This will be our last newsletter for 2023 and we’d like to sign off with some positive news to lead into 2024. We will be taking a couple of weeks off, from December 22nd, back on January 8th 2024.
There have been some positive signals for investors and borrowers recently. Let’s start with one that should please both:
Interest rates are expected to come down. We receive weekly market news, attend investment seminars and digest all things finance related so you don’t have to. Plus we enjoy it.
Here is a list of recent information that we believe will see 2024 be a better year:
ASB is predicting the OCR (official cash rate) will remain unchanged through 2024. Easy prediction to make after the Reserve Bank said there will be no more rises in May, and confirmed rates will remain unchanged until inflation is under control. So why is this good news? The Reserve Bank is looking for signs of weakness in the economy and will drop rates when they start to appear. If they can raise rates by 5.25% in 19 months you can cut them just as quickly. There are definitely signs that all is not well in the economy, anecdotally we are seeing more clients associated with the construction industry and government laid off or hours reduced. Select Wealth just shared that manufacturing numbers are down.
The Capital group are predicting the Federal Reserve Bank (The US equivalent of the Reserve Bank) fed funds rate will drop over 2024, as depicted below.
Cash on the sidelines.
There is a huge amount of cash sitting in cash accounts in the US, as indicated by the chart below (Courtesy of Capital Group). You can see that in June 2023 there was $5.43 trillion. This is what normally happens when markets tank and interest rates rise, there is a flight to safety (cash, bank savings accounts). The amount though, is huge when compared to the cash sitting in accounts around the time of the Global Financial Crisis (GFC). What happens to that cash as interest rates drop? People are happy to take on board more risk for a better return.
Its not often that cash is the top performer of an asset class as seen by the illustration provided by Booster Investments. In fact, of the last 14 years, cash has been the top performer just once. While NZ Shares and NZ Property four times each. You’ll note, a balanced portfolio tends to sit in the middle.
US company reporting
In recent reporting from US companies, earnings appear to have been through the trough inflicted by interest rate rises and is on the mend. (Courtesy of Capital Group)
There is currently good value across most sectors when compared with ratios over the last 10 years.
Based on Price/Earnings Ratios, IT and Health care appear to be the only sectors overpriced. However, they are both sectors where new innovation is rapid, and valuation models are historic looking. Also, it could be argued that with innovation in the finance sector, traditional banks could be under threat. Do consumers even need a traditional bank anymore? So, parts of the financial sector could be overvalued, even though it is below the average 10-year price earnings ratio.
What does it all add up to?
With positive US company reporting, interest rates predicted to drop and a huge amount of cash sitting around, 2024 looks positive for property, bonds and shares.
Note, apart from Boosters illustration, this data is predominantly from the US which make up the bulk of capital markets. If company’s earnings are improving, it can come at the expense of individuals (company improved cost efficiencies ie cost cutting). So, watch out for slower employment growth in the US.
If the Reserve Bank does hold the OCR at its current rate for longer, New Zealand may take a while longer to look as positive as the US. If anyone has a good poker face, it’s the Reserve bank!
From Independent Economist Tony Alexander
Interest rate outlook shifts down
Three weeks ago the Reserve Bank released their quarterly update of economic forecasts and predicted that the rate of inflation in New Zealand will fall to 2.5% by the end of next year. But they also predicted that they would increase the official cash rate one more time to 5.75% and they wouldn't be making any cuts until the middle of 2025.
On the face of it there is an inconsistency in this outlook and it has just been made even more stark by data released on the state of the New Zealand economy. Rather than growing 0.3% during the September quarter as the Reserve Bank had estimated our economy actually shrank 0.3%. More than that, earlier estimates for growth in the previous three quarters were all revised downwards.
It looks like the economy is showing a greater reaction to high interest rates than the Reserve Bank has factored into its projections. As a result we have seen some substantial falls in wholesale interest rates with extra downward pressure also coming from lower than expected inflation and economic growth numbers recently released in other countries.
Most notably also, in the United States the Federal Reserve have just said they do not anticipate raising their key interest rate any longer and plan instead to make three cuts over 2024.
The chances are now good that our central bank will start cutting the official cash rate from its current 5.5% in around the middle of next year. Before then we are likely to see banks cut their fixed mortgage rates and there is now a good chance of some reductions ahead of Christmas.
However, in the absence of solid data showing a slowing in the pace of wages growth and with business pricing expectations still at well above average levels we shouldn't expect the Reserve Bank to actually make any easing comments for a number of months. They probably won't want banks to make any large cuts to interest rates in the very near future. So the most likely scenario over the next two to three months is that the reductions in fixed mortgage rates will be relatively small and banks will take the opportunity to earn some greater profits before competition for mortgage business kicks up in earnest at some point in 2024.
Taking this outlook into account, if I were a borrower at the moment I might currently sit floating waiting for the first initial cuts in fixed rates before locking in a relatively short fixed rate. Personally, I'd struggle to justify fixing for only six months because of the hassle involved. But I could see myself showing some preference for the one year term. Good luck and Merry Christmas.
For additional information on the economy, housing market, and interest rates, you can subscribe to Tony’s free weekly Tony’s View publication at www.tonyalexander.nz
Disclaimer: This newsletter is meant to be informative and engaging, hopefully not a cure for insomnia. Please don't take this as personalised financial advice. Discuss your situation with an Advisor. This is where I need to say past returns are no guarantee of future returns.