Overseas shares still the weakest link

By BRENT SHEATHER

The first three months of 2003 had plenty of the volatility that has characterised world stockmarkets in the past few years.

By early last month global stockmarkets had fallen 9.9 per cent (in US dollars) as Iraq worries took their toll.

As war approached, shares surged back up 8 per cent, only to weaken again and finish the month 4.9 per cent lower than their starting point on January 1.

For New Zealand investors who are not hedged - insured against currency movements - the stronger kiwi dollar meant their global share portfolios were down an alarming 9.7 per cent for the three months.

Overseas bonds again outperformed shares, finishing up 3.1 per cent in US dollars but down 2.1 per cent in local currency terms.

The overall returns for an unhedged, balanced super fund or unit trust are estimated at minus 3 per cent for the quarter, before tax and fees.

International shares are now down by 55 per cent in New Zealand dollar terms since their high in October 2000.

Investor sentiment towards shares is at a low point. However, for the first time in a good while, some sharemarkets now offer value relative to bonds.

We now have the extraordinary situation in many countries that dividends from shares are higher than the yields on fixed-interest investments.

Anecdotal evidence suggests that, while some major international sharemarkets are yielding more than bonds and, in New Zealand dollars, are now back to where they were in early 1996, many investors are shunning cheap shares and opting for expensive bonds and residential property.

In the US, however, share valuations look far less compelling. Although share prices are down 42 per cent from their peak (in US dollars), the income yield is only half its historic average.

However, bond valuations look risky too. In the past 10 years, five-year New Zealand Government bonds have averaged a real - after inflation - yield of 5 per cent a year. Today the real yield is only 3.6 per cent.

Overseas the scenario is repeated. The London Financial Times says the real yield on British 10-year Government bonds is only 1 per cent, compared with a long-term average of 3.4 per cent and the paper believes that investors switching from equities to bonds risk selling shares at the bottom to buy bonds at the top.

Back home in New Zealand everyone seems to know at least one person who has struck it rich with residential property - be it on Paritai Drive or Ohope Beach.

But how expensive is the residential market and can it go higher?

Real estate agents say that last week, for example, you could buy a two-bedroom house in Mt Eden for about $350,000 which would rent for around $360 a week. Deducting expenses, we get a pre-tax return of around $13,800 a year, or about 4 per cent.

This is about 2 percentage points less than the income available from local shares, similar to shares in Britain and Europe, better than US shares and well below the income available from listed office/industrial/retail trusts.

Unless Auckland rents are about to rise dramatically, or dividends are about to plummet, shares are now quite a bit cheaper than Auckland residential property.

No one knows what is around the corner - inflation, deflation, salvation? We do know, however, that if we resist the temptation to overweight one particular sector or, worse still, one stock and instead retain a diversified portfolio with some bonds, some property and some shares then, whatever the economic conditions, part of our portfolio will be looking clever.

* Brent Sheather is a Whakatane investment adviser.