Milford Asset Management's Brian Gaynor on his expectations for the economy, sharemarket, house prices, interest rates and the NZ$ in 2014

By Gareth Vaughan

Brian Gaynor is excited. The Milford Asset Management executive director and long time observer of, and commentator on, economic and financial matters reckons he hasn't seen the stars aligning so well for New Zealand for decades.

Just before Christmas he wrote in his weekly NZ Herald column there were strong indications 2014 will be a once-in-a-generation year, like 1951 and 1974. Still with vivid memories of the 1980s sharemarket boom and bust, Gaynor's also upbeat on the sharemarket as 2014 gets underway, especially about the wave of technology companies emerging.

"There are so many things coming together at the one time," Gaynor told interest.co.nz in a Double Shot interview.

"The housing market is pretty strong and that creates a lot of house building activity. You have the Christchurch rebuild, you have a net migration inflow - an awful lot of well educated and skilled New Zealanders coming back to New Zealand. You've got the China boom, it is a concern I guess what's going to happen in China but we are still benefiting both (through) forestry and and the dairy industry from it. The level of (business and consumer) confidence is very high, and there's a new generation of businesspeople coming through as reflected by Xero and Wynyard and companies like that."

"So it's the best I've seen for a long, long time. In fact the best I've seen for over 30 years," says Gaynor.

'Exciting' technology companies

He says Milford is expecting the sharemarket to deliver returns of between 8% and 15% this year after "good but not great years" returning 23% and 16% over the past two years. But he adds Milford's sharemarket predictions have been wrong in the two previous years because they were cautious. He says he's getting a lot of  invitations to talk about the sharemarket at the moment.

"The reason why there's renewed interest in the sharemarket is because it has done well," Gaynor says. "There's new companies coming along, these tech companies, which investors find quite exciting. To get interest in the sharemarket you need a good performance plus new companies arriving on the scene."

"But not only have new companies already arrived, we (Milford) have invested in five or six unlisted companies and we see the prospects of one or two of them listing this year, and we feel that investors will find them quite exciting if they do list."

One such company, Gaynor says, is Orion Health.

'Genuine companies with a global reach'

"The good thing is we (New Zealand) do have a lot of good tech companies. And why is that? I think it's because Trade Me and Xero have been so successful that the younger guys who worked in those companies have gone out and set up their own companies. And they've seen how to build successful companies, they've seen that you can actually do quite well for yourself and for your shareholders if you do get the right business model."

"And therefore I think Trade Me and Xero have had a very positive impact upon entrepreneurs willing to set themselves up and to try to repeat the success of those two companies, " says Gaynor.

He says he's "much more excited" about the sharemarket now than in previous bullish periods, especially the 1980s.

"I know that it's easy in retrospect but I never got carried away by the 1980s. I felt that that was very false because it was property companies and it was investment companies which had very little substance to them. Now, I'm not saying that all these IT companies will be successful because they won't."

"But we have genuine companies coming through that have a global reach and have the ability to be able to do well on an international scale," says Gaynor. "I mean you can't go past the fact that people are sceptical about Xero at the moment but so were they sceptical about Trade Me. When Trade Me was sold to Fairfax originally by Sam Morgan people thought the price ($700 million) was incredibly high."

"Well that company now is worth substantially more than that. I do think you have huge upside potential with well run technology companies that have a good market penetration and know what customers want. So I'm hoping that Trade Me will be repeated a few times. And if we were to get five or six or seven Trade Me's and Xero was to continue on the path it's going, it would be a huge fillip for our sharemarket, but also for the New Zealand economy," Gaynor says.

It would take 'eight quarter percentage OCR rises before it would begin to have a negative impact'

But with the Reserve Bank hinting strongly at increases to the Official Cash Rate (OCR) this year, and potential subsequent rising mortgage and term deposit rates, will this have a negative impact on the sharemarket?

"Our interest rates are still incredibly low," says Gaynor. "We're only at 2.5% for the OCR, which from a historical context is very low. I think interest rates, and I'm talking about the OCR, could easily go to 4%, 4.5% which would be eight quarter percentage rises before it would ever begin to have a negative impact."

"If we get back to the medium, which to me in the OCR is around 5%, that's not negative. If we start going up to 7, 8 or 9% well that is negative. But that's only going to occur because the economy gets so hot that the Reserve Bank feels it just has to dampen down demand," Gaynor adds.

"So we've got a long way to go before we start talking about an OCR of 6 or 7%."

He also points out the level of confidence, among consumers and businesses, needs to be factored in. Both measures have been running hot. Consumer confidence has reached its highest level since January 2007 according to the latest ANZ Roy Morgan survey. And, according to the New Zealand Institute of Economic Research's latest Quarterly Survey of Business Opinion, in the December quarter businesses were more confident about the economy than they've been since June 1994.

"Back in the 1980s interest rates got to 17 or 18% and the sharemarket was roaring upwards. Under normal circumstances you would have expected that to have had a negative impact. I think higher interest rates will definitely put pressure on people who have got high mortgages, particularly people in the medium income group, and they may negatively impact retail spending," says Gaynor.

"But overall I don't expect that the increase in interest rates this year will have a negative effect on the economy, albeit it may do in 2015. But I think as far as 2014 is concerned it's unlikely to have a major impact. But obviously in the medium term they will."

Migration inflow to drive house prices

Meanwhile, Gaynor says house prices may rise by more than the 4.5% to 5% consensus expectation of economists this year, especially in Auckland.

"I think it could be higher than that because the thing that we're seeing more than anything else is returning New Zealanders. The external migration inflow is turning around quite dramatically and that's one of the biggest impacts, particularly in Auckland because 90% of the people coming back are going to Auckland," Gaynor says.

He's hoping for a big increase in house building to tackle a lack of supply.

"We're not getting enough new houses built, and we're not getting enough new houses built close to the inner cities. And it does appear that in Auckland at least there are major efforts to free up land and to quicken the process that allows people to develop new housing," says Gaynor.

"You're seeing a lot of ads now in the paper for new apartment blocks going up. Some of them will be good, some of them will be bad. But this is what we need."

"The Auckland housing market this year should remain reasonably strong, albeit I hope the prices don't rise by more than 10% because that's when you get into dangerous territory."

'Exporters need to learn to live with a strong dollar'

As for the strong New Zealand dollar, up around A94 cents and US83c, Gaynor says although this is tough for manufacturers, they may have to learn to live with it.

"I think our exporters have to learn to live with a strong dollar because in the end that's a reflection of confidence that there is in the New Zealand economy," says Gaynor.

Nonetheless he's hoping the dollar peaks around the levels it is at now, but suggests it might not fall far unless there are "some real problems in China" or other emerging markets.

"We (Milford) spend a lot of time trying to gather as much information as we can from China. We have a Chinese speaking fund manager here who keeps us informed about the local press and what's happening over there," Gaynor says.

"The best we can say at this stage is it (China) is a concern rather than a threat. Australia will suffer obviously if China goes down. I've been over there (Australia) twice already this year and I'm reasonably confident about Australia. You are getting a pick up in the housing market, some of the confidence levels are rising," says Gaynor.

"It's not going to be as good in Australia as it was over previous years because they didn't have a recession during the global financial crisis. But should China take a big drop down it would affect Australia. But at the moment we're not predicting either of these (events), although we're keeping a cautious eye on them."