Don't heed doomsayers

Aaron Drew.

We are fed an almost-daily diet of dire predictions about the fragile state of the global economy. At times these worries spill over into discussions with our clients concerned about the implications for their investments.

This begs the question of whether the macroeconomic environment really matters for equity returns.

Intuitively, the answer is surely yes. When our economy does better, business' revenues and profitability levels tend to increase.

But not so fast. Countries such as China have experienced very strong growth and relatively poor equity returns in the past two decades, while long-run equity returns in relatively slow-growing rich countries such Sweden - and New Zealand - have been relatively good.

Several factors may help explain the discrepancy between economic growth and returns.

First, in New Zealand and most other nations a significant part of economic growth derives from new and small businesses.

These tend to be under-represented on listed equity markets, which are typically dominated by large banks, utilities and multinationals.

Second, in today's highly integrated world, global rather than local conditions often matter more for a market's prospects.

New Zealand's equity market has been a top performer in the past year with increasing flows from foreign equity manager behemoths attracted to high-dividend-yielding stocks.

This has helped push up equity prices to levels that make our market appear quite expensive. From an integrated markets perspective, however, our market has simply enjoyed a period of catch-up.

Third, and perhaps most important, as with any asset price, expectations of future conditions matter more than what is happening today.

Asset returns since the GFC have been exceptionally high across bonds, equities, commercial and residential property.

This has partly been because global economic growth and inflation have been genuinely weak, and the slashing of rates by central banks in response has boosted asset prices higher. But it also reflects that the worst downside fears have failed to materialise.

Listening to the doomsayers may be entertaining, but following their investment advice is rarely wealth enhancing.

- Aaron Drew is chief investment officer with Hastings wealth management company Stewart Financial Group. His show Real Wealth can be heard on Radio Kidnappers on Tuesday afternoons and on podcast.