Bond Issues Slow the Share Market

In March we witnessed one of the strongest performances by global shares since the 1930’s.  For example the S&P 500 rose by 24.8% from trough to peak with the gains spread across a variety of sectors.  The rally was sparked by a shift in market sentiment driven by a variety of factors.  These include positive comments by international banks regarding operations for the year to date, tentative signs of stability in a range of indicators including US existing home sales and US durable good orders, and the US Treasury stepping up its rescue efforts with regard to buying fixed income instruments and dealing with toxic assets held by banks. 

However, the US share market is still down 11.7% for the year and while it was pleasing to see an improvement in market sentiment, it is important for investors to remain conscious that the economic backdrop is still challenging. 

Closer to home the Australian market also had a strong month and rose by 8%.  The biggest gains were in Resources, Materials, Banks, and Consumer Discretionary sectors while the more defensive sectors such as Consumer Staples, Healthcare and Telecommunications underperformed.  The NZ market posted a modest gain of 2.7%.

To outsiders, it invariably seems that the New Zealand share market is quick to fall, and recovers at a slower rate than our Australian cousins.  We need to remember that the Australian share market is stimulated by their compulsory superannuation.  This is quite unlike New Zealand, whereby the regular savings commitment into the share market is now KiwiSaver driven.  The contribution rate is somewhat lower than Australia’s, plus going forward the contribution rate may be lower overall this year than the previous year with the reduced contribution minimums.  Australians also tend to invest a higher percentage into Australian shares than for example New Zealanders do.

We also wonder if our share market is lagging because of the recent large number of capital raisings via debt issues.  Large amounts of monies have gone into bonds with returns of 7.5 – 8.5% over the past few weeks.  It comes as no surprise that already some of these bonds are available on the secondary market at a discount.  The secondary market for bonds continues to be poorly supported by the broking industry who seems preoccupied with getting another new issue away. 

If bonds are valued at market, the paper losses that have occurred over the past year may be considerably greater than the losses from failed finance companies!  Of course, there is the argument that if the bonds are held to maturity no losses will be crystallized.  That’s fine provided you have time on your side.  It certainly does not help beneficiaries when they are winding up Mum or Dad’s Estate when the actualized losses may well be 20 – 30% from good quality bonds!

Some of the major fund managers are strongly resisting the temptation of buying new bond issues.  Instead they are waiting for the bonds to become available on the secondary market.  In some cases, they are using less subordinated debt from the same issuer and purchasing it on the US market at yields significantly higher than what the more highly subordinated debt was sold on the New Zealand.  Not only are they buying better quality debt from New Zealand companies, they are buying at much more attractive yields, as the credit spreads are much greater overseas than in New Zealand.  It seems that New Zealanders do not normally demand a higher enough risk premium when lending companies money!