Carmel Fisher: Reason for optimism as market investors return

Opinion

We have all noticed the wave of optimistic commentaries in the financial media in response to the recent upturn in global share markets. Since hitting a many-year low on March 6, global sharemarkets have bounced, some by more than 20 per cent. This rebound has been dubbed the "Green Shoots Rally", with many suggesting it signals the initial stages of a recovery in the global economy.

Some commentators warn it is too early to be optimistic, and call the recovery a "Bear Market Rally" - destined to fizzle out. Their caution is understandable given there are still many areas in the global economy suffering; and it is certainly true that news emerges daily about business failures and job losses.

But it is important to separate the economic cycle from the sharemarket cycle. Shares can rally strongly even while the economy is performing poorly. Examples dating back decades show strong and sustained sharemarket rallies which began part way through an economic recession.

The sharemarket is forward-looking, and a share price today is largely based on what investors expect the company's profits and dividends will be in the months and years ahead. Even though we are overwhelmed by bad news, it is reasonable to assume that in six or 12 months' time, the news might get better. A small improvement in economic growth, a renewed sense of confidence among consumers and businesses, or a better-than-expected level of sales for a company are the sort of catalysts that can encourage investors to think more positively.

Have there been enough green shoots in the New Zealand sharemarket to warrant the recent rally? The answer is most definitely: Yes. First of all, shares were sold indiscriminately during 2008 as investors sought to reduce risk. The shares of good companies and bad were sold down, irrespective of quality, profitability or prospects. This left a disconnect between price and value such that early this year, some company shares had become too cheap relative to their assets or their earnings. When the market started to rally in March, the undervalued shares rallied the strongest. This is a good sign because though investors were not discerning as they sold last year, they have been discerning as they've bought back in.

Several companies have reduced their dividends during the past year in order to preserve cash in an uncertain climate, others have maintained their dividends and some have lifted them. With the significant share price falls of last year, the average gross dividend yield for the New Zealand share market is now close to 8 per cent which is reason in itself for the market to rally.

In an environment of low interest rates, this competitive dividend yield means sharemarket investors are being paid well while they wait for capital growth to ultimately come.

Corporate New Zealand has performed relatively well in this downturn, as evidenced by profit results released in recent months. While some high-profile listed companies have needed to raise capital, we have seen many examples of companies that have weathered the difficult economic conditions well and maintained profitability. Unlike the US, we have not seen whole industries throw themselves on the mercy of the Government; good companies have taken advantage of weaker competitors to grow market share or have reaped the benefits of expansion and diversification strategies from previous years.

At Fisher Funds, we have always preferred companies with a competitive "moat" - something that gives them an edge over their competitors so they can survive and thrive regardless of the timing and extent of an economic downturn. These "moats" have been evident in recent profit results and have certainly justified the subsequent share price performances.

There has been much talk about falling interest rates, mainly as they affect home-owners or home buyers. Falling interest rates have also had a significant impact on investors who rely on a regular income from their investments to fund their lifestyle.

As interest rates have fallen, there has been evidence of some investors looking to the sharemarket, and particularly to high-yielding shares, as an alternative to bank deposits. Other investors found the sharemarket too nerve-wracking in 2008 so they took their money out of shares and deposited it in the bank "for safety". Some of these have begun to return to the sharemarket and have been part of the green shoots rally. The support that has been given to the many capital raisings of the past few months, without other shares being sold to fund them, is evidence of investors returning to the market. Just as the weight of selling drove share prices down in 2008, we could see them driven up by the weight of buying.

In October, Warren Buffett began buying stocks in the US sharemarket, saying "What is likely ... is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up. So if you wait for the robins, spring will be over". He has previously talked about buying when other investors are at their most pessimistic. Investors have been very pessimistic, and have not been prepared to look to the future with any optimism. We can be our own worst enemies as we often extrapolate the current environment into the future and assume things will stay bad.

In my view, there are enough green shoots in evidence to suggest that at some point the New Zealand sharemarket will get better, and stay better. It's not to say the economy will soar, the whole sharemarket will soar, or there won't be bad days or weeks. But glimmers of hope? Sprouts of encouragement? Absolutely.