Positive pointers from US

By PHILIP MACALISTER

With holidays out of the way, the spending frenzy of Christmas well behind us and business back to normal it's an ideal time to check in on the markets and see where your money should be invested for the next year.

There was an understandable degree of caution and uncertainty after the terrorism attacks of September 11.

Likewise, the outlook was very confused as the United States and Europe were in, or near, recession, and no sign that the decade-long economic meltdown in Japan was likely to improve.

Yet the outlook from the experts' desks is now clearer - and surprisingly positive.

The other pleasing sign as the year begins is that those who invest, and have taken professional advice, seem to be going by the textbook.

This observation is made after scrutinising the latest funds flow data from managed fund research house FundSource. It shows that investors' money into managed funds, which is largely directed by financial advisers, is going into international share funds.

FundSource executive chairman David van Schaardenburg says that flows into international equity funds are "booming". In the three months to December 31, $235 million was invested into this sector. On top of that the survey of tax-effective United Kingdom funds, which is done by online money management magazine Good Returns, shows that another $16 million was put into overseas share funds.

This is quite a revelation, as over the past two years investors who have owned international shares have taken a hammering. In some cases the losses on investments could be as high as 25 per cent, while people who invested in New Zealand and Australian shares have done very well.

The analysis of the fund flow data indicates that investors are moving out of the sectors that have done well, and into the areas which are predicted to do well.

These investment patterns fit with the story being told by professional managers after September 11, for the need to invest overseas and the emerging view from commentators that the growth prospects for the world economy are positive.

The latest view, espoused by investment research organisation Morningstar's expert asset allocation this week, is that international equities is the most favoured sector.

Panel chairman and Economics New Zealand managing director Donal Curtin says that when the panel started discussing the investment environment one of its members kicked off the discussion by painting an extremely bullish picture for the United States economy, even going as far as to say it could record 4 per cent growth this year.

Curtin expected such predictions to be shot down by other panel members but they received widespread support.

The reasoning behind this is that the United States is in the middle of "the mother of all stimulations".

The optimism revolves around a number of factors, including: short-term interest rates at 40-year lows; Government spending boosting economic activity; sharply falling oil prices putting large amounts of money back into families' pockets; and low interest rates boosting the spending power of people refinancing their mortgages.

This economic stimulation is leading to some consistently positive data from the United States.

Curtin says that investors can expect to see some "rip-roaring quarters of growth with some holes in between".

The US-led recovery is likely to spread to the global economy so investors need to look for other markets as well.

Curtin says the emerging markets look more attractive than they have for some time and Asia (excluding Japan) is one area that is likely to benefit.

Because of this the panel raised its allocation of international shares by 1 per cent to 44 per cent of the portfolio.

But what about the Australian and New Zealand markets?

Here the panel kicked around the question: are the Australian and New Zealand economies likely to be high-growth or low-growth prospects during the year?

The general view was that they would show growth, but it was likely to be lower than elsewhere.

Overall the panel concluded that international sharemarkets showed greater potential for growth. Despite this, the panel decided to keep its overweight positions in Australia and New Zealand.

The panel runs a model portfolio with a strategic asset allocation which is meant to be the long-term average for a medium-risk investor. As part of its work it implements "tactical tilts", which shift the exposures to some assets in response to prevailing market conditions.

At present the portfolio is overweight in international shares, and the extra 1 per cent it has added to this sector has been taken from cash, despite the panel's strong view that cash is the preferred defensive asset.

It is still overweight cash with an allocation of 9 per cent.

It remains significantly underweight in the fixed-interest sector, locally and internationally.

The panel says the dominant factor for this sector is the global upswing, which is likely to reduce returns in this area. On New Zealand bonds its view is clear: don't buy them, there will be better value.

What risks do the panel see ahead?

Curtin says that the panel was "robustly confident about the world economic recovery".

Likewise, it had little support for the bearish views being expressed by others in the marketplace.

Even the parlous state of the Japanese economy did not weigh on its collective mind.

"Japan - who cares?" was its response.

Perhaps the biggest risk waiting out in the markets for investors is actually investors themselves and their sentiment.

Curtin says it may take time for investors to accept that an economic recovery is under way, and they may wax and wane on the idea, thus leading to a bumpy ride.

"Sentiment could continue to be blown around by the errant gusts of economic data (a pattern that is entirely typical of turning points in the business cycle)," the panel says.

The other factor which may have some impact is fallout from the collapse of energy trader Enron in the United States.

BT Funds Management chief executive Craig Stobo, who is a panel member, says the Enron collapse is making fund managers more careful when they look at a company.

BT now has less confidence in using audited accounts to calculate a company's worth. Its analysts are doing additional work to test the quality of the accounts.

"You've now got to go behind the numbers to see how they are compiled, and this involves interviewing the managers responsible for them."

A positive result to come from the Enron collapse is that managers will work harder than before to make sure companies are clean, as well as lean.

The panel is now significantly underweight fixed interest in New Zealand and overseas, slightly overweight cash, New Zealand property and New Zealand shares, and more heavily overweight in Australian and international shares.

Overall, the portfolio has a strong bias to growth assets - as opposed to investments which produce income - reflecting its bullish view on economic growth for the year ahead.

* Philip Macalister edits online money management magazine Good Returns. He can be contacted by e-mail on philip@goodreturns.co.nz