KEY POINTS:
We all know that "shares are for the long term" but not everyone realises just how long "long term" can be.
If 10 years is your idea of "long term", recent experience suggests that simply isn't long enough to guarantee a positive outcome.
Certainly investors who bought the international sharemarket story in July 1998 will be disappointed with things so far. Over that period, with a starting point of high share valuations, to today when shares are more modestly valued, total return was, according to London's Financial Times, negative after deducting inflation.
Take off another 1 per cent to 2 per cent for fees and international shares certainly haven't been a good investment in that period - but at least you got your money back, which is more than can be said for finance company debentures and CDOs.
If one looks at the very long term - 1900 to 2007, say - the world stockmarket has produced a very satisfactory 5.8 a year real return.
But unless you are the recently departed John Templeton or Warren Buffett you probably won't have the luxury of a 50-year investment horizon.
Retirement is more like 15 or 20 years at the most. So how much longer might someone who bought a global equity portfolio like the listed WiNZ fund in 1998 have to wait to break even in real terms?
The excellent Global Investment Returns Yearbook gives us a clue: the longest run of negative real returns for the world stockmarket was the 21 years of 1900 to 1920, when the total return from shares was 5 per cent less than inflation.
But it could have been worse. If you were unfortunate enough to have concentrated your funds in the stockmarkets of either France, Germany or Japan, you needed to wait an average of 53 years from 1900 before you got your money back in real terms - a great reason to diversify.
Why the recent volatility? The ultimate driver of share price returns is corporate profits. But shares are much more volatile than profits.
Part of their volatility comes from changes in corporate profits, but it also occurs in the form of changes in the multiple of earnings the market is prepared to pay for a company.
For example, if company ABC has profits of $1 per share and Mr Market is feeling optimistic, he might be prepared to pay 14 x earnings for the stock, so it will trade at $14 a share. But Mr Market has good days and bad days and on a bad day that same company might be valued at 10 x earnings, or $10 a share.
All other things being equal companies with good growth prospects and solid balance sheets trade at higher multiples than companies with volatile businesses and lots of debt.
Furthermore, as Tim Bond pointed out a few weeks ago, one of the biggest impacts of high inflation on the stockmarket is for multiples to fall - in other words for shares to become cheaper. That has certainly been the case in the past few years and it and the prospect of falling profits and increased volatility in economies are behind much of the current weakness in global share prices.
It is interesting to see how New Zealand shares have performed over the past 10 years compared to the rest of the world: New Zealand never had much of a technology sector, which seemed like a bad thing at the time but has worked out okay in that share valuations didn't get to the same levels as the US.
Consequently New Zealand shares have returned a very solid 9 per cent a year in the 10 years to July 2008, well ahead of inflation at 3.1 per cent a year. Unfortunately the trend among most large local investors and financial advisers in the past 20 years has been to raise their weightings in international shares at the expense of local stocks.
So much for the past. Global shares have performed relatively badly in the past 10 years so can we expect better returns in the future?
Tobias Levkovich, chief US equity strategist at Citigroup, doesn't think so. In a report to clients he forecasts that investment markets in the next 25 years could be a lot more challenging than the past quarter-century due to higher levels of inflation and interest rates and lower profit margins.
This sort of environment is unlikely to support an expansion in price earnings ratios so stockmarket returns are likely to be more a function of earnings growth and dividends.
With dividend yields low, at 2 to 3 per cent average, total returns from international shares in the long term are unlikely to get into double digits; unless, of course, they fall dramatically first.
Not very inspiring, particularly at a time when all the stockmarket seems to do is go down and finance companies take the money in but don't give it back.
However, there are a couple of rays of sunshine in the current market gloom - direct investors in international stocks probably won't have to pay any income tax on their dividends this year under FDR because they have fallen so much in value.
Also think how much more severe the local banks' bad debt problems would be had the finance companies not cornered the market in financing dodgy local property developments. It could be worse.
Speaking of which, spare a thought for the poor investors who were sold collateralised debt obligations (CDOs). Local financial planners have put some $1.8 billion of their clients' money into structured products and about $500 million of that had been written off by March.
That's not likely to be the end of the pain, however.
Two ING products, originally with some $850 million in assets, are typical of the sector. Suspended, they remain in limbo-land, with their unit holders still wondering what losses they will incur.
The Financial Times may have provided a clue last week when it reported that Merrill Lynch had sold a portfolio of $30.6 billion in CDOs for $6.7 billion. That's just 22 cents in the dollar for what was previously rated AAA.
The FT also reported that Citibank had revalued its CDOs to 61 cents in the dollar. Other transactions have been done at 44 cents in the dollar.
That deals are being done is a good sign. What local investors will end up with depends on, among other things, the type of investments owned, the assets they reference (mortgages = bad), their vintage (2006 mortgages = very bad) and, of course, their credit rating.
With credit markets and house prices not getting any better, maybe Merrill figured that 22 cents was a good price.
ING wasn't prepared to speculate on the worth of its CDO portfolios. Presumably incumbent unit-holders are sitting at home waiting for news and hoping for the best. Not a very satisfactory arrangement.
* Brent Sheather is an Auckland stockbroker/financial adviser and his adviser/disclosure statement is available on request and free of charge.
