Taking Stock – 18 December 2025

Edward Lee writes:

We recently held our final investment committee meeting for 2025, focused on where we believe the best risk-adjusted returns are likely to come from during 2026. It was not a meeting about what has worked best over the past three years. It was a meeting about what happens next, and where the best reward for risk now sits.

Over recent years, artificial intelligence has dominated market narratives and investor behaviour. Since the release of ChatGPT three years ago, parts of the US technology sector have delivered extraordinary returns. Some companies have risen more than 1,000%.

This led to the NASDAQ surging over 100% over the past three years, and at face value that performance reinforces the idea that the United States remains one of the best places to find growth. 

But when analysed carefully, these returns have come from just a small number of very large companies, accounting for roughly two-thirds of the NASDAQ’s value.

These companies are global businesses with real earnings, strong balance sheets, and genuine scale.

So as our investment committee meeting progressed, we all agreed that our concern is not that artificial intelligence is not the future; the concern is that these companies valuations have moved ahead of what even the best companies can deliver in the near term.

This is how bubbles tend to form.

They are not built on worthless assets or empty promises. They are built on good ideas taken too far, too quickly, with too much capital chasing the same outcome.

With rising company performance expectations, along with strong share price gains driven by a small number of companies, investors can lose sight of risk simply because recent returns have been so strong.

This does not mean the US market is about to collapse. It simply means share prices may stop rising as quickly, or even ease back, while company earnings catch up.

With less room for upside surprise and more room for disappointment, the focus needs to lean more towards risk-adjusted returns to ensure that investors are being adequately compensated for the risks they are taking.

As we look through that lens, the opportunity outside the United States looks more attractive than it has for some time.

European markets stand out for different reasons to the United States. Share prices are lower, dividends are higher, and returns come from a wider mix of industries rather than a small group of large technology companies. Because of that, European companies do not need everything to go right to perform reasonably well. Even a steady economic recovery and stable profits could be enough to deliver acceptable returns for investors.

Asia Pacific provides a different kind of diversification. Australia and parts of Asia are supported by commodities, infrastructure spending, population growth, and regional trade. These markets are at a different stage of the economic cycle and are far less tied to the small group of AI-driven stocks that now dominate US markets.

This is not a call to avoid the United States. The US remains home to many of the world’s best businesses, and artificial intelligence will be a genuine long-term driver of productivity and profits. But markets that have already priced in near-perfect outcomes which do not deliver the best risk-adjusted returns from that point forward.

While global markets try to tackle these high valuations on a select number of companies, the more interesting story for New Zealand investors is closer to home.

A few months ago, we wrote that, far from collapsing, the New Zealand economy was laying the groundwork for recovery. That assessment was based on economic indicators rather than headlines. While confidence was weak and the news flow was negative, the underlying data was pointing in a more positive direction. That gap continues to close.

The clearest evidence of that shift is inflation. Headline inflation is back inside the Reserve Bank’s target band, and the underlying pressure in the economy is easing. Businesses are less inclined to push through price increases, wage growth has slowed, and rents are falling.

This matters because confidence does not return while inflation is rising. People will tolerate weak growth, but they will not tolerate eroding purchasing power and ever-increasing prices. Bringing inflation under control has been the main achievement of this cycle, and this underpins everything else.

Data released this week supports that view. New Zealand’s economy grew in the September quarter, ending the period of contraction earlier this year. 

While annual growth remains weak, the lift was across most industries, which is exactly what you would expect at the early stage of a recovery. 

It does not signal a boom, but it does confirm that activity has stabilised and the economy is beginning to turn.

Now that inflation has stabilised, financial conditions have quietly shifted in a more supportive direction, with mortgage rates well below their peak and the New Zealand dollar being lower than forecast. Monetary policy is no longer acting as a brake on the economy, and the Reserve Bank has likely finished cutting the Official Cash Rate.

The relief, however, takes time to be felt. New Zealand’s fixed-rate mortgage structure means lower rates flow through gradually rather than all at once. Many households fixed to manage risk, which delayed the recovery.

As these loans reset, the average mortgage rate people are paying will reduce, even if the advertised mortgage rates have stopped falling. This puts real cash into households pockets, which will hopefully be spent. 

Households have so far responded very conservatively. Rather than spending aggressively as rates have fallen, many have continued to reduce debt. That has frustrated those hoping for a faster rebound, but it has strengthened balance sheets. 

The labour market tells a similar story. It remains soft, but it is no longer deteriorating. Unemployment appears close to its peak. Job advertisements have started turning higher and employers are holding onto staff because they know how hard rehiring can be. Wage growth has also slowed, slowing inflation.

Spending behaviour is also shifting. Card spending data shows discretionary categories have stabilised, services spending is rising, and tourism and recreation are improving.

Tourism deserves a particular mention as visitor arrivals are now close to 95% of pre-Covid levels, even though China remains well below trend. That tells us two things. First, the tourism recovery has largely happened without China. Second, there is still upside when China does eventually return.

The rural economy continues to do well. Dairy and meat prices have held up better than expected. A milk price around $9.65 provides real cash flow, which has provided farmers with the funds to reduce debt (rather than spend aggressively), delaying the flow-through to the wider economy. That will not last forever. Stronger balance sheets eventually lead to spending, particularly in regional New Zealand, which is already ahead of the cities in this cycle.

The housing market is becoming more stable. While prices have largely stopped rising, sales activity is picking up from very low levels. New rents have eased, which helps keep inflation down and supports household cashflow. This level of stability is enough to lift confidence. House prices do not need to keep rising to achieve that, although forecasts suggest prices could increase by around 5% in 2026.

Residential construction remains at low levels, even as population growth recovers. Building consents are starting to rise, and early signs suggest activity is beginning to improve. Some builders are already reporting that work is starting to return.

Card spending data for architects, engineers, and surveyors is also improving, supporting the view that the construction sector should gradually recover. Even internet search activity around renovations and building has picked up. These are early signals, but they are the right ones.

Despite this, tax revenue has come in below expectations, while government spending is slightly higher. As a result, the operating balance, which measures whether the government is running a day-to-day surplus or deficit, is deeper in deficit than forecast, causing NZ to continually borrow money to keep the lights on.

The path back to surplus is now tight, with the first forecasted surplus now delayed until June 2029, rather than the original target of May 2028.

From today’s starting point, there is a real risk that surplus slips into 2030 unless future budgets are tighter, further restricting growth.

This suggests the government is more likely to limit spending than take on additional borrowing beyond what is already forecast. Net government debt is expected to rise from $180bn to $246bn over the next four years.

As a result, this is not an economic cycle that a Budget can fix. There is limited capacity, and little justification, for further borrowing to drive growth while debt levels remain elevated.

That means the recovery will need to come from easing inflation, improved household cashflow, stronger business conditions, and a lift in consumer confidence.

Markets have already begun to look ahead. The debate is no longer about how much further interest rates fall, but about when they eventually rise again, with some banks prematurely rising rates and removing interest rate specials. 

This shift always feels uncomfortable when growth still looks weak, but it is a familiar pattern to ensure stability. By the time confidence returns fully, the conversation has usually moved on.

So the groundwork for recovery has been laid. Inflation is under control, financial conditions have shifted in a more favourable direction, and household and farm balance sheets are strengthening. Combined with a recovery in tourism and stabilising house prices, confidence is beginning to follow.

The next phase of the cycle will not look like the last one, which is why positioning investor portfolios for what comes next matters far more than chasing what has already worked.

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Chris Lee & Partners Limited