GDP and Inflation

NZX50 goes on climbing: Irrational exuberance or harbinger of good times ahead?

Wednesday April 20, 2016 Mark Cox

Almost day after day of late, the NZX50 seems to hit new record levels.  As at the time of writing (close of business 19 April 2016), the NZX50 was at an index level of 6,868.04.  This was 18% more than one year ago, and 178% (i.e. nearly three times) more than at the low point around the trough of the Global Financial Crisis in March 2009. 


nzx berl


This raises the question of whether investors in the stock market are exhibiting the sort of behaviour that was observed in the 1980s, or whether they are expressing well-founded confidence in the New Zealand economy.


Before answering that question, it is worth explaining what the NZX50 shows and what trends in the index might signify.


The NZX50 is simply a way of representing the collective value of the 50 largest companies that have been floated on the New Zealand stock exchange.  Broadly speaking, the index will go up when more shares are bought than sold; and it will go down when more shares are sold than bought.


Investors will tend to buy shares in a listed company, if they think its profitability will improve; and they will sell shares in the company when they think its performance will worsen.  In a well-performing economy, company profitability tends to increase; and indexes like the NZX50 tend to climb when this happens.


But getting back to the original question: has the NZX50 risen so much because investors have been speculating wildly, or because the economy has performed well? 


Wild speculation can probably be dismissed as an explanation because the mood of investors does not seem to echo the exuberance of the 1980s. Investors now appear to be rather more temperate. 


On the other hand, although New Zealand’s economy has performed relatively well, and seems destined to continue to do so, it is probably more than confidence in the economy that has been driving investors in the stock market.  One reason why money has been going into shares is that most competing asset classes, apart from property, have performed relatively poorly and offer unattractive investment returns.  These competing asset classes include cash, bonds, precious metals and commodities. If other asset classes start to offer better returns, it is likely that share prices and stock market indexes will rise more slowly.