We continue to have a cautious view on the global economic and market outlook as:

- the global housing crisis has still not bottomed
- the banking sector is still going through a significant deleveraging process
- the upcoming corporate earnings result season is likely to be poor
- interest rates have more upside than downside potential (other than in New Zealand) due to rising inflation pressures.

For the US economy and sharemarket to make a substantial and sustainable recovery the US residential housing market must start to improve markedly. The good news is an adjustment process is under way with new home sales and building levels down dramatically. This will eventually lead to lower US housing inventory levels. The bad news is that this process will take some time to conclude. In the meantime there are increasing numbers of foreclosures adding to housing inventory levels.

The deleveraging of the US financial system is another key factor behind our caution about the US outlook. Deleveraging also applies to households, who are being squeezed by rising costs, falling house values and the increasing possibility of losing their jobs. Companies are also being affected by having to borrow at higher rates. Finally, banks are capital constrained with multiple bad debt exposures and face increased regulation. There appears to be little scope for this deleveraging process to be completed quickly.

The market’s expectations for corporate earnings growth has progressively decreased over the past six months. For the US, June quarter earnings are expected to be down 7 per cent with a large variation in company results and outlook statements.

Finally, in a period of a global economic slowdown inflationary pressures are rising. Much of this is stemming from the emerging economies, which are now effectively exporting inflation to the developed world. In emerging countries an economic slowdown may need to be carefully engineered to ensure that inflation does not run out of control. There is some risk, in a vulnerable economic environment, that this adjustment may not be smooth.

New Zealand is a variation on the above themes with the economy currently in recession and a savage residential property sector adjustment unfolding. Not only is there a volume and price downturn but property developers (and their financiers) are also “hitting the wall”. Other areas of concern are the retail sector, where companies are really struggling, coupled with the prospect of rising unemployment levels across most sectors. Throw in banks dealing with increasing credit delinquencies and rising funding costs and you have a recipe for a very tough domestic economy for the next 6-12 months.

The good news is that the current (and future) New Zealand Government has a tax cut programme and the RBNZ has significant scope to cut rates. Both tools will be used to boost a flagging economy but this will take time to take effect. Thus, an export led recovery appears the most likely scenario for New Zealand to lift itself out of its current economic downturn. There is also some selective value starting to emerge in the New Zealand sharemarket, after it has been one of the poorest performers over the past six months.

Last 5 posts by Anthony Quirk

• Wealth transferred to banks - February 4th, 2009
• Keep investments selective - January 22nd, 2009
• Caution is the word - October 16th, 2008
• CDO write-offs have local ramifications - July 29th, 2008