Brent Sheather: Hard to pick trend after a good year

This time last year things were looking grim - just about every expert was saying that while things were bad, a depression was impossible.

But most secretly worried that the financial markets were signalling just such a dire outcome and were thinking about putting in a vegetable garden.

Back then we noted that the best-performing asset classes were low-risk and the lower the risk the better the return - 30-year US treasuries returned 42 per cent in US dollar terms and about 70 per cent in New Zealand dollars. NZ Government bonds returned 15.9 per cent.

So with everyone worried about the future at the start of 2009 an overweight bonds strategy seemed like the order of the day.

Anecdotal evidence suggests that many investors rebalanced their portfolios in favour of a higher fixed-interest weighting and the bond issues certainly came thick and fast.

But Tim Bond, reporting from Barclays Capital in London, sounded a cautious note, that bonds exhibit serial negative correlation - that is, good years are frequently followed by bad.

That was a good call from Bond - fortunes reversed sharply in 2009 with shares topping the performance table and bonds recording big negative returns.

Yields on 30-year US government bonds rose from 2.69 per cent to 4.63 per cent, resulting in a capital loss of 25.5 per cent.

Safety first didn't work in 2009 - and those investors who sold out in despair will be kicking themselves, at least until the next downturn.

So, against the odds, 2009 was a vintage year with the world stockmarket returning 30.8 per cent in US dollar terms assisted by a weak greenback.

With the exception of Japan, every big stockmarket in the world had a double-digit year, but the party for the many local investors who don't hedge out the impact of currency was spoiled by the strong kiwi.

Over calendar 2009 the New Zealand dollar appreciated against the US by 25.9 per cent from 0.5785 to 0.7282.

This had the effect of reducing the return for local investors investing unhedged in global equities to a very ordinary 3.9 per cent.

But it was possible to do well investing overseas by avoiding the greenback - Australian shares had a standout year, rising by 41.5 per cent in New Zealand dollar terms, helped along by a 3 per cent depreciation of the kiwi against the aussie.

As noted earlier, in 2009 the riskier the market the higher the returns - emerging markets were up by 40 per cent, US high-tech stocks returned 22 per cent and Latin American stocks rose by 65 per cent, all in New Zealand dollar terms.

After a shaky start things turned bullish around February following a profit result by US banking giant Citicorp and the positive sentiment built from there despite many experts declaring that it was just a bear market rally.

In this market, where investors were attracted to cyclical stocks likely to produce good profits in an improving economic environment, New Zealand shares were popular with international investors and consequently our home bourse came up with a very creditable 19 per cent return.

The table compares the performance of some selected asset classes in US and New Zealand dollar terms.

With the start of the new decade it is appropriate to consider what investment strategies have and haven't worked over the preceding one. In the past 10 years world stockmarkets have produced very disappointing results for investors due in large part to their high valuations in 2000.

In kiwi terms the world stockmarket has fallen on average by 3 per cent a year with the Japanese stockmarket down by 7 per cent a year and European stockmarkets down by 1 per cent a year.

In contrast Australia continued its long-term outperformance with an average 9.1 per cent a year return and New Zealand also managed to beat world markets with a compound 6.2 per cent a year.

For international investors, bonds at 3.2 per cent a year beat shares by a handsome margin despite their lower risk and even in New Zealand, at 6.8 per cent a year, government bonds were just ahead of local shares.

For gold bugs the decade was a rewarding one, with the metal rising by an average of 10.3 per cent a year.

Currencies had a big impact on returns, with the kiwi rising by an average of 3.4 per cent a year against the greenback over the decade while it was virtually unchanged against the aussie.

What all this meant for the average investor in a balanced fund was a very ordinary 3.1 per cent a year before tax and fees, roughly half the returns from six-month term deposits.

Not a great advertisement for taking on risk.

On the bright side the poor performance of the stockmarket over the past 10 years means valuations are now far more reasonable than they were in 2000 and thus the outlook for equities in the next 10 years is materially better than it was back then.

This is because, looking at the US stockmarket, for example, while share prices have fallen by an average of 1.0 per cent a year in US dollar terms in the decade, dividends have continued to grow.

In the US dividends on the S&P 500 were US$16.48 in 1999 and the latest estimate for 2009 is US$22.31, an increase of about 38 per cent.

Nothing is certain but it is a better than even bet that, although markets have recovered strongly in 2009, equities will outperform bonds in the next 10 years.

This -1.0 per cent a year return for 10 years is a pretty extraordinary result looking at historical data back to 1926, as out of the 74 overlapping 10-year periods since then returns from US stocks have been positive 70 times, or 95 per cent of the time.

The other three 10-year periods, where shares returned a negative result, were 1999 to 2008, 1930 to 1939 and 1929 to 1938. The worst performing 10-year period was 1999 to 2008, when returns were -1.4 per cent a year, and the best 10-year period was 1949 to 1958, when returns averaged 20 per cent a year.

It is anyone's guess what will be the best-performing investment in the next 10 years, but the high level of enthusiasm for emerging markets at the moment doesn't auger well for their prospects, in the short term anyway.

Not many New Zealanders will have been lucky enough to own last decade's best performers - the Financial Times reports that the best-performing stock market in the world last decade was that of Peru, which returned somewhere around 850 per cent over the period or, if you are into alternatives, a case of Lafite Rothschild 1982 rose in value by 876 per cent.

Readers should note that the latter investment is high-risk as one could well have drunk the wine immediately one got it home and missed out on the returns completely.

* Brent Sheather is an Auckland stockbroker/financial adviser and his adviser/disclosure statement is available on request and free of charge.