The year that was: 2009 – the great stabilisation

- Editor


Throughout the year, central bankers and government treasury officials around the globe continued to use an ever increasing array of unorthodox policies in an effort to ensure the global financial system was able to function, and that economic growth did not fall to depression levels. Policy makers will point to much improved global growth forecasts for 2010 as proof that the moves they made were successful. Businesses, in particular financial institutions, were forced to strengthen their balance sheets and while some of the new capital came from traditional channels, an extraordinary amount was provided by governments around the world. This shift of debt from the corporate/private level to the sovereign/public level left a number of countries in dire straits fiscally and facing a long, slow recovery if they are to return to pre-crisis debt levels. In that respect, 2009 could also be seen as the Year of the Great Debt Swap.

2009 began with cautious optimism as governments around the globe announced stimulus programs to spur a recovery in economic growth. Capital markets enjoyed a brief new year’s rally before some of the troubles of the previous year reared their ugly heads again. Attention was again focused on the health of the large financial institutions as company earnings and economic data continued to disappoint. Governments were forced to pledge support and provide capital to large banks, insurance companies and government sponsored entities such as Freddie Mac and Fannie Mae. In early March, US Treasury Secretary Geithner released details of a Financial Stability Plan that involved stress testing the large banks and setting up a ‘bad bank’ in an attempt to remove illiquid, hard to value assets from bank balance sheets. This led to an improvement in market sentiment and coincided with the bottoming in the rate of decline for a number of key indicators including housing data, consumer and business confidence and unemployment levels. As economists and analysts wrote pages hypothesising on whether the recovery would be V-shaped, U-shaped, the shape of an inverted square root sign or indeed not begin for some time, credit and equity markets staged one of the steepest recoveries ever witnessed. The rally from the early March lows was as sharp as the decline and continued virtually unabated for the rest of the year, although not at the same pace.

Global Economy

As a result of the global financial crisis, 2009 was always going to be a difficult year for world economic growth. At the beginning of 2009, there were still enough encouraging signs from the developing areas of the world for the International Monetary Fund (IMF) to forecast positive global growth of 0.5%. This was made up of negative growth in the advanced economies compensated by larger positive growth in emerging economies.

It soon became clear that the troubles of the global financial system had yet to be fully resolved and developing countries would be slowed down by a larger degree than initially expected due to less capital inflows and falling international trade. Economic data did improve over the course of the year in a number of countries as business and consumer confidence readings recovered from very low levels. Despite this recovery, by the end of the year the IMF still expected the world economy to contract by nearly 3% for 2009 with a 10% fall in world trade.

The US and European economies both contracted sharply in the first quarter of 2009 following on from equally bleak readings for the last quarter of 2008. Europe’s decline was not quite as steep as the US. The larger economies of Germany and France recovered relatively quickly, while smaller countries at the periphery of Europe struggled. Ireland, Portugal, Spain, Iceland, Greece and a number of Eastern Europe countries all featured in the news for the wrong reasons with collapsing house prices and deteriorating fiscal positions of national governments causing concerns.

Over the course of the year, government stimulus packages were put in place providing some support to falling growth. For the third quarter of 2009, the UK was the only developed economy that did not register positive economic growth. The struggling financial industry in Britain makes up a larger proportion of the economy relative to other nations. Elsewhere, stimulus packages have been more successful. One of US president Obama’s first steps when he took office in January was to introduce a massive US$900 billion economic stimulus package. At the end of 2008 China dipped into its significant reserves and launched a two-year, 4 trillion Yuan (US$590 billion) economic stimulus package. China has the luxury of not having to deal with the procedural hurdles more democratic nations face and the bulk of this extra spending was quickly in place. The government sponsored banks were forced to continue lending with scant regard for increasing levels of non-performing loans, and by year end a property boom appeared to be underway. While the Chinese economy did not grow at the pace of previous years, it did not slow down to the extent many predicted.

Interest rates lower for longer

Having cut rates aggressively in 2008 in response to the global financial crisis, central banks continued to loosen monetary policy and indicated they would leave rates low for as long as required to prevent dampening an economic recovery. The steep rise in commodity prices and food prices off very low bases in 2009 might normally have suggested inflation headaches for policy makers. However, large output gaps and excess capacity utilisation meant inflation has not looked like it’s getting out of control to date. High levels of unemployment have kept wage inflation under control. The US Fed had already lowered the target rate to 0.25% by the end of 2008, and this remained the target for the whole of 2009 – only slightly above the Bank of Japans target rate of 0.1%. The European Central Bank (ECB) and Bank of England (BOE) both cut rates by 150 points to 1.0% and 0.5%, respectively. As well as moving cash targets to emergency low levels, the focus of central banks has been on ensuring the mechanisms by which credit is extended to businesses and consumers function more efficiently. The UK and the US initiated the largest quantitative easing programs relative to the size of their economies, focusing on increasing the supply of money in the financial system, rather than the rate at which funds are lent. This led to some economists predicting a hyper-inflation scenario but as yet this has not played out; though, the impact of the QE programmes has been reflected in weaker currencies. The US dollar and British pound were two of the worst performing currencies of 2009.

