KEY POINTS:
Three-quarters of the way through 2008 and the average portfolio with a balanced mandate, such as that typically held by a superannuation fund or retired retail investor, will be down by an estimated 6.0 per cent before fees in the nine-month period.
This is a poor result, well below the 8.0-9.0 per cent a year we can reasonably expect from a balanced portfolio in the long term. But not all that bad when one considers the various financial storms buffeting the world at present.
A lot of people have done a lot worse. In the September quarter itself overall returns were negative, with the average portfolio likely to report an estimated 2.1 per cent decline.
Contributing to this poor result was a 3.2 per cent decline from the world stockmarket and a 3.8 per cent fall in New Zealand shares.
Even this dismal return was flattered by a 12 per cent fall in the kiwi dollar against the US. In US dollar terms the world stockmarket was down by 15.2 per cent and global bonds were down by 0.8 per cent.
The estimated 2.1 per cent fall for a balanced portfolio in the September quarter assumes that investors have an asset allocation as per the traditional 40 per cent bonds, 10 per cent property and 50 per cent shares and property typical of a balanced portfolio in New Zealand and that they have done as well as the market in each sector.
One of the few highlights in the quarter for local investors was the announcement by the Reserve Bank that the overnight cash rate was being reduced from 8.0 per cent to 7.5 per cent.
The OCR determines short-term interest rates and the downward move prompted a flurry of activity by retail investors to lengthen the maturity of their bond portfolios so as to lock in high interest rates beyond the six months typical of bank deposits.
In the quarter, longer-term bond yields have declined by 66 basis points (100 bp = 1.0 per cent). The flip side of falling bond yields is rising bond prices as interest income becomes more expensive. Consequently the New Zealand Government Bond Index returned 4.2 per cent in the quarter - well ahead of short-term deposits which returned just 2.1 per cent.
The quarter was an extraordinary one for the credit markets and it underlined the wisdom of limiting one's fixed-interest portfolio to low-risk bonds if one is to realise the benefits of bonds as a stabilising force in volatile markets.
In bad times like this interest rates bifurcate - low-risk bonds go up in price while risky ones fall in price. For, example, in the quarter low-risk 2017 New Zealand government bond yields fell by 66 basis points to 5.68 per cent, but the yield on many higher-risk bonds skyrocketed as investors worried that they would not be repaid.
The real action, however, was in the US where interest rates on three-month US government bonds got down to just 0.02 per cent. Yields haven't been this low since Pearl Harbour.
The wonder of compound interest certainly isn't much of a phenomenon at these levels. Clearly the bond market is pricing in a very austere future for the world.
Writing in the London Financial Times, Tony Jackson drew parallels with 1929 and quoted an observation by economist Maynard Keynes in 1931 "that the whole panic resulted from the slump in the value of assets held by the banks. The future of capitalism depended on getting that fixed".
The difference hopefully between now and then is that central banks around the world look prepared to do anything "to get the lights on".
While the government bond prices have been rising, non-government bonds have been on a downward slide all year with many of the collateralised debt obligations (CDOs) registering credit events as a result of the Lehman, Freddy Mac and Fannie Mae receiverships.
This makes one wonder whether local investors in finance company debentures and CDOs via local unit trusts would have been better served by an immediate liquidation six months or so ago when the funds were originally suspended, at whatever bid was then available.
This may not have been the best option for fund managers but, with one alternative involving the continued payment of management fees and the other seeing these fees terminated, it doesn't take much guesswork to know which way things normally go.
In New Zealand dollar terms the US stockmarket outperformed most others in the quarter with a very creditable 3.8 per cent return, well ahead of European markets, which fell by 9.6 per cent, and Japan, which was down 6.0 per cent. The key factor here was commodities, especially oil.
When oil prices fall investors seem to buy US dollars and US shares. It is a bit ironic that many crises seem to start in the US but somehow its stockmarket is able to outperform.
Biggest disappointment in the quarter for many retail investors will have been Australian shares in which many New Zealanders are overweight thanks to the tax advantages of the fair dividend rate of tax, and which fell by 15.1 per cent as resource stocks sold off.
Since the quarter, ended markets have been in virtual freefall with Wall Street having fallen by about 22.7 per cent at the close on October 10. The question is, where to from here?
In a particularly insightful piece of analysis, Tim Bond of Barclays Capital in London compares the current banking crisis with what happened in Sweden in 1990-1993.
At that time bad debts in the Swedish banking system rose to about 12 per cent of GDP following a credit and real estate bubble. The IMF reckons US losses this time around could total 10 per cent of US GDP.
The Swedish Government intervened in September 1992, injecting government capital into the most troubled banks and implementing a guarantee for all bank liabilities apart from equity.
Share prices bottomed within a month of the government intervention in 1992 and had regained their pre-crisis peak by January 1994. Swedish households raised their savings levels sharply, initially deepening the recession. However, the economy began to grow again about nine months after the government intervention.
The good news is that, as far as asset returns were concerned, the Swedish stockmarket fell 45 per cent between July 1990 and October 1992 but the low was made in the month after the government intervention in the bank system. Over the next 12 months, the stockmarket rallied 43 per cent and rallied a further 20 per cent the ensuing year.
Bank stocks dropped 23 per cent in the month immediately after the intervention, but that was the low. One year after the intervention, bank equities had risen 520 per cent from the low point.
According to Bond, "the lesson in this respect is that the government intervention - initially perceived as traumatic - in fact established a sharp inflexion point for equity values. Even though the economy remained in recession for a further three quarters and credit continued to contract for almost a further 11 quarters, the equity market delivered very strong returns from the month after the intervention point."
Brent Sheather is an Auckland stockbroker/financial adviser and his adviser/disclosure statement is available on request and free of charge.
