Kevin Armstrong: Looking forward to the absolutely unexpected

Kevin Armstrong

The close of the year is often seen as a time for planning and the opportunity for a fresh start. This is healthy and constructive but, unfortunately in investment circles, it is seen as the time for forecasts of the year ahead.

Forecasting markets is always hard and it doesn't get any easier just because it's the end of one year and the beginning of the next.

To be fair to the forecasters, the old adage that, "They forecast because they are asked, not because they know", should be remembered.

Many forecasts congregate around similar themes with the result that certain views appear to carry a higher level of conviction and even validity. Unfortunately, this is rarely the case as last year's most frequently made forecasts illustrated.

Twelve months ago, the world appeared to have shrugged off the after-effects of the technology and sharemarket boom and bust.

Through 2004, investors had been well rewarded in shares, commodities and property, virtually everything had gone up.

However, with memories still fresh of the bloodbath just a couple of years earlier, caution was a common feature in many year-ahead views.

"A low-return environment" was the frequently heard all-encompassing and, apparently, measured comment that introduced many of the views. The next most frequently heard forecasts were for collapses in the US dollar and the global property market.

With the benefit of hindsight, it is clear that these three widely held views were of little or no value to investors.

By the end of last year, the US dollar had already fallen 30 per cent on a trade-weighted basis but the current account deficit was ballooning to what was thought to be an unsustainable level and the logical outcome of this unsustainability was for the greenback to fall even further.

It didn't, and against most currencies, the kiwi was the most notable exception, the US dollar rallied dramatically over the last 12 months.

Property also failed to collapse this year. Admittedly, certain markets such as England and Australia did cool in response to central bank tightening but other regions and countries have seen their property markets march on to even higher highs.

Finally, this year was anything but a low-return environment: it was a highly rewarding year across virtually all asset classes.

An overly cautious strategy based on low-return assumptions would have cost an investor.

It would be fair to say the year delivered more surprises, albeit pleasant ones, than expectations. Perhaps looking for surprises in 2006 may prove more rewarding than hoping for the expected.

There is an element of what the great New York Yankees coach, Yogi Berra, famously called "deja vu all over again" about the popular outlook for next year.

The US dollar is still expected to be weak, and more sustained weakness is required if the still huge current account deficit is to be fixed.

Property continues to be described as an accident waiting to happen with the doomsters warning that a property collapse will have far graver consequences for the world than when the tech bubble burst in 2000. And the general outlook is apparently that investors should be bracing themselves for a "low-return environment" in 2006 after the very rewarding 2005 and 2004.

Those views may be right but their sheer popularity should raise at least a little suspicion among investors. Other surprises for next year may occur in the bond market and in gold.

Longer-term bond yields, globally and in New Zealand, have been largely range-bound for much of the past few years. After the dramatic deflation scare 2 1/2 years ago, when long bond yields plunged to record lows, there has been a growing belief that the long-term low in yields had been seen and that a gradual drift back up could be expected, particularly as fears of inflationary pressures have grown.

Perhaps the surprise for next year will be that these inflation fears pass and that long-term bond yields remain range-bound or even break out of the bottom end of their range. If this were to happen, relatively unattractive, when compared with New Zealand cash rates, long-term bonds may prove to be highly rewarding, particularly if our cash rates fall faster and further than most expect.

Gold has resurrected itself as an investment asset over the last few years as its price has more than doubled back to levels not seen in almost 20 years. Now, after this rise, it has become increasingly popular to incorporate an exposure to gold in an investment portfolio with forecasts ranging from another doubling to far more over the next few years.

The surprise, or disappointment, in gold may be that it once again slips off investors' radar screens with lacklustre or worse price appreciation and no current yield.

Next year is unlikely to be an extrapolation of the last two relatively rewarding and benign years, but equally it is unlikely to be a measured low-return year. It is probable that there will be rewards available but they'll just be harder to find.

None of these comments are intended as specific forecasts of what to expect next year, rather they are intended to illustrate where surprises may lie.

It is an oxymoron but anticipating surprises in investment markets has always been more rewarding than backing the broadly anticipated.

* Kevin Armstrong is the chief investment officer of the ANZ/National Bank