NZSX-50 likely to lose 5-10pc

The sharemarket is set to suffer a significant fall over the next year as the benchmark index is at "unsustainable levels", broker Forsyth Barr says.

It blames a combination of economic and market factors similar to those that preceded a 27 per cent plunge in 1997.

In a research note "Troubled Waters", Forsyth Barr analysts said: "In our view, the NZSX-50 index is likely to decline by 5 to 10 per cent over the next year and we favour investments in international equities."

The market's 10 per cent rally in the year to date had pushed its median price to earnings ratio to 15.5 and the implied growth rate to 4.5 per cent.

"Unless earnings are upgraded, we believe the equity market cannot sustain current levels."

The broker said economic and market conditions such as a rapid depreciation in the dollar and a subsequent market rally were now similar to those immediately before the 1997 plunge.

"While history never exactly repeats itself, sometimes it is clear in retrospect that a known combination of economic and market factors was likely to lead to a fall in equity markets. We believe that to be the case today."

While the 1997 fall was exacerbated by the Asian economic crisis, Forsyth Barr said "obvious signs" of pressure on corporate earnings were being ignored. These included:

* The impact of higher oil prices on corporate costs and profitability directly and indirectly through a decline in consumers' discretionary income.

* The threat of inflation heading towards 4 per cent.

* Profit downgrades over the next few months.

* The risk of a correction in the Australian sharemarket, which was also looking overvalued.

But Macquarie Equities investment director Arthur Lim said the market was likely to hold its own over coming months. Crucial differences between 1996-97 and the present were "a lot of cushions coming into play" for the economy.

Lim said high employment, substantial Budget surpluses and infrastructure spending combined with the "very critical component" of strong global economies were likely to soften the impact of any slowdown.

The country's relatively high interest rates gave scope for rate cuts "if things really go too far out of whack" while in 1996-97 a monetary policy "misfire" worsened the impact of the Asian crisis on the economy.

Meanwhile, companies were now much better placed to handle a slowdown and a "high level of corporate interest from Australia" was likely to provide support for the market.

Although First NZ Capital research manager Barry Lindsay agreed with Forsyth Barr that the market was looking overvalued, particularly with its price to earnings at a premium to the global average, he was not expecting a significant market setback. First NZ believed the market would essentially be flat for the rest of the year.

Like Lim, Lindsay believed corporate activity would continue to provide support for the market.

"We've seen further evidence of that today with the bid for Gullivers Travel at a significant premium."

Troubled waters

* Forsyth Barr says the sharemarket is overvalued.

* It sees similar conditions to those prevailing in 1996-97 before a 27 per cent market correction.

* Risks to corporate earnings are being ignored by the market.

* A 5 per cent to 10 per cent correction over the next 12 months is likely.