2001, the year of living dangerously

By BRENT SHEATHER*

After markets reached new highs in 1999 and 2000, this year has been nothing but bad news for share investors.

So far this year international shares are down 16 per cent. For New Zealand investors the weakening kiwi dollar cushioned the blow; measured in US dollars international share prices fell by 25 per cent.

The statistics are worrying but many people look out the window and see that the sun is still shining, the shopping centres are busy and life seems to be back to normal.

It isn't. The market's focus has shifted from return to risk. Apart from the threat of more terrorist attacks or the looming conflict with Afghanistan spiralling out of control, the big worry is that individuals will reduce spending and push a struggling world economy into recession.

Alan Greenspan and other central bankers are hoping that lower interest rates will offset these negative forces somewhat.

Wish them luck. Better still, go out and buy something.

When trying to make sense of all these gyrations one needs to remember that just because share prices have plunged, they aren't necessarily cheap now; valuations from the late 1990s may no longer be relevant.

They always were high relative to historic figures but some plausible arguments suggested that this time it was different.

It may yet prove to be so, but nevertheless US shares now produce a pretty miserable dividend yield of 2.1 per cent, well below the long-term average of 3.1 per cent.

Share prices have fallen because investors now demand a higher premium for the risk they run by owning shares, while at the same time estimates of future dividend growth have decreased.

So what is the best strategy now? It is always difficult to know, and a balanced portfolio of bonds, property and shares will always be the right answer for the bulk of one's funds.

Perhaps the best thing to do with any extra investment dollars is to take the opposite approach to the movement in the markets. In other words, with shares falling, we should buy more.

That is easier said than done. Faced with all the negative numbers, the immediate reaction can be to switch from shares to cash.

There is another way of lowering the overall riskiness of a portfolio without missing the chance to share in any recovery: look at your fixed interest portfolio and move from risky debt to investments where there is zero risk of default, such as Government bonds.

No one has a crystal ball but it seems that as financial markets become more complex and the pace of change increases it is important to have a solid core in one's portfolio which can be relied upon to produce cashflow in virtually any economic circumstances.

More surprises are inevitable and investors with higher-risk portfolios will almost certainly need to brace themselves for more uncertain returns.

* Brent Sheather is a Whakatane stockbroker and investment adviser. This is the first in a series of quarterly reviews looking at how the investment markets have been performing.