New Zealand


Global Economy 

  • The global economy is likely to remain influenced by many of the same factors during the coming year. Based on current information it is difficult to see what could cause either a sharp increase or decrease in global economic growth. Consistent with this outlook are leading economic indicators from the International Monetary Fund (“IMF”) which point to economic growth of around 3.4%.  
  • The Chinese economy will remain a key focus during 2016. The IMF forecasts economic growth to slow to 6.5% from 6.9% as structural economic reforms continue. It appears likely that China will allow its currency to fall further. The impact of a steady devaluation is manageable; however, an unexpectedly large devaluation would be more destabilising as we observed in August last year. A sharper than expected slowdown in China remains the key risk for the global economy. 
  • In the US, the IMF has forecast economic growth to be  similar to 2015  at 2.6%. The focus remains on assessing the impact of December’s interest rate rise on the economy.  Although a further rate rise is “on the table” in 2016, it seems difficult to justify a further increase in the near term given the current global backdrop and some “patchy” economic data. 
  • Australian economic growth also looks set to remain stable during 2016 with an IMF forecast of 2.9%.  A key area of focus will be developments in the Australian residential property market. Personal consumption accounts for nearly 60% of Australia’s economic growth. The willingness for consumers to spend in recent years has no doubt been assisted by the increase in wealth received from rising house prices. 
  • Residential property price growth is expected to decline during 2016 as lending restrictions placed on investors continue to impact demand. Residential mortgage interest rates also appear to have bottomed with the banks no longer passing on any RBA interest rate cuts. The chart below shows the declining participation by investors in new home loan creation. 

Source: JP Morgan 

Cash and Fixed Income

  • The RBA is forecast to cut interest rates by 0.25% to 1.75% during 2016. The RBA made reference to the volatility in global markets at its February meeting and remains alert to any potential impact on the domestic economy. There is now more scope to lower interest rates to support the economy given the risk of further overheating the residential property market is receding. 
  • The structural headwinds for the Australian dollar will remain in place during 2016. China’s slowing economy continues to place pressure on commodity prices and the prospect of lower domestic interest rates looks likely to push the currency towards $0.65 under most forecasts. 
  • Lower domestic interest rates means yields on domestic fixed income will remain around 3 – 3.50% over 2016. The sector remains attractive for its defensive qualities which were again on display during January’s equity market decline. The sector provided positive returns during January against falls in the domestic equity market. 
  • Global fixed income also displayed its defensive qualities during January, posting positive returns against falls in global equity markets. Although global interest rates remain low, there remains scope to achieve a 4% income return from the sector by investing across a diverse range of countries and sectors. 
  • Our 2016 fixed income strategy remains unchanged in the current environment. We remain focused on areas of the market which provide both a reasonable yield and diversification benefits. We continue to avoid higher yielding sectors which carry a higher risk of capital loss. Sectors such as global high yield and emerging market debt still do not provide a sufficient a return for the potential risk to capital.  


Australian Equities

  • Australian equities appear reasonably valued trading on Price / Earnings (“PE”) ratio of around 15x in January against a long term average of 14.3x. The forward dividend yield is approximately 5% and in excess of 7% when franking is included. Dividend yields remain attractive when compared to domestic interest rates and the fixed income sector. The chart below shows the PE Ratio at December 2015 against the long term average.  

 Source: JP Morgan 

  • The main challenge for Australian equities is finding earnings growth in market dominated by banks and resource companies. Stocks which are exhibiting earnings growth are being aggressively re-rated by investors and any company showing declining earnings is getting aggressively sold off regardless of the quality of the business. This is causing some valuation extremes in both directions.
  • Given the above dynamic, it remains better to hold a portfolio of quality stocks rather than follow short term momentum, which can turn quickly in a volatile market. Investors have “thrown out” blue chips stocks in favor of small and mid-sized growth stocks were there is higher perceived earnings growth. As a result, the S&P/ASX 20 is now the cheapest area of the market on a valuation basis. 
  • The market is likely to churn sideways for much of 2016 in what is likely to be a volatile year. Opportunities are likely to present themselves when good businesses, with stable cash flows are oversold during market volatility. An income return of 5% and modest capital gains would be a good outcome in what looks to be another transitional year. 

International Equities 

  • International equities will continue to play an important role in portfolios during 2016. The sector provides important diversification away from sectors which are prominent in the Australian market. International investing provides the opportunity to reduce exposures to the financial and resources sectors and increase exposure to the IT and health care sectors.  The table below compares the sector exposures between International and Australian equities.

 Source: JP Morgan 

  • From a valuation perspective, Europe, UK and parts of Asia are undervalued relative to the US. Europe and Japan remain focused on easing monetary policy, whilst the US is moving in the opposite direction by raising interest rates. The Chinese market remains unlikely to attract significant professional interest under its current structure. However, many larger Chinese companies can be accessed via more developed Asian markets such as Hong Kong and Singapore. 
  • Investing in international equities during 2016 will also provide an opportunity to benefit from any further falls in the Australian dollar. The Australian dollar also tends to decline during periods of market volatility and this provides an added source of diversification for a portfolio.
  • International equities generally favour growth over income and as a result income from the sector ranges from 2 – 2.5%. Capital growth is more likely to come from regions where economic policy remains accommodative. A positive total return from a combination of income, capital growth and the currency would be a satisfactory outcome during 2016 as the world’s major economies continue their transition.   


  • The primary role of alternative investments or hedge funds is to provide diversification from equity market risk. These strategies have been “true to label” during January posting strong positive returns during what has been a very weak start to the year for equity markets. 
  • The strategies are designed to benefit from rising and falling markets across stocks, commodities, bonds and currencies. These strategies are likely to play another important part in portfolios during 2016 given the volatility in these markets, looks set to continue.   

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