portfolio considerations · 7/31/2017 · portfolio considerations the world ignores trump, they...

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New Zealand Equity Strategy 31 July 2017

Portfolio Considerations

The World Ignores Trump, They Will Ignore the NZ Election

In 2014, the policy agenda on the left provided concerns, this time around

a National-led coalition is the most likely scenario with the concern the

coalition mix. Regardless of the election result, we expect a moderate

fiscal stimulus from spending on housing and infrastructure as well as

concessions to more significant coalition partners than previous

elections. New Zealand should maintain its relative advantage in political

stability compared to the rest of the world, making a capital flight from

international investors unlikely.

National-led government most likely

While surprises have occurred in a number of international elections we don’t

expect this to apply in NZ. The most likely scenario remains a National-led

coalition.

The uncertainty is around whether National needs NZ First or not, rather than

whether National forms a government.

Figure 1. Probability of various coalitions forming government (polling 2016–2017)

Source: Forsyth Barr analysis

Misery index reinforces no impetus for change

Electoral swings normally require a catalyst. We have used NZ’s misery index to

outline the likelihood for this to occur in this election. Normally change has

occurred when the index has been high and rising. Currently, the index is low.

This suggests change is less likely. Several parties are pursuing policies in an

attempt to increase voter participation; however, we doubt sufficient numbers

can be motivated to change their behaviour. In-fighting amongst left-leaning

parties also suggests disaffected voter choice shifts to be between NZ First and

The Opportunities Party (TOP). The more the latter gets, the better it is for a

National–led coalition.

Whatever happens, expect more spending

The issue this election is expected to revolve is the level of investment in

housing and infrastructure. Welfare policies are not expected to have sufficient

currency to see a significant swing to the left, given the low level of NZ’s misery

index. However, higher spending is likely with the anticipated inclusion of more

significant minor parties in any coalition and more groups needing to be

satisfied. Given tighter monetary policy (via credit conditions) more fiscal

spending should be positive for companies exposed to NZ Inc.

Brian Stewart

[email protected]

+64 4 495 8209

John Hughes

[email protected]

+64 4 495 5268

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Portfolio Considerations New Zealand Equity Research

The World Ignores Trump, They Will Ignore the NZ Election 2 31 July 2017

Executive Summary

Be greedy if others become fearful

Uncertainty is something markets do not like, and following the surprises delivered in the

US Presidential election, UK referendum on Brexit and subsequent UK general election,

some investors may be concerned as the NZ election draws closer.

In this report we outline our view on the outcome of the New Zealand general election in

September. We maintain our view that the NZ economic cycle should extend longer and

that there are potential upgrades to companies exposed to NZ Inc. Valuation is still the

main issue, but given our interest rate outlook we believe investors should buy any risk-

off dips that could occur because of election concerns.

What we think happens

A National–led coalition still most probable

A status quo National led collation is increasingly likely, especially with “Left leaning”

parties competing for the same voting base, effectively splitting the left vote.

The policy attacks to gain voter share should also be viewed as making the

formation of a left-leaning coalition post-election more difficult.

NZ First remains the probable king-maker, but for a left-leaning coalition to form a

government it would require a minimum of Labour, The Greens and NZ First. The

dichotomy of the latter two party’s policy positions certainly poses challenges.

There is no evidence to suggest things would be worse under a left-leaning

coalition

Academic research shows the difference in NZ equity market performance slightly

favours National-led governments; however, the differences are statistically

negligible and in terms of absolute returns these are more dependent on the

economic cycle.

This is reinforced by NZ’s MMP style government which favours coalitions and policy

outcomes around the median voter. While this is likely to result in higher government

spending, without revolutionary change even a surprise result is unlikely to be

viewed externally as a bad outcome.

Performance data for NZ equities in election years since the implementation of MMP

is limited, but shows only two elections in five have transpired with the market

performing poorly (net of global market changes) post the result. In 1999 when a

change in government to a Labour-led coalition occurred, and in 2011 when a

National-led coalition was re-elected.

Policy risks in 2017 are fewer than in 2014

There is less to worry about this time around. The radical policy implications for

industry seem to be the Greens desire to charge for water and all parties on the left

implementing higher minimum wages (+5 to +13% increases proposed).

We don’t believe TOP will get parliamentary representation so don’t see non-cash

implied rentals being included in the tax system.

