This article originally appeared in the NZ Herald.
The big dilemma facing investors this year is where to put their money. Have sharemarkets run too hard, and if so, what are the other main domestic and offshore investment options?
The first area to look at is the historical performance of global sharemarkets, New Zealand residential property and bonds (fixed interest investments), as well as domestic term deposit rates.
In the decade ended December 2017, the NZX had the highest return of the six asset classes in the accompanying table, with a gross return of 107.8 per cent. The next best performing asset classes were Auckland houses, with a 95.8 per cent return, and New Zealand bonds, 95.5 per cent.
New Zealand bonds didn’t have a negative year during the decade, while the ASX, NZX, NZ houses and Auckland residential property had two down years out of 10.
Meanwhile, the MSCI Index, which represents global sharemarkets, had three negative years in the 10-year period.
The NZX has had a great run but it doesn’t have the bubble feel of the mid-1980s when the domestic sharemarket experienced annual increases, in capital terms, of 116.8 per cent in 1983 and 99.2 per cent in 1986.
In the 10 years ended December 1986, the benchmark NZX 50 Capital Index soared 1140 per cent, whereas the NZX 50 Gross Index rose a more modest 108 per cent over the past 10 years.
Most major NZX listed companies aren’t cheap, but the market doesn’t have the huge excesses, particularly the outlandish creative accounting policies, of the mid-1980s.
The ASX benchmark gross index has had a much more modest 50.0 per cent return over the past decade.
The 2009 year was the best, with a 37.0 per cent return following a negative 38.4 per cent the previous year.
As these ASX figures are in Australian dollars, and the NZ dollar has appreciated by 3.9 per cent against this currency since December 2007, then unhedged ASX returns to New Zealand investors were less than 50 per cent in the 2007-17 period.
Based on future earnings, the Australian sharemarket appears more attractive than the NZX at present but the former hasn’t been able to generate much momentum in a global environment where market momentum is extremely important.
The MSCI Index, which is measured in US dollars, expanded 63.4 per cent in the 10 years to December 2017. However, as the NZ dollar depreciated by just over 7 per cent against the greenback during this period, the unhedged returns to NZ investors would have been greater than 63.4 per cent.
Global share valuations are elevated but the MSCI’s 63.4 per cent appreciation in the past decade is relatively modest compared with a positive index return of 96.7 per cent for the decade ended December 2007, a 173.0 per cent rise in the 10 years ended December 1997 and a 402.0 per cent surge in December 1977 to December 1987.
The New Zealand housing market, particularly Auckland, also had a strong run over the past decade, with the former up 63.2 per cent and the latter 95.8 per cent according to REINZ’s house price indices.
Auckland housing outperformed the rest of the country by a wide margin between 2009 and 2015 but this trend has been reversing in recent years.
Auckland house prices increased by only 0.7 per cent in 2017 and the market will be tested in February to April, when new listings traditionally increase after the holiday break.
New Zealand bonds have also had a great run, as reflected by the S&P/NZX Investment Grade Corporate Bond Total Return Index, which appreciated by 95.5 per cent in 2007-17.
Bond funds benefited from the decline in interest rates as this boosts the value of their long-dated fixed-interest securities.
The six-month bank term deposit rate, which is a mid-year rate derived from Reserve Bank statistics, has fallen steadily from 8.45 per cent in mid-2008 to only 3.31 per cent in June 2017. The latest six-month rate is 3.30 per cent.
These low interest rates raise the question: where do investors put their money to achieve returns in excess of 5 per cent? This is an important issue for individuals who collectively have deposits of $166.2 billion, a massive increase on the $87.1b of deposits at the end of 2007.
One problem facing investors is the huge increase in bond redemptions and the shortage of new issues to replace these maturities. In the last two weeks of December 2017, more than $1.5b worth of bonds matured.
An estimated $4.5b worth of bonds will mature in the first quarter of the current year and there is unlikely to be a similar amount of new issues to replace them.
However, a reasonable amount of the $4.45b worth of bonds are held by wholesale investors and offshore interests.
There is a strong possibility that a $835 million ANZ perpetual bond will mature in April and, if this occurs, an estimated $6.0b of corporate bonds will mature in the first half of 2017.
A shortage of new bond issues may result in retail investors being crowded out of the new issue bond market by wholesale and offshore investors.
Herein lies the dilemma facing retail investors: total deposits have increased dramatically over the past decade, interest rates are low but there are more old bonds maturing than new bonds being created.
These phenomena, which exist in many developed countries, are major reasons why global sharemarkets remain attractive to investors.
Sharemarkets received a further boost this week with the release of the latest International Monetary Fund (IMF) World Economic Outlook Update.
The IMF believes that world output grew by 3.7 per cent in 2017, compared with 3.2 per cent in 2016, and the Fund’s economists are forecasting global growth of 3.9 per cent in 2018 and 2019.
The IMF had this to say: “The cyclical upswing underway since mid-2016 has continued to strengthen.
“Some 120 economies, accounting for three quarters of world GDP, have seen a pickup in growth in year-on-year terms in 2017, the broadest synchronised global growth upsurge since 2010”.
Investors, particularly in the United States, are anticipating that strong economic growth will boost company earnings and dividends, which are essential ingredients for further sharemarket gains.
The best advice for investors in 2018 is not to spend all their time trying to determine whether sharemarkets are going to rise or fall, whether bond markets are due for a major correction or whether cash is king and all other investments should be avoided.
The best option for 2018 is to have a mix of assets, including shares (New Zealand, Australian and global), bonds and cash.
The mix should be determined by the risk profile of each individual, with the bigger risk takers having a stronger bias towards shares, particularly global equities, while more risk averse investors should have a bias towards cash and bonds with lower exposure to sharemarkets.
The 2018 investment outlook is uncertain and the best advice for investors is that they seek qualified advice and avoid putting all their eggs in one asset class.