For the past few years, New Zealand has been the place to be for share investors. Our market has powered ahead, proving more resilient during weak periods than overseas markets, yet rising just as much during periods of strength.
However, we shouldn't be fooled into thinking our market is bulletproof, that we will always be the top performer, or that our currency will only go up.
Moving into 2014, I see risks increasing. This is particularly so for those share investors who have had such a great experience with the local market that they have very little interest in even considering any international diversification.
Here are five reasons why the next few months could be an opportune time to consider taking some profits in NZ shares, and spreading a bit of that money overseas.
NZ shares have risen more strongly than other markets
New Zealand has been an excellent performer over recent years. Over the past two years the NZX50 index has increased 21.4 per cent a year, which means it is a stunning 47.4 per cent higher than it was two years ago. While other major markets have also risen strongly over this period, none have performed as well as this.
It should be noted that the NZX50 index includes dividends, while other indices do not. If dividends were included, the gap would close slightly, although the New Zealand market would remain the strongest performer.
NZ shares are more expensive than other markets
There are many ways to gauge whether a share or a market is good value, and none are perfect. We must look at a multitude of factors including the economic outlook, dividend yields, earnings growth expectations and where share prices are trading relative to historic averages.
The price/earnings (PE) ratio is generally accepted as a reasonable indicator of value. On this basis, the NZ market does not stack up very well compared to peers. The average PE of the NZ market over the past 20 years is 14.1x and at present, it is trading 15.6 per cent above this level at 16.3x.
The other major markets we follow are trading, on average, 9.2 per cent below than their 20-year average PE ratio. For example, US shares are 6.7 per cent below their 20-year average, while UK and European shares are 15.3 per cent and 12.2 per cent cheaper than their respective 20-year averages.
While the New Zealand economy is almost certainly more strongly positioned than these other regions, one could argue that the relative pricing makes up for this difference in outlook.
The NZ dollar will fall in 2014
The currency is well above long-term averages against all major trading partners. This is because our economic backdrop is strong, so our currency will likely stay above these historic levels for a while yet.
However, we should learn from what we saw earlier this year. When talk first emerged of the US central bank (the Federal Reserve) tapering its quantitative easing programme, the NZ dollar fell more than 10 per cent in less than three months.
I expect the Federal Reserve to begin this tapering process some time during the first half of next year. When that happens, the US dollar will strengthen, our currency will weaken and this will provide a boost to offshore investments.
Interest rate rises in 2014 could stifle returns
The Reserve Bank of New Zealand (RBNZ) has clearly signalled that 2014 will be the year that interest rates rise, for the first time in almost four years. While the exact timing and quantum of rises is hard to predict, we can be fairly sure the Official Cash Rate (OCR) will finish next year higher than the 2.50 per cent where it sits today.
I expect the OCR to end 2014 somewhere between 3.0 per cent and 3.5 per cent. With most other developed markets, including Australia, the US and Europe unlikely to raise interest rates until 2015 at the earliest, the local market could suffer a drag that other markets won't face.
Political risks are real, and potentially significant
With a general election scheduled for next year, politics will be a major theme that should not be underestimated.
I expect it to be a tightly fought race, and markets will not wait for the final result before they react. Should a Labour/Greens coalition begin to fare well in the polls, markets will start to factor in the impact of their leadership on the economic landscape.
In broad terms, we could see income taxes rise, the introduction of a capital gains tax, increased regulatory risk for key sectors (starting with, but not limited to, electricity) and a change in the way the RBNZ delivers monetary policy.
A Labour/Greens coalition is expected to be less friendly to businesses, could try to shift more power back to unions and could look to more harshly regulate any sectors they perceive to have monopolistic characteristics. None of these points necessarily mean that our market is due for a major fall, so we shouldn't panic. Nor should we significantly reduce our holdings in NZ equities. After all, there are many positives regarding our market, such as a robust economic backdrop, strong linkages into Asia, high dividend yields and some companies with excellent prospects.
It is, however, a reminder of the need for international diversification. We have had a great run over the last two years, but the best returns over the next two could belong to someone else.
• 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 specific investment advice.