To contrast this lack of policy certainty with 2014:

The value of the then newly listed SOE Electricity generators were under threat,

facing re-nationalisation and a NZ Power buying model which removed pricing

power from the companies.

Sky City was also under attack with its Convention Centre deal being

questioned.

There were the usual calls for living wages by the left.

The uncertainty in this election is the coalition mix and what concessions NZ First

demand in any government.



Election uncertainty hasn’t been discernible historically

Tracking equity markets over time (holding global conditions constant), there is no

evidence to suggest that election uncertainty triggers equity market underperformance.

The NZDUSD weakened significantly in two of the last three elections; 2008 representing

an extreme period of global risk-off post the GFC. The 2014 change does not appear to

have been election related given there was no change in the direction post the election,

despite this removing the threat of the lefts anti-business policies.

Figure 2. NZ Equity performance less MSCI local currency

Source: Forsyth Barr analysis, Bloomberg

Figure 3. …as has the currency

Source: Forsyth Barr analysis, Bloomberg

Reviewing international ownership of the NZ equity market, we have seen ownership

increase since the 2012 election of a National-led government; but equally, ownership fell

during the risk-off periods post the GFC.

We think any association between international ownership and electoral outcomes is

coincidental rather than linked.

Figure 4. Election results and international ownership


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Election periods highlighted

Right-ledLeft-led



Election Overview

National retains majority of the popular vote

Over the last three years National has consistently led polls with the largest proportion of

the popular vote (average 47.3%). Even the retirement of John Key was insufficient to

knock National from this position with National average polling year to date 45.8% of the

popular vote.

However, National is unlikely to be able to form a government on its own. Since New

Zealand adopted MMP, no single party has achieved a majority in parliament. In 2014

National got close but that was because of the large wasted vote.

Wasted Vote: Expect it to be lower in this election

The level of wasted vote in NZ elections is determined by the percentage of the overall

vote that non-parliamentary parties received (these parties failed to achieve 5% of the

party vote or win an electorate seat). This vote is then reallocated amongst successful

parties.

The level of wasted vote is largely determined by the number of higher profile parties that

fail the electoral hurdles.

In 2008, NZ First’s failure to achieve the 5% threshold exaggerated the level of wasted

vote, while in 2014 high profile campaigns by Kim Dotcom promoting Internet/Mana and

Colin Craig’s Conservative Party added +5.4% to the usual level of wasted vote.

The underlying level of wasted vote by single issue parties has settled in recent elections

to be ~1.0%.

TOP is the only high profile new party contesting this election but currently only polls

around ~1.0% We have been impressed with TOP’s digital presence; but making the 5%

hurdle will be a tough ask. Should TOP just miss the mark we still see the wasted vote

being lower than it was in 2014.

Figure 5. Votes for non-parliamentary parties

Source: Forsyth Barr analysis, Electoral Commission New Zealand

TOP

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Cobbling together coalitions

As always coalitions will be the name of the game.

Simulating coalition groupings using polling data over the last year, the current coalition

has a 30% chance of being able to form a government.

A Labour/Green coalition would almost certainly need NZ First to have a chance at

governing. In all polls over the last two years National could have formed a coalition with

NZ First, and we believe this is still the most likely outcome.

Figure 6. Probability of coalition groupings forming a government (polling data 2016/2017)


Left vs. Right positioning

While we talk left and right coalition groupings, the voter perspective of where parties are

on this spectrum is noteworthy and may be different to investor expectations.

Figure 7 calibrates where exit polls in the 2014 election placed the various parties on this

spectrum.

The current make up in parliament has a centre-right coalition in government but the

majority is only 4 seats.

Figure 7. Voter perception of Party position on Left-Right Spectrum


Figure 8. Current Parliamentary mix

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NZ First King Maker

As we move into the 2017 general election polling suggests that despite being the fourth

most popular party, NZ First is the likely king-maker.

Historically, NZ First has benefited from voter swings to the right with NZ First’s vote

negatively correlated to votes received by the left.

Following the decline in the Labour vote, NZ First’s polling is most negatively correlated

with the Green vote. Add in the prominence of welfare policies being put forward by the

Greens, the left vote looks set to be split between more parties.

Deals don’t mean coordination

Labour/Green Memorandum of understanding means nothing

The Greens and Labour have entered into a MOU to work together to change

government. However, policy positioning has been anything but coordinated.

