Investment review

• US real gross domestic product (GDP) rose by an annualised 3.5% in the September quarter, the first sign of expansion since the June 2008 quarter. A range of indicators suggested that a patchy sort of recovery is underway. The manufacturing ISM indicator unexpectedly dipped slightly to 52.6 in October, while the non-manufacturing ISM showed a solid rise to 50.9. Auto sales plunged following the end of the cash for clunkers scheme, leading to a 1.5% month on month (mom) fall in retail sales in September, while ex-auto sales rose by a healthy 0.5% mom. However, consumer confidence fell during the month. Housing market indicators were mixed. Housing starts, permits, new home sales and mortgage applications were weaker than expected, while existing home sales were strong and house prices rose for the fourth consecutive month in August on the Case-Shiller index. Employment fell by more than expected in September and the unemployment rate rose to a 26-year high of 9.8%.
• In Europe, business surveys pointed to an economic expansion, with the EU Purchasing Managers’ Index rising to 50.7 in October, its highest level in 18 months. Germany’s Ifo business climate index continued to trend higher, reaching a 13 month high of 91.9 in October. Industrial production in August continued to increase from its lows earlier in the year with gains of 11%, 6% and 5% in Italy, Germany and France respectively. The weakest major economy in the region was the UK, which recorded a surprising fall in GDP of 0.4% quarter on quarter (qoq) in the September quarter, while industrial production fell by 2.5% mom in August.
• The recovery remained strongest in Asia, helped by the bounce in global trade. Industrial production in Japan was up 22.4% in August from its low in February, while consumer sentiment reached a two year high. China GDP rebounded by 8.9% year on year (yoy) in the September quarter, with the country showing exports recovering, industrial production up 13.9% yoy and retail sales up 15.5% yoy.
• The Reserve Bank of Australia (RBA) became the first major central bank to raise interest rates, increasing its cash rate by 25 basis points (bps) to 3.25%. Norway’s central bank raised rates later in the month by 25 bps to 1.5%.
• Outlook: The global economic recovery is expected to broaden and intensify over the next six months. However, we will need to see a more meaningful pick-up in final demand, otherwise the recovery so far – driven by temporary fiscal stimulus and changes in inventories – will not be sustained.

New Zealand

• Economic data pointed to further economic expansion in the September quarter. However, to date, we’ve seen a wide gulf open up between the very positive confidence indicators compared with measures of actual economic activity, which (outside of housing) remain fairly subdued.
• Consumer confidence rose to a 22-month high in October on the ANZ-Roy Morgan index, but we’ve seen a pretty modest increase in spending so far. Retail sales rose by 1.1% mom in August and ex auto sales rose by 1.2% mom. However, this follows a weak couple of months and nominal trend sales growth is running at about 2.5 yoy.
• Business confidence slipped a touch in October on National Bank’s survey. However, the own activity indicator reading of an above-average net 31% is still consistent with annual real GDP growth of circa 4%. The BNZ Capital - Business NZ Performance of Manufacturing Index rose to 51.7 in September, the highest since February 2008. The Quarterly Survey of Business Opinion showed a surge in confidence and forward looking indicators. However, this reflects the weak position of the previous survey and is a reminder of how far and fast confidence has rebounded in the last three months.
• House sales continued their rising trend, up 44% yoy in September, as did house prices. The REINZ Monthly Housing Price Index rose by 1.9% mom in September and is now up 7.9% from its low in January. Consistent with improving trends in the housing market, dwelling consents continued to improve. While year-on-year comparisons remain weak, the number of consents excluding apartments was up 25% in October from the low reached early this year.
• CPI rose by 1.3% qoq in the September quarter and by 1.7% yoy, the lowest annual increase in five and a half years. That said, underlying measures range from 2.0% to 2.8% and annual non-tradeables inflation at the bottom of the recession only fell to 3.0%.
• At its official cash rate (OCR) review, the Reserve Bank (RBNZ) of New Zealand the left the OCR unchanged at 2.5%. However, it firmed its policy tone by removing any reference in its statement to a possible lower OCR and brought forward the first rate hike from the latter part of 2010 to the second half of 2010.
• Outlook: We expect to see ‘harder’ economic data like GDP and retail sales improve over the next six to nine months, as currently suggested by the survey evidence. The stimulatory policy environment and better global backdrop should support this trend.
• 
  

