Market consensus forecasts for GDP growth numbers to be released this Thursday are for a +0.8% increase in the September quarter over the June quarter. Forecasts from economists on how the economy performed in the second half of 2011 have been very changeable over recent times. Initially it was thought the Rugby World Cup only has a limited positive impact on the economy as locals spent all their money on tickets to attend the matches at the expense of other discretionary spending.

However, more recent statistics do confirm a reasonable boost in retail and accommodation spending through the September/October period. Overseas visitor numbers were well above prior estimates, even if they did not spend the megabucks at all the new Auckland waterfront restaurants and bars that sprung up. On top of the RWC affect, the fantastic growing season in the agriculture sector has increased production. I would not be surprised to see a GDP growth number slightly below +0.8% as manufacturing and construction industry sectors were very subdued.

I do not agree with other economic commentators that we are going into 2012 with a mood of a hangover from the RWC and that the economy will struggle to post reasonable growth. What I observe is far more positive with export commodity prices still well above average, interest rates still at record lows and the exchange rate has come back from above 0.8000 to the mid 0.7000’s which keeps exporters profitable. However more importantly for the economy, business investment can be expected to be much more robust as the cost of capital hurdle rates of return are just so much lower. With the 10-year NZ Government bond risk-free interest rate now below 4.00%, any calculation of cost of capital is well below historical averages.

What that means is that for a new investment or business expansion to go ahead, the return on funds invested only has to beat a much lower cost of capital metric. More projects will get off the ground in such an environment. Ahh, what about the European recession/debt crisis dragging the global economy down to stop such new investment decisions you may ask? My view is that the local media/commentators have over-blown the impact of Europe on our economic performance. Latest US economic figures are encouraging (not adversely affected by Europe’s problems) and China has plenty of capacity with both fiscal and monetary policy to prevent a major slowdown in their economy. The Communist leaders in Beijing know all too well that they cannot allow to growing middle classes to be become dissatisfied. They have the resources to maintain 8% GDP growth and thus demand for Australasian commodities will not fall away.

All it needs now for NZ GDP growth in excess of 3.00% next year is someone to sort out the insurance mess in Christchurch to get the housing rebuild underway. The more positive 2012 outlook suggests that the RBNZ will be seriously looking at monetary policy settings (the OCR) come mid 2012.

Lessons in counterparty credit risk

KiwiSaver investors who have their money managed under default scheme managed by ASB Group Investments/Sovereign (FirstChoice KiwiSaver Scheme) should be asking some hard questions about the management of their money. A recent Sunday Star Times article (11 December 2011) by financial reporter Rob Stock highlighted that FirstChoice had $376 million of their Cash Fund invested in bank deposits with their own parent bank ASB Bank. Rob found it difficult to get full information on the managed funds and when I attempted to take a look at FirstChoice’s investment statement on the website the document failed to open.

As total Cash Fund investments in all KiwiSaver schemes are $3.4 billion, it is hard to imagine FirstChoice’s Cash Fund being much larger than $600 or $700 million. Therefore, it appears that over 50% of the First Choice Cash Fund is invested with one counterparty bank (the parent ASB Bank). Any cash investment portfolio should have a maximum limit of no more than 10% or 15% exposed to one counterparty at any one point in time, to prudently manage and spread credit risk. You would think a bank should know something about credit risk!

Apart from a totally inappropriate credit risk position, FirstChoice’s returns on their Cash Fund are pathetic at 2.70% for the last 12 months and 3.10% for the last three years. By definition, cash investments must mature within 12 months (both interest rate re-set and legal maturity date to get your money back). FirstChoice appear particularly lazy in just placing the funds on deposit with their parent bank, instead of investing in a range of securities from Commercial Paper to other fixed interest securities maturing within 12 months. Recent credit rating downgrades for the Australasian banks should have decreased the dollar amounts of maximum credit limits for individual bank names in these KiwiSaver Cash Funds.

NEW ZEALAND DOLLAR MARKET COMMENTARY

Sideways is the preferred NZ dollar direction

The Kiwi dollar exchange rate finishes the year hovering around the mid-0.7000’s, more or less where we expected it to be at this time. For those with NZD/USD currency exposures it is highly relevant that the Kiwi has bounced off the 0.7400 region on two occasions in recent months, it also retreated quite quickly from 0.7800 when it spiked up a couple of weeks ago. It is hard to see global commodity prices and sharemarkets zooming upwards over coming weeks, therefore upside for the Kiwi above 0.7700 appears limited. On the other hand, wholesale dumping of the Kiwi is also highly unlikely given our relatively positive economic fundamentals and some global investors taking a liking to NZ Government Bonds.

In addition to the normal value drivers of the NZD/USD exchange rate (AUD/USD, EUR/USD, CRB Index, Dow Jones Index, VIX market volatility index and the copper price etc) some very good lead-indicators for the Kiwi’s direction are the US and Chinese manufacturing surveys. The Chinese PMI and US ISM indices have been decreasing since mid-year, which meant that the NZD strength to 0.8800 was always unsustainable.

The manufacturing indices now suggest that the Kiwi dollar should be trading in the low 0.7000’s. On the basis that the Chinese PMI and US ISM stabilise and start to increase over coming months, the NZ dollar should hold well above 0.7000 and then head back above 0.8000 at some stage next year when our interest rates are also moving upwards.