This article was previously published in the NBR.
Like many Kiwis, for my family 2023 began with a rainy week on holiday trapped indoors when we’d rather have been at the beach. It felt like an apt way to start the year, given the dismal 2022 investors endured and the general consensus outlook for 2023. It feels like everyone is resigned to the fact we will enter a painful recession, however the outlook for the New Zealand share market is more promising.
The New Zealand share market does not equal the New Zealand economy
The New Zealand share market in 2022 fared relatively well by global standards, with the S&P/NZX 50 gross index returning -12%, compared to -18% for the S&P 500 in the US, for example.
Yet the New Zealand market is a curious beast. It contains around five times the number of ‘defensive’ companies compared to other global benchmarks, and an eclectic mix of companies. Some companies like Fisher & Paykel Healthcare and a2 Milk generate almost all their sales offshore. So, the prospects for the New Zealand share market, and companies within it, are a bit different to the local café or tradie.
There is understandably concern over the strength of economic headwind we face domestically from Kiwis refinancing mortgages onto higher rates in 2023, and how much discretionary spending this will suck out of the New Zealand economy.
We have seen early signs of the impact through some listed companies who are exposed to Kiwis’ discretionary spend. For example, My Food Bag saw delivery numbers in the 6 months to September down over -9% with profits down -38% compared to the previous year. Over the November-December period, The Warehouse Group saw sales down -5.5% year on year (when just a few months ago, in September, inflation was running at +7.2%).
2022 was a case of shoot first, ask questions later
The share prices for many companies have felt the brunt of investor concerns heavily already. You would be forgiven for thinking Mainfreight had a terrible year as a business, with its share price down -28% in 2022.
In fact, over the course of the year, analyst expectations for profit in its upcoming 2024 financial year are up around +14%. Management is more confident than ever on fulfilling Mainfreight’s long term global growth potential. The team has a fantastic track record of profitable growth. They turn up to work every day very much aligned and hungry to gain and satisfy customers and grow the business despite a potentially tougher environment. The latest update showed their profits in October and early November were 11% higher than last year.
The leadership team has been adding to their significant shareholdings recently, underscoring the strength of their belief in Mainfreight’s future prospects. As legendary investor Peter Lynch put it, “insiders might sell their shares for any number of reasons, but they buy them for only one: they think the price will rise.”
Mainfreight is by no means alone, other companies with some exposure to the local economy like Freightways have been treated similarly by investors. Of course, investing in these companies does not come without risk as business could be slower than expected. But it would seem at least some of this risk is already reflected in the share prices.
Negative sentiment can enable powerful turning points
When market sentiment becomes particularly negative towards a company or sector, there can be a sharp reversal if the pessimism proves unfounded. 2022 saw many examples of this, such as The a2 Milk Company and Fisher & Paykel Healthcare, the second-best performers in the S&P/NZX 50 index for the year and fourth quarter, respectively.
The a2 Milk Company endured a tough time in recent years, contending with the impacts of COVID related border closures, inventory management headaches and a falling birth rate in China. Some market participants had written it off as a train wreck. But under its rebuilt management team a2 has steadily executed well to deliver on its strategy. It’s share price rose +24% over 2022 and finished the year up +76% from its lows. Most of this was an unwind of the pessimism in the share price, as analyst expectations for its future earnings are broadly unchanged.
Similarly, Fisher & Paykel Healthcare underperformed through the first three quarters of 2022. Demand for consumables in its Hospital division were lower than expected, as customers reduced their higher-than-normal inventory holdings before purchasing more product. An end to this dynamic, and a surprise small positive earnings announcement in the first half result, saw sentiment improve and the company’s share price up +24% in the December quarter.
We’ve seen that simply showing things are not as bad as feared can lead to strong share price performance for these growth companies.
What a difference a year can make
2023 has begun as almost the polar opposite of 2022. Investors are fearful rather than greedy and it now feels that interest rates can only go up – there has been no central bank ‘pivot’ towards lower rates yet.
Investors are currently prizing defensive companies with lower earnings risk and paying a premium to do so.
Spark and EBOS are examples of this. In 2022, highly valued growth companies were among the worst performers, in part due to their high starting valuations. The performance of defensive companies may be constrained in 2023 – because starting valuations are higher than historic levels and some have potentially lower long-term earnings growth compared to the growth stocks that were sold-off so spectacularly in 2022.
A year is a long time. By the end of 2023 the broader outlook may have changed, but no one will ring a bell to tell us this is happening. Regardless, if beaten up growth companies can deliver even close to expectations or better, they may see some of the biggest gains, as a2 and Fisher & Paykel have recently shown.
