Intl shares: Spectacular growth unlikely this year

BNZ's Geoff Mason cautions investors not to get too bullish about prospects for international shares in 2002.

Monday, January 28th 2002, 1:08PM

by Geoff Mason

It is fair to say that sentiment in equity markets is pretty bullish at the moment. Although global equities were hit by one of the sharpest profits slump in United States corporate history, markets finished the year on a very high note with many investors expecting that the worst of earnings and economic performance would be over by the end of the first quarter.

While the market’s rebound is understandable, there are several reasons why we would urge caution at this stage.

First, the timing of the US recovery is still open to question. Although indicators that reliably signal an end to a recession, rising confidence and new orders, are all pointing in the direction of a recovery, most conditions (with the exception of the manufacturing sector) have not yet rebounded to a level above where they stood in the recession months prior to September 11.

Second, even if markets are right and the US downturn has bottomed, the recovery in 2002 is unlikely to be spectacular.

For one thing there is no obvious growth drivers, apart from perhaps the inventory cycle. Households are in no shape to drive a recovery, the slump in the stock market has taken its toll on the real value of household’s net worth, which has fallen nearly 14% in real terms from its peak in early 2000.

Wealth effects are typically small and quite gradual, but this fall, which broadly matches the record post-World War 2 decline after the first oil shock, is likely to be a sizeable dampener on spending this year.

Also households are likely face further corporate retrenchment as firms move to contain costs. Already there are signs of a large shakeout in the labour market looming with the Consumer Board’s index of help-wanted falling in November to its lowest level in 37 years.

Until companies have rebuilt margins and balance sheets, a process that will involve more job cuts and confidence declines, it is difficult to see that US profits growth will be more than anaemic.

A lack of pricing pressure is also likely to keep earnings under pressure. One positive aspect of the current global downturn is that inflation in the industrialised world looks set to slow to the lowest level since the 1950s in the second half of next year.

Already there are signs that inflation has peaked in most major economies as spare capacity has opened up and energy prices have fallen. With global growth likely to be weaker over 2001 and 2002 than at anytime in the past two decades and oil prices remaining low, headline inflation in the G3 economies could approach zero and core inflation below 1% in 2002, acting as a significant drag on pricing power.

As a consequence we believe that markets will be disappointed about both the timing and the vigour of a US recovery, limiting any sustained rally in global equity markets. That said, a recovery of sorts is highly likely to emerge towards the end of 2002 underpinned by the strong US monetary and fiscal stimulus and lower oil prices. Given that equity markets tend to lead the economy by around three to six months, it is likely that global equities will finish the year slightly higher, with returns to New Zealand investors boosted by currency weakness.

Geoff Mason is the manager of investment strategy at BNZ Investment Management.

Geoff Mason is Manager - Investment Strategy BNZ Investment Management.

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