Mark Lister

On Investing

Mark Lister: Ten positive points to wash away the gloom

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Scanning recent business headlines, confidence surveys and economic strategy reports, it is clear that just about everyone is concerned that things can only get worse.

Greece is approaching insolvency, several other European countries are also struggling and the United States doesn't have the answer to its persistently high unemployment rate. To compound the problems, there doesn't seem to be much political unity or leadership to come up with any feasible solutions.

Against that backdrop, it's easy to suggest that the debt problems will only get worse until some very hard decisions and significant austerity measures take place.

Market volatility will continue as governments reluctantly accept this outcome and, in the aftermath, global economic growth (and consequently investment returns) will remain below average for years.

It may be the lingering euphoria from the Warriors' great win over the Tigers (will they do it again tonight?), or Ireland's humiliation of Australia, but is it really all bad out there?

I'm as realistic as anyone about the outlook, but I'd like to focus on 10 encouraging points among the long list of things to worry about.

1. Share valuations are reasonable. A price-to-earnings (PE) ratio is a commonly used measure to determine how expensive shares are. This ratio compares the price of a company with the earnings it generates. A lower number suggests good value, while a higher number suggests that a company is more expensive. The New Zealand market is trading at an average PE ratio of 13.5 (slightly less than its long-term average of 13.7) and the Australian market is at 11.7 (below its long-term average of 14.3). The US market PE is 12.2, not quite as cheap as the lows reached in the financial crisis, but also much lower than the highs of over 16 that were reached in 2007. This is important because markets are most vulnerable when they are expensive relative to historic averages (as they were in 2007), rather than as they appear now.

2. Dividend yields are above long-term averages and what is available in fixed-interest markets. A portfolio of good-quality New Zealand shares and property trusts will easily generate an annual dividend yield of 7 per cent and, in Australian shares, a yield of about 5 per cent can be achieved. In the US, the 2 per cent yield on a 10-year Treasury bond is easily outpaced by the sharemarket's average dividend yield - a relatively rare occurrence. As well as being an indicator of value, the fact that dividend yields are (in many cases) higher than those available in term deposits and fixed interest may provide some share price support, as income-seeking investors have limited choice.

3. Interest rates are likely to remain low for some time. It wasn't long ago that most economists were expecting the Reserve Bank to increase the Official Cash Rate by 0.5 per cent at its next meeting. Australia was also expected to raise its benchmark interest rate from its current 4.75 per cent level. Recent global events have quashed these expectations, with local interest rates on hold for now and any move in Australian rates likely to be down rather than up. With more than 80 per cent of us sitting on floating mortgage rates, this will keep costs low for borrowers, help consumer and business sentiment and support the aforementioned yield gap between shares and other investment options.

4. Oil prices have fallen from their highs. West Texas oil is 25 per cent lower than its May high and Brent crude is 12 per cent off its highs. Oil is a key input for most sectors of industry and fuel prices also have a big impact on consumer confidence.

5. Corporate balance sheets are much stronger than they were in 2008. Average debt levels in Australia are now at 27 per cent (compared with the long-term average of 50 per cent) and the corporate world (in contrast with some governments) is much more conservatively positioned than it has been in the past. Corporate debt levels in New Zealand and the US have fallen by a similar magnitude. A huge amount of new capital was raised over 2008 and 2009 and many companies have very little debt, or even excess cash. Briscoes, Ebos, NZX and Hallenstein Glasson are a few names that spring to mind locally that are debt-free with net cash holdings. We also have the likes of Sky TV paying extra dividends to its shareholders, not to mention the takeover activity bubbling away as companies look to take advantage of strong balance sheets, low interest rates and reasonable valuations.

6. Reporting season suggests that profitability is still intact. During the August reporting season, three-quarters of US companies beat expectations and recorded earnings growth of 16 per cent for the year. Locally, we saw comforting results from plenty of good-quality companies such as Auckland Airport, Sky City and Port of Tauranga. Australia's largest company, mining behemoth BHP Billiton, posted a net profit of US$21.7 billion ($27.8 billion) for the 2011 year, an impressive 73 per cent increase on last year.

7. New Zealand and Australia are in a strong position economically. Australasia is looking increasingly well-positioned compared to other parts of the developed world. Unemployment is relatively low, we have a stable banking system, our key exports are in strong demand, we are close to the growth engines of the world in Asia and we have sensible political leadership. Government gross debt levels are 35 per cent and 22 per cent of GDP for New Zealand and Australia respectively, compared with 100 per cent in the US and 121 per cent in Italy. Our central banks have room to reduce interest rates if necessary (compared with the US, where interest rates are already at zero) and the Rugby World Cup and Christchurch rebuild should provide some positive economic sentiment over the next 18 months.

8. Our currency has room to fall if it needs to. I expect our currency to remain strong due to our higher interest rates and stronger economic fundamentals. But in times of extreme volatility, we often see our dollar decline. In 2008 it fell from US80c to US50c in less than a year. Should we see a recurrence of some of the serious global risks from a few years ago, our currency would be an important shock-absorber that would boost our export sector and insulate us from potential weakness in soft commodity prices.

9. Political dysfunction will hopefully be overcome by pragmatism. Whether it is the two houses of the US Congress or the 17 member states of the Eurozone, lack of leadership and general political disagreement have made a difficult situation worse. This is more of an opportunity rather than a strength, but a bit of common sense and pragmatism from the politicians would go a long way to moving us toward some solutions.

10. Management and executives have been buying shares in their own companies. According to recent reports, executives and CEOs at US companies have been buying shares in their own companies at the highest levels since March 2009 (which turned out to be the bottom of the market). European company executives have been doing the same more than at any time since the worst period of the financial crisis in 2008. Managers often have greater insight into their companies' prospects and some obviously believe their companies are undervalued.

Mark Lister is head of private wealth research at Craigs Investment Partners. His disclosure statement is available free of charge under his profile on www.craigsip.com. This column is general in nature and should not be regarded as personalised investment advice.

- NZ Herald

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