With economic storm clouds gathering, is it time to start thinking defensively? Alan Wood takes a look.
During a period when a terror attack is reported every week and economists are predicting a New Zealand, if not global, economic slowdown, it seems timely to readjust your investment portfolio.
While a slowdown, or worse a recession, would point investment punters toward safe defensive stocks – telecommunications, gas, electricity and infrastructure – it is not quite as simple as that. Such stocks are already fully valued, equity research experts say.
While the New Zealand share market has boomed in the past three years, the strong equity gains have not continued this year. The market is likely to track sideways.
In the past 12 months there have been much better performances in overseas sharemarkets, and while the outlook offshore remains stronger no one should expect the future to hold stellar growth.
First NZ Capital’s Jason Wong says mum-and-dad investors should realise that returns from New Zealand or offshore equities may not be what they once were. “I think overall returns are going to be pretty modest all round. You can say go global – (but) the global equity market has seen a pretty good run and therefore you can’t expect those sorts of solid returns to be ongoing.
“Therefore people’s expectations in investment should be pretty modest at the moment . . . don’t expect too much out of your portfolio.”
Mr Wong says the New Zealand sharemarket has been outperformed by most other markets in the year to October 31. “It’s actually been one of the worst-performing financial markets in the world over the year to date.”
While some emerging markets have grown by up to 40 per cent and Australia and Japan are ahead about 20 per cent, New Zealand is up only 8 per cent.
But despite the poor performance some argue shares are a better place to be than real estate.
Reserve Bank governor Alan Bollard certainly seems to think so, with his repeated attempts to talk down house prices.
There is an argument whether cash in the bank, fixed interest or shares are more worthwhile at present, given the risks ahead. Diversification could be one way to tackle the quandary.
Brokerage and investment houses say that Dr Bollard has a right to talk the housing market down in the current climate – despite angering some who have been given a rose-tinted view of life as a property owner.
Dr Bollard has started trying to cool house prices late, given that people on fixed mortgages will not experience the impact of rate rises immediately, Mr Wong says. “The problem really stems back from earlier in the cycle where he was very slow to tighten. He stop-started for a while. The ball was in his court 18 months ago – he knew what he had to do and didn’t.”
The high interest rates attract investment from overseas, helping keep the Kiwi dollar high to the disadvantage of export-focused companies, while the rates also make it more expensive for local companies to invest in machinery or infrastructure for growth.
Forsyth Barr’s Rob Mercer says too much attention has probably been paid to house price gains by the Reserve Bank and others, given there have also been substantial equity gains.
“House prices have gone up in every country by the same amount we’ve gone up so we have seen monetary policy very fixated on housing market,” he says.
“We’ve seen economists fixated on it as well and they’ve also been fixated on recessions and collapse as well.
“We follow a more pragmatic approach – at the end of the day what we want is a healthy economy that’s competing on a global stage in terms of attracting capital.”
ABN Amro Craigs’ Cameron Watson says it is an interesting time in view of the risks from high debt and high housing prices. Given the three markets – equities, bonds and fixed income and housing – those playing the sharemarket appeared more aware of risk.
“Our sharemarket has come back from earlier this year, and share investors face risk every day,” he says.
The housing market has had good times for the past 15 years, and perhaps memories of the possibility of a crash have faded.
He says a lot of people investing now – even those in middle or top management – have no experience of a substantive downturn. In fixed income, again there hasn’t been a big credit default, that is, a leading institutional failure, since the late 80s or early ’90s.
Also, credit spreads are too tight – not enough extra return exists for investing in a riskier environment.
The equity market from now would be driven by yield or dividend return and not much else.
“Profits have been pretty flat and the economy has slowed. We wouldn’t see (the market) rising from here . . . but essentially New Zealand shares pay pretty good yields so essentially build yourself a portfolio that yields you 7 per cent.”
Most see any equity gains ahead to be in markets such as Japan, Europe, emerging markets of Asia and the United States.
Analysts also see a chance to take advantage of a strong currency to invest in these markets and perhaps sell when the Kiwi dollar eventually retreats, as has been picked for some time. It is expected to fall back to about US65c by the end of 2006 and to retreat against the Aussie dollar, to somewhere between A85c and A90c, in the next 12 months.
Indicators of a currency retreat include inflation ahead of peer countries, gross domestic product running more slowly and a higher current account deficit compared with that of peers, Mr Mercer says.
He sees better prospects in international shares, with New Zealand coming off a period of out-performance.
However, talk of the deficit being a big problem would be overstating the situation. “We’re not the only country with higher current account deficit . . . some of it has been overspending but some of it is actually for growth as well – capital expansion – so it’s not an unhealthy deficit from that point of view.”
While the currency is likely to retreat, it should not repeat the sharp fall of the last down cycle given New Zealand’s relative improvement on economic fundamentals, Mr Mercer says.
In terms of stocks, he recommended defensive shares but only where there was good value. “Don’t overpay for defensive earnings.”
Stocks that were already fully priced included Contact Energy and Auckland International Airport. “They’ve both had recent corrections over the past couple of months, (but) they’re still relatively expensive.”
Telecom is another defensive stock and with it investors can take on some risk where there’s a soft landing. Infratil is trading at a 50 per cent discount to valuation and is an investment opportunity, Mr Mercer says.
Mr Wong says some New Zealand utilities such as Contact Energy are expensive by world standards. Sometimes an investor would be better looking at companies that are more cyclically exposed but look cheaper than the utilities, even given the associated risks. “Fisher & Paykel Appliances, for example, is a perennial underperformer – and in a relative value sense it’s probably good value compared to some of the utilities out there.”
He says it is hard to give broad recommendations for sectors to target. “You’ve just got to really nail down what is the company up to, how is it performing – rather than broad sector generalisations.”
Mr Wong says it is worth looking overseas given the potential currency gains as our currency rate reverts to true value.
What’s more, overseas markets are actually less expensive in relative terms. “You can buy cheaper stocks compared to New Zealand, and the macro environment is much better compared to New Zealand.”
Wong says cash is hard to beat – given the return of more than 7 per cent in the bank. Longer-term bonds did not offer value given a steep negative yield curve. “If they’re buying a 10-year bond – at 6 per cent you can get a 90-day at 7.3 per cent.”
Gains in housing are drawing to a close.
Source: Stuff NZ
Photo credit: eyecmore via VisualHunt.com / CC BY-SA
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