In our view both Labour and the Greens are cannibalising the left rather than capturing

new votes. In fact the Green party has positioned itself further to the left of Labour.

Maori/Mana: Doing it for themselves

Maori and Mana Parties have an agreement not to run against each other. This improves

Hone Harawira chances at regaining Te Tai Tokerau, provided Maori tactically vote.

Maori also have increased chances of gaining Tāmaki Makaurau and potentially Ikaroa-

Rawhiti electorates. Again tactical voting is required, but this could give Maori 3 seats vs.

2 based on the current level of polling.

This represents Maori/Mana attacking the Labour electorate vote (rather than the party

vote) but we don’t think it stops there.

Right more co-ordinated

National, United Future and ACT have also agreed to work together, with Bill English

publically endorsing Peter Dunne (United Future) and David Seymour (ACT). This is not

unusual and the voters are used to reading the messaging from the parties.

Epsom: Masters of the tactical vote, expect ACT to keep its seat

National voters have voted tactically in this electorate since 2005, giving ACT this seat.

This is unlikely to change in 2017 but ACT needs to poll higher to allow a party list

member to join David Seymour in parliament.

Ohariu: United’s Future to be tested

This electorate is now more open after the Greens opted to clear the way for the Labour

candidate. National have tended to contest this seat but have advocated more for the

party vote. Given the 3:1 party vs. electorate vote for National in the last election, tactical

voting appears to be in place and to avoid confusion National’s candidate has already

declared that he will be voting for Peter Dunne.



Issues: Housing and Welfare

In our report “We Don’t Know How Lucky We Are” (6 July 2017) we highlighted that

migration issues would most likely be played out through housing policies. This is playing

out as we expected, with the other major differences in policy platforms is welfare

spending.

Housing — everyone agrees to spend more

The 2014 NZ Electoral Commission study into voter attitudes showed nearly all voters

were in favour of spending more on the housing issue regardless of party bias.

Figure 9. Voter attitude to Public sector Housing spending (2014 study)

Source: Forsyth Barr analysis, Electoral Commission 2014 post-election study

All parties have responded. How much is proposed to be spent differs but more houses

needing to be built is the common element to all policy measures.

Labour proposes establishing an Affordable Housing Authority to work with the

private sector to cut through red tape and get new homes built faster. It proposes

partnering with private developers, councils and others to build affordable homes.

The initiative would have $2bn of funding which would be recycled as the homes are

sold to first home buyers. Any capital gain, if sold on within 5 years would be handed

back to the government while various initiatives would also be introduced to reduce

speculation driving up values. These include banning foreign speculators, removing

the ability to utilise tax losses and making capital gains on homes sold within 5 years

(currently 2 years) subject to capital gains tax.

Green priorities are initially an increase in emergency housing, but also include

government building 10,000 homes which could be available under a rent-to-buy

initiative and where rents would be capped at 30% income. Given the speed of

recycling is much slower, this potentially tie-ups twice the capital of the Labour policy

proposal.

NZ First proposes acquiring land and selling this to first home buyers, on extended

repayment and low interest rates (initially 2% p.a. for at least 5 years). Non-residents

who are not New Zealand citizens would be ineligible for home ownership except if a

genuine need could be demonstrated. Because only the land is being acquired these

initiatives should be less expensive, albeit because the sections are sold to First-

home buyers rather than developers the speed of any implementation looks

challenging.

National already proposed a $1bn housing infrastructure fund alongside Housing NZ

initiatives to redevelop its portfolio.

Interestingly TOP stands out from the rest, attacking housing affordability not through

subsidies and spending but via taxing home owners the estimated rent savings from

this ownership.

With all parties proposing higher spending we don’t expect voter bases shifting,

particularly given National voter attitudes towards welfare spending (Figure 10).

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Welfare: Just a swapping of votes

Figure 10 outlines voter attitudes by party to Welfare spending. This shows that there

may be some appetite for more spending by left leaning voters but little appetite from

National voters. Accordingly, unless there is a swing to the left, this does not appear to be

a voter rich segment where the left can increase voting support.

Figure 10. Voter attitude to Welfare spending (2014 study)


For the record all left leaning parties propose lifts in the minimum wage. Labour is

the least aggressive proposing a +~5% increase to $16.50 minimum, while the

Greens propose a massive ~12.5% increase to $17.75. NZ First pushes into the

middle ground at $17.00.

