Global Markets

At the beginning of the month investor confidence rose, supported by confirmation of the US economic stimulus plan and other measures being taken to overhaul the US financial system. In addition, optimism was buoyed further by the agreement of US lawmakers to the Obama administration’s US$275 billion plan to forestall housing foreclosures. Stabilising the US housing market is seen as crucial to establishing a sustainable recovery for the US and other economies around the world. However, release of economic data that indicated that the US economy was continuing to slow and the fact that the Chinese government did not announce any additional stimulus measures, weighed on market sentiment over the month. However, the Chinese government indicated that 8% growth for 2009 was achievable and confirms the expectation that China, and the Asian region more generally, will lead the world back to growth over the next 12 months.

NZ and Australian Shares

The NZX50 moved in line with offshore markets as reported earnings for some companies reflected the impact of the global slowdown. However, for companies like Fisher and Paykel Healthcare and Pumpkin Patch, the lower NZD has been supportive and boosted earnings. While the Australian market was down, it performed better than other international markets, and the near 2% fall in the NZ/AUD exchange rate helped to further reduce the impact of the market fall in NZD terms. The Australian economy is still only expected to undergo a mild recession.     

Interest rates

In New Zealand, short term Interest rates have continued to fall as expectations have increased that the Reserve Bank of New Zealand will cut the Official Cash Rate (OCR) further in March. The slowing of the world economy, and its ongoing impact on NZ economy, supports a further easing in interest rates.  Bank term deposit rates are likely to fall below 4%. The NZD was relatively stable over the month trading around US$0.5050 at month end. The currency is likely to remain under pressure given the outlook for the OCR. 

It’s always darkest before the dawn

As stock markets have fallen over the last year the price at which investors can effectively “buy” the market has become very “cheap” by historical standards. This is reflected in market valuation measure such as the Price to Earnings (P/E) ratio. For the US S&P 500 index, the level has fallen to around 12 times the value of earnings versus an historical average of around 19 times. This raises the question: Is it a good time to buy?

If we map the relationship between the level of the P/E ratio at any point in time and performance of the market in subsequent years (see chart below) we can see an answer. Looking at the chart we can see historically that when the market P/E has been at similar levels to the current level (10-15 times range) this has normally heralded a very strong period of performance to come in subsequent years. The chart below shows that in any 10 year period since the 1950’s, where the period began in a year where the market P/E ratio was in that 10-15 times band or lower, the return over the next 10 years were, in most instances, well in excess of 10% p.a. Conversely, when the P/E ratio at the start of a 10 year period has been above 15%, the return in the ensuing 10 year period has tended to be under 10%.  Given that the current P/E ratio for the S&P 500 index is around 12 times, the expectation is that over the next few years the average per annum return should be strongly positive. It should also be noted that in all but one 10 year period since 1950, equity returns have been positive. Both these points should provide comfort that, if we take a medium term view, the next few years should be good for investors.

Buying when the market is low

 Accumulating equities as the market falls will maximise gains

Typically this emotionally driven selling is what, in part, forces a market to become over sold.  We can see this empirically in the graph below, which compares market cashflows and performance for US equity funds.  The chart shows that as performance rises the money flowing into equity funds generally rises (1995 to 2000, 2004 -2007). As the market falls (2000- 2003, 2007-2009) money has generally been withdrawn. This pattern of activity tends to crystallise losses and misses the gains from the recovery. It is important to note that markets do move in cycles and have up periods and down periods in response to economic and political circumstances. However, given that the market over the long term has historically always recovered and gone on to make a new high, down periods should be seen as an opportunity to increase your allocation to equity markets at below average prices rather than reducing your allocation and selling at low prices.  By maintaining our investment discipline and using market down-turns to accumulate equity allocations we have the best chance of maximising gains.

Maintaining investment discipline