The Reserve Bank of New Zealand (RBNZ) cut 150 points in January to a record low of 3.5%. This was followed by successive 50 point cuts at the February and April meetings to leave the OCR at 2.5% for the remainder of the year. The Reserve Bank of Australia (RBA) followed a similar pattern but was less aggressive in their cuts meaning the cash target across the Tasman bottomed at 3.0%. This was the first time since the late nineties the cash rate in New Zealand was below that of Australia (except for a month in late 2003). Australia’s unemployment rate increased but nowhere near as much as other developed countries and technically the ‘lucky country’ never even entered recession, managing to eke out positive economic growth in all but one of the recent quarters. Its proximity to, and trading with, the developing Asian region meant it was ideally placed to weather the storm. The RBA felt comfortable enough with Australia’s growth prospect to hike 25 points at three successive meetings in the last quarter of 2009, thereby removing what they considered the ‘emergency cuts’ to monetary policy. The RBA was the only central bank amongst the G20 countries to hike rates in 2009.

Bonds

Having proven their worth as one of the few true diversifiers over the course of the global financial crisis, returns from global government bonds did not reach the heights of the previous two years. The JPM Global Government bond Index hedged to NZ dollars advanced 3.2% for the year following gains of 9% and 15% for 2007 and 2008, respectively. However, relative to the last ten years, government bond prices endured a volatile 12 months as yields moved sharply with investors torn between two conflicting forces. On the one hand the commitments made by governments to provide fiscal stimulus to keep economies from stagnating suggested there would be an excess supply of bonds in the near future. Contradicting this, however, was the steepness of the yield curve due to central banks bringing the short-end down to record low levels. This encouraged investors to take on some duration and purchase longer-dated bonds further out the yield curve. The quantitative easing programs whereby governments were active in purchasing longer-dated bonds also supported bond prices.

The star of the show in the fixed income world for 2009 was undoubtedly credit markets. Having blown out to multi-year record highs in 2008 and early 2009, credit spreads contracted sharply, moving ahead of equity markets. The tighter spreads and increased demand for corporate bonds was central to the improving sentiment in capital markets over the year. Companies were able to adjust the composition of their balance sheets, replacing bank debt and commercial paper with longer dated bond finance. This was particularly true for large companies in investment grade and sub-investment grade (junk) bond markets. At the other end of the scale, small and medium enterprises were still struggling to access credit, and remained reliant on bank funding.

Equity markets

2009 followed in the footsteps of years such as 1933, 1938, and 1975 in staging an impressive rally after a dreadful worst case scenario had been priced into equity markets. Fears of economic growth collapsing as a result of the global financial crisis resurfaced in January/February and equity markets reached new multi year lows. Governments and central bankers around the world made it clear they would not allow the global financial system to fail and the measures they introduced led to a recovery in business and consumer confidence. The initial rally off the mid-March lows was sharp as investors no longer priced in a depression scenario. Companies began rebuilding their inventories having run them down to very low levels and leading indicators turned sharply upwards suggesting the worst had passed. Wary investors were convinced that the early indicators of recovery were a false dawn, but as consumer and business confidence gained momentum those investors reluctantly bought into the rally. Despite relatively minor speed bumps at various points in the year, the equity market rally ran virtually unabated to the end of the year.

Financial companies were forced by governments and rating agencies to raise additional capital to cover write downs and other losses. Outside of the financial sector many other companies also tapped the equity and debt markets by issuing bonds or shares. Cash was also preserved by slashing capital expenditures, cutting dividends and halting share buyback programs. Earnings reports indicated companies were still struggling to stop top-line revenue from falling further and executives became increasingly unable to provide earnings guidance with any level of certainty. However, drastic cost cutting - reflected in rising unemployment levels - meant that earnings surprised on the upside versus pared back analysts’ expectations at each stage throughout 2009, providing further fuel for the rally.

One feature of the equity market around the world last year was the differentiation between cyclical companies and more defensive companies. While a distinction is normally observed at various stages of the economic cycle, it is not usually as marked and nor does it occur as abruptly as that observed in 2009. The trend of 2008 where defensive sectors held up relatively better than their cyclical counterparts continued in early 2009 as equity markets sold off. Then from the early March lows, cyclical companies led the rally as it became apparent that the global economic system would return to growth, albeit initially on the life support provided by governments and central banks. Demand for hard and soft commodities was driven by emerging countries such as China and India and the performance of materials sector (+47%) was second only to information technology (+50%) over 2009. Utilities finished the year unchanged from 12 months earlier, the only sector not to post a gain. As is usually the case in a market rebound, the early stage of the recovery was driven by the most ‘beaten up’ companies as they recover from very low levels (the so called ‘dash for trash’). In this case it was the financial sector (+22%) that rallied first with banks benefiting from reduced competition, better trading conditions and the steep yield curve.