In other welfare measures Labour proposes increasing Working for Families by

introducing winter payments for beneficiaries/super of $470–700 pa, as well as a

$3,120 baby grant.

The Greens propose +20% lift in all welfare benefits to be paid for by adding another

marginal tax bracket (40%) for those earning over $150k. This positions the Greens

increasingly as more of a welfare party with green policies. This runs the risk of

reducing some of the “green” vote but if successful attacks Labours voting base.

TOP is also attacking the Labour vote, proposing a $10,000pa 0–3yr baby and

beneficiary grant, and introduction in time of an Unconditional Basic Income (UBI).

Beneficiaries and over 65 year olds are phased in first before this is then extended to

18-23 year olds, a clear attempt to attract youth votes as well.

Increasing the likelihood that these policies just split the Labour vote between the left

parties are voter attitudes to government narrowing income differences, there are not

many National votes to be lost and when we look at how we rank in the OECD there

appears little ammunition to push a higher minimum wage campaign.

Figure 11. Government should do more to narrow income differences


Figure 12. Yet NZ minimum wages/median better than most (2015)

Source: Forsyth Barr analysis, OECD

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The Youth Vote…the car was going the other way

Getting greater Maori and Youth participation in the electoral process has been an aim for

some time. The prize (realistically) is attracting the youth vote, with this the largest

category of non-voters based on the 2014 election.

In 2014 the 2nd largest registered voter age group (after the 70+) was 18–24 year olds.

Unfortunately, this grouping had the largest representation of non-voters with a total of

126,000 of those registered not casting a vote.

This has prompted a number of parties to propose packages to target picking up and

increasing the number in this grouping that vote.

Figure 13. The missing million (730,000) voters in perspective — by age grouping

Source: Forsyth Barr analysis, Electoral commission

In terms of packages aimed directly at this demographic:

Labour is proposing 3 years of free post-school training be introduced from 2019.

NZ First proposes introducing a universal student living allowance as well as loan

write-offs where training has been in areas of skill shortages.

TOP has also entered the fray marketing a $10,000pa Unconditional Basic Income

for 18-23yr olds, albeit this only takes effect when funding is available and after

similar initiatives for families with very young children and over 65 year olds have

been implemented. Policy raising the drinking age to 20 and upping the cost of

alcohol may also be counterproductive.

The Greens offering appears weak in comparison, with a Student Green Card

offering free off-peak public transport plus deferral on paying back loans if saving for

a house, the only new initiatives.

Given the delays in implementation of most of the policies and obvious trade-offs required

in any coalition negotiation, changing the voting behaviour of youth voting looks a long-

shot but if social media messaging is anything to go by TOP may surprise.

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Outcome: National For the Win

Most likely scenario remains the exiting National led coalition. The uncertainty is probably

more around whether they need NZ First or not, rather than whether they get in.

At the same stage in 2014, opinion polls overstated the actual outcomes for Labour, the

Greens, and to a lesser extent, National. NZ First polling was understated in the final

result. This time around, given the policy positioning we believe both NZ First and TOP

should gain but believe it will be at the expense of the Labour and Green vote.

We also point out that swings to the left or right normally require a catalyst. To illustrate

this we have utilised a misery index for NZ (an average of unemployment, inflation and

the degree to which growth levels are below trend). When the misery index has been high

and rising this has provoked voters to seek change. The one exception was in 2011 when

left leaning parties were once again attacking each other.

Currently, the index is low and with limited voter currency for welfare we don’t believe

there is sufficient incentive for voters to seek change at this election.

Figure 14. Change usually coincides with high misery indices, this measure is low at present

Source: Forsyth Barr analysis, Statistics NZ

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NZ First & Greens split Labour vote



Investment Implications

The investment implication from the election is further support of our view that the NZ

economic cycle continues to extend. Should we see a NZ centric sell-off because of

election concerns, buy it, otherwise we see status quo as the outcome with a little more

stimulus helping NZ Inc.

We don’t believe international investors will bat an eye in regard to the outcome and

recent ASX ownership data confirms Australians continue to gather NZ equities.

Even if these investors consider that there was a chance that there would be a change in

government, NZ’s MMP framework does not promote revolution; incremental change at

the policy margin is much more likely.

In the case the left triumphs (our least likely scenario) we would expect:

More spending on welfare and an increase in the minimum wage (probably by +5%

rather than the more extreme proposals). This would most likely be passed through

in increased pricing. Any larger increases would potentially be counterproductive.