International shares

• Review: Following the massive run on global shares since March, markets took a breather in October. Volatility stepped up a gear as investors wondered whether or not markets rose too far too fast, considering the lingering doubts about the strength of the economic recovery. After a strong run in the first half of the month, a correction in the order of 5% ensued, with the MSCI World Index down by 2.2% for the month.
• The correction came despite a strong US earnings season. By month-end about 81% of S&P 500 companies reporting had beaten expectations. Tight cost control was a feature of the reports, which enabled companies to increase their margins as the economic recovery got underway.
• By region, emerging markets outperformed developed markets as did Japan. The UK and US performed broadly in line with the world index, while Europe underperformed. By sector, energy and consumer staples were the only two broad sectors to show positive returns, while the worst performing sectors were financials, utilities and industrials.
• Outlook: We see the recent market correction as healthy. We do not believe the market is overvalued and like the improving economic fundamentals. Consequently, we remain positive on the market despite the possibility of further short term downside and volatility.

New Zealand shares

• Review: In line with recent trends, the New Zealand market performed better during the correction, after underperforming during the global rally. The NZX 50 Index rose by 1.7% and the NZX Portfolio Index rose by 1.9%.
• There was a lot of corporate news to digest with the annual meeting season well underway. The key message was that business conditions were improving coming out of the recession, but there remained a lot of uncertainty about the outlook.
• Restaurant Brands was the top performing stock, with its strong result in a diffi cult economic climate appealing to investors. Other strong performers included Auckland International Airport, Pike River Coal, Warehouse Group, Sky City Entertainment Group and Contact Energy.
• Worst performing stocks included Pan Pacific Petroleum, a new entrant to the NZX 50; Rakon, following its capital raising; Fisher & Paykel Appliances, whose businesses are struggling in the current economic climate, particularly in the US; Fisher & Paykel Healthcare and Telecom NZ. Pyne Gould Wrightson announced a strategic partnership with Chinese firm Agria, which includes a conditional cornerstone shareholding, setting the stage for a capital raising.
• Outlook: New Zealand shares remain good value relative to cash and bonds and earnings are at the beginning of an upswing from a depressed level. They are likely to lag any positive trend in global shares, but equally they will perform better in a relative sense should global shares correct further.

New Zealand listed property

• Review: The listed property sector index gained 1.7% over the month of October in line with the broader sharemarket. ING Medical Properties Trust and Goodman Property Trust were the best performers, up 4.3% and 4.0% respectively. National Property Trust was the worst performer for the month, down 2.0%.
• Kiwi Income Property Trust and National Property Trust announced six month portfolio revaluations during the month. Kiwi Income Property Trust’s net portfolio value reduced approximately 3.5%, or $66 million, to $1.83 billion. The retail portfolio declined 2.5%, largely due to further weakening of capitalisation rates, while the office portfolio declined 5.0% mainly because of a softer outlook for office rents. The weighted average capitalisation rate for the overall portfolio increased 18 bps to 7.88% over the six months to 30 September 2009. National Property Trust reported a net portfolio value reduction of 2.2% or $4.4 million to $196.7 million for the six months to 30 September 2009. The decline was also largely attributable to weaker capitalisation rates and an easing in market rentals.
• AMP NZ Office Trust reported a first quarter net operating profi t of $16.08 million (after current taxation), a $2.64 million increase over the previous corresponding period. Rent reviews for the first quarter were up 6.8% to $34.99 million which included rent reviews, new leases and lease renewals carried over from the second half of 2009 financial year as well as those completed in the first quarter of the current financial year. Interest costs reduced $2.13 million or 32.8% to $4.37 million from the retirement of bank debt following the completion of the renounceable rights issue.
• Outlook: We expect that valuations will remain affected by lower market rents and, to a lesser extent, softening capitalisation rates. Further asset sales are likely as some of the listed property vehicles continue to focus on reducing gearing and others are willing to sell non-core assets if offers are at attractive levels. As the property market conditions reach their lows and begin to improve, the vehicles with strong balance sheet positions may look to take advantage of acquisition opportunities that arise in the market.

