International Equities: Buying opportunity coming
Bank of New Zealand Investment Management strategist Michael Daly explains why there will be a good buying opportunity for international shares this year.
Friday, February 2nd 2001, 1:19PM
by Michael Daly
Last year was a year in which global technology, media and telecommunication sectors, not to mention Internet companies, got their come-uppance in no uncertain terms. The speculative mania that reached an apogee in March 2000 unwound savagely, and is best illustrated by the halving in the level of the tech-heavy Nasdaq index in the US over the past nine months. This compression in technology sector values has been mirrored across Europe and Asia.
At the start of this year an unwelcome addition to an ugly scenario has already made its mark.
The outlook for real economic growth in the US has deteriorated so suddenly that recession in the first half of this year looks increasingly probable.
The Federal Reserve's surprise 0.5% cut in short term interest rates on 3 January has only added to the sense of angst, as shown by the equity market's being unable to hold onto the gains made immediately after what should have been a very encouraging announcement.
If the world's leading economy is going "ex growth" the outlook for the rest of the world is in jeopardy. The so called "old economy" stocks, most of which never took part in the great bull market in the rush for "new economy" stocks at any price, could miss out on their chance in the sun altogether.
Bank of New Zealand Investment Management's own view is less dire. However, we believe an excellent buying opportunity will present itself in 2001, quite likely before mid year. We reason as follows, focusing on the US market:
Taking the New York Stock Exchange as a whole, the average size of share price decline from one year highs has been 20%. This qualifies as a bear market. 36% of all NYSE shares, nearly all of them tech companies, have fallen by more than 20%. The excess valuation of the tech sector relative to the rest of the market, which reached an extreme a year ago, has been entirely unwound. Investor pessimism, as shown in the very high reading of the S&P 500 put to call option ratio, is at levels consistent with a bottom in the market. Portfolio cash ratios have risen in recent months, and are now at a level comparable to late 1998 when global financial system collapse was feared. The aggregate liquidity ratio in equity mutual funds in the US is close to 8% at present, and is higher for more aggressive growth and tech sector funds. Ample liquidity is waiting on the sidelines.
Additionally, global government bond yields, having plummeted to the lowest levels since the Asian and Long Term Capital Management crisis of late 1998, are currently discounting both global recession and deflation. Not only does this indicate that the point of maximum economic pessimism is being reached (a "buy" signal for equities, as in late '98), but discounted cash flow models will increasingly be highlighting the improving relative, and indeed absolute, valuation of equities.
None of this denies that company earnings will continue to be disappointing for much of this year. But share price performance seldom has anything to do with concurrent earnings growth - in fact there is sometimes an opposite relationship. This is because the market discounts company earnings growth far into the future. The profit outlook for 2002 is relevant, not 2001. The fact that the Federal Reserve cut interest rates so swiftly and sharply is most revealing in this context. The Fed has shown it will take whatever action is required to prevent the economy from losing too much momentum and risking a self feeding cycle of pessimism, reduced capital spending, a fall in overall credit quality and ultimately a true credit crunch in which banks are unable to lend to even credit-worthy borrowers.
How far could the Fed go in reducing interest rates, if the need arose? The answer is, a lot further. The current very low inflation environment is the surest guarantee that a severe economic slowdown will not eventuate. The Fed could cut another 150 basis points off the Fed Funds rate and still leave the real rate at only the average of the post1987 period. Clearly, the Fed could reduce rates by more than that without becoming overtly stimulatory. And then there is fiscal stimulus to fall back on, with a political consensus building for personal tax rates being reduced in this financial year.
The late 1998 equity market correction showed that the optimal time, from an equity investment perspective, is when the changes in economic indicators are at their most negative points. The coming months will likely provide much ugly economic news, offering opportunities for the brave to enter the market at basement prices.
Michael Daly is the investment strategist at BNZ Investment Management.
Michael Daly is the investment strategist at BNZ Investment Management.
Special Offers
Commenting is closed
|
|
Printable version |
|
Email to a friend |
