The size of the hangover usually corresponds with the size of the party!
Is this upcoming economic slowdown going to be a minor flesh-wound or a significant recession? At Montgomery Investment Management, we are receiving a lot of inquiry about adding to investments (minor flesh wound) versus a significant recession (the bear market has a long way to run).
While it is impossible to forecast the future, we have experienced a lot of share price damage since the latter part of 2021, led by the Nasdaq Index which is down 33 per cent in the past seven months.
One area worth focusing on is the rising official cash rates from five English-speaking Central Banks, detailed below. As I have mentioned previously, only the Reserve Bank of New Zealand (RBNZ) seemed to understand the threat of 40-year high inflation rates by commencing their tightening cycle on 6 October 2021. Omicron aside, the Reserve Bank of Australia (RBA) was the slowest out of the blocks, delaying their first tightening by six months to 6 April 2022.
This delay likely means the RBA will have to play catch-up football, and in the table below I have made a guestimate of where official cash rates will be by the end of the September 2022 quarter. In short, I am not nearly as pessimistic as most market commentators.
Official cash rate increases – date, level and estimate at 30 September 2022
New Zealand |
% |
USA |
% |
UK |
% |
Canada |
% |
Australia |
% |
6/10/21 |
0.50 |
17/3/22 |
0.25 |
16/12/21 |
0.25 |
26/1/22 |
0.25 |
6/4/22 |
0.35 |
24/10/21 |
0.75 |
5/5/22 |
0.75 |
3/2/22 |
0.50 |
2/3/22 |
0.50 |
8/6/22 |
0.85 |
23/2/22 |
1.00 |
15/6/22 |
1.50 |
17/3/22 |
0.75 |
13/4/22 |
1.00 |
|
|
13/4/22 |
1.50 |
|
|
5/5/22 |
1.00 |
1/6/22 |
1.50 |
|
|
25/5/22 |
2.00 |
|
|
16/6/22 |
1.25 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Guestimate at 30/9/22 |
2.50 |
|
2.25 |
|
2.00 |
|
2.00 |
|
1.85 |
Based on the data and various consumer surveys coming out of New Zealand, my assessment is the significant increase in the prices of food, fuel, electricity and gas will really start to bite very soon. Further, the reduction in house prices from rising interest rates and higher debt servicing charges will have a negative wealth effect on consumers and discretionary spending will be reined in accordingly.
May 2022 saw a four per cent (or $35,000) decrease in the median New Zealand house price to $840,000. However, the decline from the peak in late-2021 is now approaching 10 per cent (around $90,000 from $930,000). And if we assume the average mortgage for recent house buyers required a loan to value ratio of 50 per cent (i.e. debt of $465,000 and equity of $465,000), the important point to acknowledge is that the buyer’s equity, in this example, would have declined by $90,000 or close to 20 per cent on $465,000 to $385,000 in the past seven months.
Unsurprisingly, the latest Westpac McDermott Miller Consumer Confidence Survey recorded its lowest reading and its sharpest decline for New Zealand consumers since the data was first collated nearly 35 years ago, indicating a severe slow-down similar to the 1991 recession and the 2008 Global Financial Crisis. I suspect the other English speaking economies mentioned above won’t be far behind.
This is also known as the debt-deflation cycle.