The emerging nations became the main hope for driving global economic growth over the next few years given that they do not have the same debt hangover as their developed counterparts. The emerging regions equity markets recovered much more quickly developed markets. The Asia Pacific ex-Japan region was up 67% for the year and Latin America gained 63%, more than double the returns from more established areas such as Europe (29%), North America (+28%), and the United Kingdom (+28%). Japan was the laggard posting a 9% gain as it remained in the economic doldrums. The Japanese economy is ultra dependant on the export sector and was not helped by a strong Japanese Yen.

New Zealand’s equity market lived up to its ‘low-Beta’ characteristics with its limited financial and commodity exposure, falling less than the market early in the year but rallying to a lesser degree as equity sentiment improved. The NZSE50 finished the year up 20.5% after being down 11% at one stage in March. As was the case in offshore markets, capital raisings were a feature of the year as companies shored up their balance sheets. In the second half of the year, there was some initial public offering activity including a successful listing for Kathmandu. Top performers for the year were Restaurant Brands (+184%) and Pumpkin Patch (+124%).

New Zealand

New Zealand was one of the first countries to enter recession in 2008 before the global financial crisis took further toll on domestic growth. It wasn’t until the third quarter of 2009 that the local economy grew after five consecutive quarters of contraction. On a positive note, the recession here was much shallower compared to the majority of other developed countries. The first quarter of 2009 was the worst in most countries including New Zealand, but the 0.9% QoQ contraction in the local economy paled in comparison to some of the larger nations. Unemployment reached 6.5% by the third quarter of 2009, the highest level since the beginning of the decade. However, the jobless rate did not blow out as some worst case forecasts predicted and the 6.5% level is not a long way above the historical average. The RBNZ played their part by lowering the Official Cash Rate to a record low of 2.5%, providing some relief to borrowers at a business and household level. The New Zealand dollar fell below US$0.50 in March providing some assistance to the export sector.

NZ commodity prices recovered after falling sharply in 2008 and early 2009. Prices for dairy goods led the way. Whole milk powder prices bottomed at US$1800 per tonne in July and by the end of the year had rallied to above US$3500 per tonne. The kiwi dollar strengthened over this period to lessen the gains somewhat; however, Fonterra was able to increase their forecast for the 2009/10 season to $6.05 per kilogram of milk solid. The horticulture and meat/wool industry did not fare as well, with generally small price increases offset by the higher NZ dollar. Of the other main export industries, only forestry and aluminium saw an increase off the mid-year lows in terms of price in NZD.

The much anticipated slowdown of the NZ housing market had begun in 2008 and continued in early 2009. However, a combination of limited supply, positive net migration and the lowest mortgage rates for decades meant house prices stabilised quickly after falling less than 10% on a median basis, much less than many had expected. Indeed by the last quarter of 2009, a mini boom was underway again on lower number of sales than in 2008, but nonetheless median house prices ended 2009 at around the levels reached at the previous peak in late 2007.

National took the reins from Labour at the end of 2008 and, as promised in the election, tax cuts followed in March 2009. However, Finance Minister Bill English spent a good deal of the year explaining to the public, government departments and businesses that cuts to government spending would be required to prevent New Zealand’s fiscal position from deteriorating further. New Zealand maintained its AA rating with the major rating agencies; however, Fitch has placed the country on outlook negative. A working tax group is due to report to the Government in January 2010 with recommendations for measures to improve the efficiency, transparency and fairness of the tax system.

The NZ dollar roller coaster

Even for the traditionally volatile New Zealand dollar, 2009 was noteworthy for the dramatic swings in the local currency. By December 2009 the Kiwi was back above US$0.72, the same level as August 2008 before the panic from the global financial crisis reached new heights. In the 17 months in between, the NZ dollar fell as low as US$0.493 before recovering just as quickly to record a remarkable round trip journey. As risk aversion heightened early in the year, the NZ dollar continued to be shunned in favour of safe haven currencies. Speculative carry trades against low yielding currencies were removed and investors sought the relative safety of the US dollar. From the lowest level since late 2002 the last three quarters of 2009 saw relatively high yielding ‘commodity currencies’ such as the NZ and Australian dollar rally virtually unchecked as risk appetite and global growth prospects improved. Australia’s relatively benign passage through the global recession was reflected in a stronger Australian dollar. Versus the AUD, the NZ dollar fell 3.5% over the year to end 2009 buying AUD$0.809.