International bonds

• Review:With Australia’s and Norway’s central banks both tightening monetary policy, there was much speculation about when the G5 central banks would initiate tighter monetary policy. It was well acknowledged that the addition of quantitative easing policies complicated matters this cycle. The general view is that the central banks of the US, Euro area, Japan and UK are still some way off raising interest rates but that policy statements will need to be gradually modified to address the eventual turnaround in policy. US 10 year Treasuries fell to 3.15% early in the month, • th, before ending 8 bps higher at 3.38%. The 2 year rate actually fell by 6 bps to 0.89% as the market lost some confidence in any chance of an early tightening. UK and Germany 10 year rates were little changed, up 3 bps to 3.62% and up 1 bp to 3.23% respectively, while Japan’s 10 year rate rose by 11 bps to 1.42%.
• The magic ride for corporate bonds came to a halt, in line with increased risk aversion. Moody’s BAA corporate bond index showed the first monthly increase in yield since March, with the rate up 10 bps to 6.27%.
• Outlook: Government debt yields are in a trading range which we see persisting for the rest of the year. Corporate debt continues to offer the best value in the fi xed income space, although after a very strong run investors are likely to become more selective.

New Zealand bonds and cash

• Review: The RBA’s early tightening had a negative impact on New Zealand’s bond market as investors saw both New Zealand and Australia as early adopters of tighter monetary policy compared to the G5. While the market began to aggressively price in tighter New Zealand monetary policy from as soon as January, the RBNZ’s comments later in the month led to some reversal and the market to push out the timing and extent of rate cuts through next year.
• The 90 day bank bill rate fell by 2 bps to 2.79% while the 2 year swap rate traded in a wide range, reflecting gyrating expectations on monetary policy. It began the month at 4.32% and rose as high as 4.87%, before falling back down to close the month at 4.53%. New Zealand 5 year government stock rose by 18 bps to 5.50% while the 10 year rate rose by 12 bps to 5.73%.
• Outlook: Our central forecast remains that the tightening cycle begins in March 2010. This changing mood towards tighter monetary policy and further signs of economic recovery are likely to encourage a flattening yield curve.

New Zealand dollar

• Review: The collapse in risk appetite towards the end of the month resulted in the New Zealand dollar falling for the first month since February. The NZD/USD cross rate rose strongly, surpassing the $US0.76 mark in the third week, before collapsing to end the month at $US0.7229.
• After its hammering through the year to date, the pound sterling was the strongest major currency, while the yen was the weakest. The earlier than expected tightening by the RBA, as well as a strong trend in commodity prices, helped support the Australian dollar.
• The monthly point to point changes in the NZD belie the rollercoaster ride. The biggest falls were against the pound sterling (-3.0%) and Australian dollar ( 2.4%), followed by a 1.0% fall against the euro and just 0.1% fall against the USD. The NZD rose by 1.0% against the yen. On an MSCI weighted basis the NZD fell by 0.6% while it fell by 0.8% on a trade weighted basis.
• Outlook: On our constructive view of the global economy and sharemarkets, the trend for the NZD is more likely to be higher than lower over the next six months, supported by higher commodity prices and the RBNZ moving to tighten policy ahead of the G5 central banks.