colonial Motors (1962), Steel & Tube (1967), Nuplex (1967) and Renaissance Corporation (1968).
The NZX needs more long-listed companies with genuine growth plans as only two of these 10 companies — Ebos and Abano — have strong growth orientations.
Brian Gaynor is an executive director of Milford Asset Management.