The long term outlook for international shares
There is currently a lot of market noise with investment markets being spooked by fears of multiple sovereign debt crises and a slowing of growth. Last week, Wall Street fell by over 6%, and the New Zealand dollar fell by a similar amount. This should just about offset any international share losses during the week by New Zealand investors provided the currency was not hedged.
Our asset allocation advisers Farrelly’s develop share return and risk forecasts, based on the outlook for growth in earnings per share (EPS), assessing fair value price earnings ratios (PEs) and adding in an allowance for dividends and currency. The outlook for EPS and the level of the New Zealand dollar become the most critical factors in forecasting international and Australian returns for the next decade. The current level of dividends is known, and markets have short memories where losses are concerned. Because of this they can reasonably confidently forecast a return to fair value PEs sometime over the next ten years.
High levels of government debt in Europe and the USA are the centre of the investment world’s attention. The concerns are around debt downgrades and whether some countries will default. Small downgrades will have a minimal long term impact on markets. Small defaults should be manageable, and the majority of developed countries will slowly bring their deficits and debts under control. This will involve austerity packages which will be painful and unpopular. You may well have seen images on television to this effect in Greece and Italy.
The recent share market falls have brought prices back towards levels that reflect the difficulties facing most developed countries. It is unlikely that they will be able to grow their way out of debt, as very low economic growth is inevitable over the next decade. Most emerging markets do not have high government debt or slow GDP growth. New Zealand is fortunate in that much of our trade now goes to these emerging market countries rather than the traditional North America and Europe markets. Contrast this to the fact that less than 15% of the S&P500 companies derive more than 20% of their sales from emerging markets.
So how much has changed since September 2005? Using forecasts from research house Farrelly’s, we see the following for shares:
This shows that the yield on New Zealand shares has increased over the past six years, and that the expected index return over a ten year period has also increased. For international shares the yield has increased as the prices have fallen. It is also expected that the overall pre-tax return should be higher for currency unhedged international shares over the next ten years than for New Zealand shares. If investors were looking for income from dividends, New Zealand shares in general offer significantly higher dividend returns than international shares.
Putting this into a portfolio context, for a “Balanced Risk Profile” portfolio the forecast ten year pre-tax returns have increased from 6.8% to 7.6% over the last six years. And for investors, this represents a premium over cash of 3.1% versus 1.1% in 2005. So now, in theory, it is a much better time to invest in a diversified portfolio than it was six years ago.
Disclaimer
Steven Barton (FSP 32663) and Susan Pascoe Barton (FSP 32382) are Certified Financial Planners and Authorised Financial Advisers. Their initial disclosure statements are available free of charge by contacting them on (07) 3060080 or they can be downloaded from www.pascoebarton.co.nz. This column is general in nature and should not be regarded as personalised investment advice.