Another punishing quarter for equity investors

By BRENT SHEATHER

The past three months has been more of the same old grind for share investors: down, down, down, with global equities, as measured by the MSCI Index in New Zealand dollar terms, falling by 15 per cent.

In the year to date, international shares have lost more than one-third of their value. Global sharemarkets at the end of September were back at the same level they were in September 1997. In five years international shares have gone nowhere.

None of the main regions provided any respite from the bear market over the three months: the United States, Europe and Japan were down 13.9 per cent, 19.7 per cent and 8.5 per cent respectively.

As the graph illustrates, the only areas in the black were fixed interest securities, with local and global bonds positively thriving in this desperate environment. New Zealand shares also bucked much of the downward trend as equity investors switched into markets offering worthwhile dividend yields.

The world has become increasingly risk averse as shown by the interest rate on short-term US treasury bonds touching a 44-year low in September to yield just 1.96 per cent. No surprise, then, that long dated, AAA rated bonds such as 30-year treasuries in the US and, locally, the Government's 2011s became highly sought after, propelling the global and NZ government bond indices higher.

Global bonds have now outperformed global equities by 9.2 per cent a year over the last five years.

So much for the equity risk premium. Markets are rewarding investors for taking less risk rather than more. In the bond markets, too, logic was reversed: lower quality credits have underperformed safer bonds.

The question on most investors' minds is will it get worse before it gets better? Expert opinion is divided. One side cites undervaluation based on yields relative to government bonds and the other points to PE ratios remaining on historic highs.

A professor from the London Business School has cheerfully pointed out that we should not get too excited that the current dividend yield of the British stock market is now up to 3.8 per cent because it reached 11.7 per cent at the depths of the 1974 bear market.

He added that just because we had had three bad years in a row did not make it any more likely that next year would be better. The probability of another down year is apparently 38 per cent.

In the other camp Jeremy Siegel, author of Stocks for the Long Run, last month argued that the worst might be over, citing three structural changes as justifying the current higher-than-average stockmarket valuations.

Professor Siegel says that better government policies have made shares less risky, thereby justifying a lower discount rate, and lower transaction costs and taxes have combined to make shares more attractive.

Indicators that now is the time to buy include the fact that hardly anyone is, sharemarket trading volumes are low, and old favourites such as listed technology funds are trading at huge discounts.