The NZ equity market now trades at a premium to world markets, largely because our high dividend yields are attractive in a yield-hungry world. Mean reversion is a powerful force in asset markets and over the medium term either corporate earnings will catch up with stock prices or these prices will fall.
Given the continuous disclosure requirements that listed companies are now subject to you'd think there wouldn't be too many surprises come reporting season, but this isn't the case with 10 per cent movements in share prices on reporting dates not uncommon, particularly in Australia.
Some companies take advantage of the busy time before Christmas when investors are distracted to slip damaging updates into the market (also know as confession season) but there are still plenty of surprises on the day. For instance Contact Energy's financial numbers met market expectations but an almost 10 per cent sell-off occurred when they announced that rather than return surplus cash to shareholders, they would investigate overseas geothermal projects.
In NZ, consensus forecast median earnings growth for the market for this year is about 8 per cent but at an aggregate level the expectation is much less as some of the larger stocks have low growth rates.
During this reporting season we saw aggregate year on year revenue growth of only 3 per cent, which is below nominal GDP growth, and EPS growth of only 1 per cent to 2 per cent. Dividends, however, grew strongly, up over 9 per cent, due to big increases from electricity companies.
In Australia, the reporting season has generally been disappointing, but the overall market is up strongly on the back of the interest rate cut by the Reserve Bank of Australia.
The Australian market is now trading on a forward PE multiple of 16 times, again above its historic level of 14 times, but it still looks cheap compared to NZ. In aggregate it looks like listed company profits will have grown about 2 per cent over 2014 and dividends by 4 per cent as companies increase pay-out ratios.
One mystery in Australia, and also globally, is why more companies aren't taking advantage of historically low interest rates to engage in merger and acquisition activity.
Top quality corporate bonds, like those issued by Nestle, are now trading at negative yields and it is surprising that businesses aren't taking greater advantage of low long-term interest rates to acquire selectively competitors in sectors where valuations are still reasonable.
In summary, low interest rates globally are leading to broad asset price bubbles across a range of investments from shares to bonds to commercial and residential property.
At this stage in the cycle we believe investors need to be more cautious and also understand that after years of smooth sailing that volatility is likely to increase again.
While the reporting of historic financial results and the outlook comments can impact on stock prices in the short term, when building client portfolios we try to look through the results and focus on the longer term outlook for a business.
Paul Glass is principal at Devon Funds Management. This column is general in nature and should not be regarded as specific investment advice.
