Spicers positive on equities

Global investment themes

The key factors in the formation of our outlook include:

• the impact on the profit cycle of the sooner than expected economic recovery,
• the outlook for central bank tightening around the world, and
• the heightened need for investment analysts to investigate unusual company accounting techniques.

The impact on the company profit cycle of the sooner than expected economic recovery
Recent global economic data indicates that a recovery is occurring earlier than was expected. However, equity markets have been subdued in their reaction, generally moving sideways. This is partly the result of concerns over accounting irregularities and the outlook for the price of oil.

Investor sentiment is somewhat sceptical, with the performance at the end of last year reducing the attractiveness of equities from a valuation perspective. Sluggish growth in many global economies has combined with falling commodity prices to raise the spectre of deflation. Employment costs are still high and profit margins remain under pressure. Current and projected write-offs stemming from companies' excessive capital spending and acquisitions gone wrong may increase reported earnings volatility and make people less willing to take on the extra risks of equity investing.

But the cyclical forces at work are very encouraging. There is a strong link between business output and earnings - not final sales and earnings. During the recent economic slowdown, final sales held up well, but companies met this demand out of inventories, creating little in the way of new production or employment. As companies rebuild inventories their business output will run ahead of final sales and there will be a significant improvement in the bottom line. Coupled with lower targets from last year's results, and less expectant corporate management, there is potential for 2002 earnings to come through strongly.

How quickly will central banks raise interest rates?
A swift tightening of interest rates is unlikely to accompany this global economic recovery. One of the main reasons central banks can be comfortable with current interest rate policies is the ample spare capacity available in the industrialised world. At a company level, measures of capacity utilisation are universally low, particularly for labour. On this basis, any movements in unemployment rates will probably provide the best clues as to central bank reaction times.

Many central banks are likely to leave rates low for longer than usual, although this will not be a universal trend, as some have already raised rates and we expect that diverging monetary policies will be deemed appropriate for different countries. As a result, we expect widening interest rate differentials and this may be a catalyst for greater currency volatility this year.

Some unusual company accounting techniques that investment analysts must consider
The recent Enron collapse has highlighted the importance of thorough company analysis and the need for investment analysts to go beyond the auditor's opinion when evaluating company financial information. Simply relying on headline financial information and the opinions of interested parties is insufficient for establishing a valuation on which to base an investment decision.

The Enron case involved the use of special-purpose entities to finance company activities and to avoid consolidating these assets and liabilities into the company's balance sheet. The collapse of the company came about when it was revealed that these entities contained substantial unreported losses.

US equities - The best-performing stocks will offer a combination of earnings growth and financial stability. Low inflation and reduced pricing power are still evident across most of corporate America. Companies with lower levels of debt will be less vulnerable to bumps in the economic recovery. We are particularly wary of widely-owned stocks whose prices reflect expectations of extremely high and growing profitability.

Non-US equities - Our view of continental Europe continues to be positive. UK stocks also remain attractive, on the basis of Britain's minimal inflation, looser monetary policy and appealing valuations. We continue to be negative on Japanese equities. Emerging market equities have been among the world's top-performing investments over the past few months and there is room for some continued out-performance should a global economic recovery take hold in 2002.

Australasian equities - Consumption and confidence data from both Australia and New Zealand are consistent with a significant pick-up in domestic demand. Companies with exposure to growth in domestic demand are likely to benefit, however we caution against over-enthusiasm for the retailing or building sectors given our expectation of local central bank tightening.

Australasian property - A rising bond yield environment will be likely to place a cap on the performance of listed property trusts in Australasia through the upcoming period of forecast global growth. While we do not expect outstanding returns we do endorse low-geared listed property as a sector within a diversified portfolio.

US fixed income - While low levels of short-term rates are very stimulatory, the Federal Reserve has the luxury of an economy with a great deal of spare capacity and, therefore, interest rate rises are likely to occur slowly.

Non-US fixed income - In Europe, we continue to favour core countries (Germany, France, the UK), while underweighting most peripheral markets. The UK market, already attractively valued relative to euro-zone markets, stands to benefit from increasing speculation that Britain will adopt the euro sooner rather than later. The outlook for Japan has deteriorated still further.

Australasian fixed income - Longer-dated maturities, which are less exposed to the raising of short-term interest rates, offer the most value, while selected corporate bonds are also attractive.

Currency - Little has changed in terms of our currency outlook and we continue to favour hedging back into Australian and New Zealand dollars.

Fixed income markets have seen greater volatility and may need further correction before presenting an attractive risk-return profile. Property investments will benefit from the recovering economic cycle but could struggle longer term once the interest rate cycle catches up. Cash remains a suitably defensive investment, more so than fixed income (bonds) at the current time.

Diversification across all asset types remains the key to minimising the impact of market events and exposure to any single asset class at a particular time in the cycle.