Research: The Exchange Rates and the Economists
Economist Donal Curtin explains why forecasts about returns and rates have been wrong.
Monday, July 31st 2000, 12:00AM
The latest survey of managed fund returns shows international equities have once again proved by far the most rewarding asset class for New Zealand investors – spectacularly so in the past year (with the managers surveyed returning 33.4%), and systematically so over the past five years (25.1% return a year).
An important component of the total return, especially in the last year, has been an equally systematic drift downwards in the value of the NZ$. On its trade-weighted index (TWI) it was down 10.7% in the year to June 30, and has lost 3.3% a year over five years.
Interestingly, this decline has been wholly at odds with the forecasts of the economists surveyed in the quarterly Aon Economists’ Surveys.
Last October, for example, when the TWI was 54, the economists were picking a rise to 58.4 a year ahead. In January, when the TWI was 55.6, the economists predicted 57.6 a year ahead. And in April, when the TWI was 55, they were still optimistic, picking a rise to 57.9. On June 30, the TWI was actually 51.7.
No doubt fund managers were equally adrift: their expectations of returns from international equities have been well short of returns actually achieved, and very likely an over-optimistic expectation of the NZ$’s value played its part there, too.
What can investors learn from this (apart from something they should already know, which is not to place unrealistic trust in economic forecasts)?
Maybe four things.
One, local bullish sentiment needs to be discounted. It may be patriotic, but it is not realistic. Australia’s local forecasters, by the way, have made exactly the same overoptimistic mistake on their A$. Borrowing Greenspan’s phrase, local forecasters in both countries have been irrationally exuberant, ignoring (among other things) the global surge in the US$.
Two, a common rule of thumb model of both the NZ$ and A$ has broken down. The theory that "improving farmgate and/or pithead prices are good for the NZ$/A$" has fallen in a heap. It was never a wonderful theory, but it worked well enough for long enough, and had widespread acceptance. Now it’s gone.
Three, a better theory comes into the picture. It has various names in the economics literature (you might have heard of Fundamental, or Sustainable, Equilibrium Exchange Rates, FEERs or SEERs for short). What it says, in a nutshell, is that countries with big balance of payments issues (like us) need to have an unusually competitive or "cheap" exchange rate to get exports really moving and make imports really expensive. This seems to fit us nicely – and suggests no early rally in the NZ$.
Four, there is a forgotten player in the exchange rate game, namely the overseas fund manager.
Take your Boston based equity manager looking at the universe of MSCI country indices: the capital value of a US$ she invested in the NZ market in January ’93 (an especially good time to invest in NZ) is now about US$1.20. Invested in the Australian market, it would be about US$1.70. Invested in non-US world equities, it would be worth some US$2.15. And not only were returns better elsewhere, trading liquidity and the range of topical sectoral opportunities have been limited in NZ relative to other countries.
Fund managers in other asset classes (money market and bond funds) also have had less reason to invest here, as the super-normal returns they earned in the early days of our inflation-busting monetary squeeze have fallen away.
This is not the sort of experience that encourages new inflows into the NZ$.
As for me, I’ve been as guilty as anyone, reckoning that the relative cheapness of NZ assets and a cyclical upswing ought to have helped the NZ$. In my latest input to Aon’s economists’ survey, though, I have pulled back and now think an extended period of TWI trading around today’s levels looks more likely.
On recent forecasting experience, however, an astute but contrarian investor would conclude that the best time to buy the NZ$ would be when the last economist turns bearish.
Donal Curtin is the managing director of Economics New Zealand. This article first appeared in the Aon Investment Update.
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