We have already outlined, in our migration report, that mix changes in immigration

should offset any declines in numbers.

The most likely scenario is a NZ First/National coalition.

National would still be the largest participant and the concessions to NZ First are

expected to most likely centre around housing and infrastructure policies.

Don’t count out the status quo

A number of polls still show National being able to govern with its current support

partners, either explicitly or within the margin of error. We do not believe that the

status quo should be ruled out as a scenario; especially if the cannibalisation of the

left vote continues.



Forsyth Barr Model Portfolio

Figure 15. Portfolio Construction by Thematic


Figure 16. Thematic Bias


Figure 17. Portfolio holdings

Code Thematic Rating Last Price Forsyth Barr ETR FB Weight Forecast PE* Div Yield Bias

Aged Care 10.6%

OW

ARV Structural Growth OUTPERFORM $1.30 24% 2.0% 15.8x 5.0% OW

MET Structural Growth OUTPERFORM $5.58 14% 2.6% 13.8x 1.3% OW

RYM Structural Growth OUTPERFORM $8.80 11% 6.0% 20.9x 2.4% OW

Consumer 1.5%

UW

EVO Value OUTPERFORM $1.00 40% 1.5% 9.9x 7.2% OW

Energy 8.5%

OW

NZR Value OUTPERFORM $2.45 26% 3.1% 14.1x 9.6% OW

ZEL Defensive Yield OUTPERFORM $7.73 14% 5.4% 12.7x 7.7% OW

Financials 7.0%

OW

ANZ Value $31.71 14% 4.9% 12.2x 5.3% OW

CBL Structural Growth OUTPERFORM $3.56 16% 2.1% 11.9x 3.5% OW

Health Care 13.6%

OW

ABA Structural Growth RESTRICTED $10.30 6% 2.8% 17.0x 4.8% OW

EBO Structural Growth NEUTRAL $17.94 10% 3.3% 17.3x 4.2% OW

FPH Structural Growth OUTPERFORM $10.94 6% 7.5% 31.1x 3.0% Neutral

Industrials 7.3%

OW

ATM Structural Growth NEUTRAL $4.26 -1% 3.0% 28.1x 2.6% Neutral

CVT Structural Growth NEUTRAL $6.03 37% 2.2% 19.6x 3.1% OW

SAN Value NEUTRAL $7.26 8% 2.2% 14.0x 5.6% OW

Info Technology 0.0%

UW

Materials 6.0%

Neutral

FBU Cyclicals NEUTRAL $7.90 0% 6.0% 12.1x 7.3% Neutral

Property 4.0%

UW

PCT Defensive Yield OUTPERFORM $1.25 7% 4.0% 19.6x 6.7% OW

Retail 5.0%

OW

KMD Cyclicals OUTPERFORM $2.24 12% 2.6% 12.0x 8.2% OW

MHJ Structural Growth OUTPERFORM $1.30 31% 2.4% 13.0x 6.3% OW

Media/Telecoms 0.0%

UW

Transport 14.2%

UW

AIA Defensive Yield UNDERPERFORM $6.82 -10% 4.9% 31.8x 4.4% UW

FRE Structural Growth NEUTRAL $7.96 -7% 1.9% 18.7x 5.6% Neutral

MFT Structural Growth NEUTRAL $24.14 -2% 4.8% 19.8x 2.8% OW

THL Cyclicals OUTPERFORM $4.26 13% 2.7% 12.6x 8.5% OW

Utility 20.3%

OW

CEN Defensive Yield NEUTRAL $5.32 3% 5.4% 15.2x 6.4% Neutral

GNE Defensive Yield NEUTRAL $2.43 -3% 4.0% 13.1x 9.1% OW

IFT Defensive Yield OUTPERFORM $3.07 14% 2.1% n/a 7.6% Neutral

MEL Defensive Yield NEUTRAL $2.86 -1% 5.6% 20.3x 8.3% OW

TLT Structural Growth OUTPERFORM $2.14 9% 3.3% 14.3x 2.1% OW

Cash 2.1%

OW


Growth, 43.7%

Value, 11.6%

Cyclical, 11.2%

Defensive Yield, 31.3%

Cash, 2.1% 13.0%

8.8%

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-23.0%

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Growth Value Cyclical DefensiveYield

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