Investment case for equities remains solid

European Central Bank president Mario Draghi is likely to remain supportive of equity markets in the medium term. Photo by Reuters.
European Central Bank president Mario Draghi is likely to remain supportive of equity markets in the medium term. Photo by Reuters.

Most markets performed respectably in the first half of the year with the NZX50, in New Zealand, posting the strongest return in the six months to June 30. Business editor Dene Mackenzie talks to Craigs Investment Partners broker Chris Timms about the first six months and what he expects for the rest of the year.

At the start of the year, expectations another rally of the magnitude of last year seemed unlikely, Craigs Investment Partners broker Chris Timms said.

However, it was a year of solid gains for equities, given economic growth was accelerating in most regions and earnings growth was likely to be robust.

United States, Australian and New Zealand shares had performed as expected, while emerging markets were surprisingly strong.

United Kingdom and European shares lagged, he said.

''We remain positive on global equities, including Australia, at current levels and see potential for offshore markets to perform better than our own.''

The high New Zealand dollar also provided an opportunity to add to offshore holdings, particularly as some weakness could creep into the currency as the US Federal Reserve ended its quantitative easing programme in late October, and as the pace of domestic economic growth passed its peak.

The investment case for equities remained solid on a 12-month view and total return basis, Mr Timms said.

While the current environment exhibited a few concerning signs - high government debt levels, stubbornly high unemployment, artificial central bank support and high valuations - every major region was expected to experience positive economic growth and for corporate earnings growth to continue.

''It is difficult to see a significant market correction taking place when growth is gaining momentum and while earnings are growing steadily.''

In the short term, perhaps the next three months, there was potential for volatility to re-emerge and market weakness to ensue.

That would come on the back of full valuations, geopolitical risks, rising interest rates in the US and investor complacency, he said.

Applying some caution in buying shares should be considered, along with taking profits in higher-risk positions or reducing holdings that had become larger than they were intended to be, Mr Timms said.

New investors would be encouraged to be patient, selective and cautious in their investment approach over the short term.

 

Economic growth

Global economic growth was positive for the coming years. Between 2014 and 2016, expectations were for every major region to experience positive growth.

Regions forecast to experience the strongest growth were the US, the UK, New Zealand and Australia. China was expected to grow strongly, although at a more moderate level than in the past two decades.

Europe and Japan were forecast to grow but at a much slower rate.

Europe had many issues to work through while Japan was plagued by demographic challenges.

 

Earnings growth

As was the case with economic growth, corporate earnings growth was expected to accelerate over the coming two years. Of the five key regions, the US, Europe and Australia were expected to experience the strongest growth. New Zealand was expected to see more modest earnings growth although Mr Timms argued it could probably be relied upon as more achievable and more insulated from the risks that could emerge across Europe, the US and Australia.

 

Equity markets

Some markets had been tracking broadly as expected, such as New Zealand, Australia, Europe and the UK. However, the US and the emerging markets had been surprisingly strong, both reaching year-end targets within the first half of the year, he said.

 

UNITED STATES - current view neutral

US equities had a solid outlook as the economy continued to recover and earnings growth remained robust. Value was harder to find after a strong performance. The Federal Reserve was expected to remain supportive over the medium term although much less so than in the past as quantitative easing ended and interest rates potentially increased from current near-zero levels. For New Zealand investors, the bright side of any such changes would be a potentially stronger US dollar.

 

EUROPE - current view positive

Europe continued to exhibit risks, although the worst appeared to have passed and opportunities existed in equities. The European Central Bank was likely to be more accommodative in future, supporting the market in the same way the Federal Reserve had done in the US.

 

UNITED KINGDOM - current view positive

The UK market looked good value, had attractive yields and was showing signs of economic stabilisation amid a stronger housing market and a more robust labour market. While economic growth and earnings growth remained muted, on balance, there were opportunities in the region, particularly if the central bank moved to a tightening bias and the consequential impact on the New Zealand dollar relative to the British pound.

 

EMERGING MARKETS - current view neutral

Emerging market economies had stronger demographics than many Western nations and excellent long-term growth outlooks. Craigs had a positive view on the outlook for emerging markets although, in the short term, there was further volatility coming. Investors had enjoyed significantly higher returns in developed economies than in emerging economies in the past five years. Emerging market valuations had become too good

to ignore. Investors should add exposures in emerging markets both directly and through companies selling into emerging economies. It should be acknowledged risks were higher than for developed markets and there was potential for greater volatility.

 

AUSTRALIA - current view positive

Australia looked reasonable against the backdrop of a lower currency and lower interest rates, the latter of which should keep yield stocks well-supported. Consumer spending was likely to remain constrained following a tough Budget and the economy generally beholden to the mixed outlook for China.

 

NEW ZEALAND - current view neutral

Attractive dividend yields should support the market, while the Canterbury rebuild and strong migration would keep the outlook for the economy robust. High-quality companies continued to post solid results and the local market remained a low volatility place to invest. Craigs was comfortable with New Zealand equities although value was difficult to find and investors should look for weakness to accumulate holdings.

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