World's share markets - best start in 18 years!

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Happy New Year! - best start to a year on the world's share markets for 18 years 

US GDP: the strong and weak of it...

KiwiSaver 5 years on ...

2012 may not be remembered for the best summer we have ever seen, but it will go down in history as one of the best starts to a new year on the world’s share markets for a very long time. In fact, 2012 has seen the best start to a year on world markets for 18 years!

The MSCI All Country World Index (an index which measures the performance of a basket of world shares) gained 5.8% in January ¹  - which is its best January since 1994. And the S&P500 in the United States gained 4.4% - which is its best January since 1997.² 

These strong results come on the back of some very positive momentum in the latter part of 2011. The US Dow Jones Industrial Index had its biggest points gain ever in a three month period from 1 October to 31 December; a gain of 1,344 points, or 12%.

The US share market (still the world’s largest share market) has quietly been making gains over the past four or five months, despite all of the worry about Europe and its debt crisis. From the end of September until last week (February 8th) the Dow Jones had gained 18% and the S&P500 was up 19%.³

These gains have added almost US$3 trillion to the value of the US share market. A significant amount of money! And it has largely flown under the radar of the average ‘person on the street’.

Even the European and emerging share markets, which were heavily sold off in 2011 falling by around 20% each, have started the new year on a much more positive footing. Year to date (to February 8th), the Euro Stoxx 50 Index was up 8.9%; the German DAX up 14.4% and the UK’s FTSE 100 Index was up 5.8%. The MSCI Emerging Markets Index had gained 14.5%.⁴

Why the sudden improvement in the world’s share markets?  As mentioned above, in the case of the US share market there has actually been some quite positive momentum for several months now. There is also the possibility that the worlds share markets have ‘normalised’ the main area of concern of late – the Euro zone debt crisis – and is taking the drawn out resolution of Europe’s issues in its stride. At least there does seem to be more positive progress there as the Euro zone leaders work on their fiscal compact plans.

There are other reasons to be positive too. The slow but steady pace of economic recovery in the US is becoming more evident week by week. The latest employment data from the US (released February 3rd) was much better than economists had expected and has seen the unemployment rate fall to a three year low of 8.3%. The share market likes this!

Another positive for share market is the record low interest rates globally. And just 2 weeks ago the US Federal Reserve said that they’ll be keeping their interest rates at a record low of 0.25% until 2014 now, rather than 2013. Central banks across the developed world are holding interest rates at all-time lows.

This means that investors who are only invested in bonds and cash are going backwards in terms of the real (after inflation) returns from these assets. So with improving economic and corporate earnings data continuing to rollout, all that pent up demand for a better return on investment means investors have been happy to put money back to work in the world’s share markets.

The New Year’s Eve party continued right through January. Investors who have remained well diversified with a spread of growth and income assets will have been well rewarded for their discipline.

Sources
^{1 US In local currency terms, source MSCI,  2 Bloomberg, 3 Bloomberg, 4 All index performance is from Bloomberg and is in local currency terms.}             

By Bevan Graham, Chief Economist, AMP New Zealand

The US economy posted its strongest quarterly growth of the 2011 year in Q4, contrary to most of the world’s major economies which generally lost momentum as the year progressed. The result printed at a seasonally adjusted annual rate (saar) of 2.8%, up from 1.8% in Q3 but weaker than the average 3.0% market expectation. Annual growth came in at 1.7% for the 2011 calendar year.

Consumption growth came in weaker than expected at 2.0% (saar) for the quarter. This was the primary reason for the weaker than expected overall GDP result. Even then, weak income growth meant the consumption growth was partly funded out of a reduced savings rate, which dropped from 3.9% in Q3 to 3.7% in Q4, the lowest savings rate since Q4 2007.

While it was the strongest overall result of the year, this was largely due to a significant build-up of inventories, which added 2.0 percentage points to the quarterly result. Excluding this component, GDP was only up 0.8%. That’s soft.

Other components were as expected. Residential construction increased 10.9% (saar). We put that down to a “bounce off the bottom” and good weather over the quarter. We don’t expect housing to be a persistent driving force of US growth anytime soon. The Government was a detractor from growth over the quarter, posting a contraction of 4.6% (saar), mostly from a decline in defense spending. We expect the Government sector to be a detractor from growth for the foreseeable future as Federal, State and local government all move to more sustainable budgets.

Here’s the good news: the two sectors we have looked to drive growth since the recovery started, exports and business investment, put in further solid performances. On a saar basis, exports were up 4.7% in the quarter while business equipment and software posted a 5.2% gain. That’s a great export performance given weaker global growth towards the end of the year.

There are some important messages in this GDP result. Firstly, it was not as strong as a cursory glance at the headline number would suggest. We do not expect the improving quarterly trajectory of 2011 to persist into 2012. We are still happy with our 2012 calendar year forecast of 2.0% for 2012.

Secondly, the US economy is in the early stages in an important rebalancing. Over the foreseeable future we expect consumption to remain soft reflecting slow jobs growth and continued household deleveraging, albeit at a slower pace. At the same time we expect the government sector to contract and exports and business investment remain the strongest areas of growth. The problem for the US economy is that exports are only 10% of GDP: we expect that ratio to rise overtime, just as we expect manufacturing to increase its share of sectoral growth. Time to dust off the rust belt!

More generally, the major challenge for the US economy in building higher sustainable growth is to produce goods the world’s consumers (e.g. China and India) want to buy at globally competitive wages. This is a structural recession requiring a structural recovery.

By Damon O'Brien, Authorised Financial Adviser, Spicers

KiwiSaver has twice been in the news in recent months – initially following changes announced in the 2011 Budget and more recently due to suggestions that long-term investors might be sacrificing significant rewards by staying in ‘default’ funds instead of moving into funds potentially better suited to their long term investment horizon.

On the first point, the Government did signal changes to KiwiSaver in last years Budget and these changes are scheduled to take effect from 2013. Will these changes make KiwiSaver less attractive? Absolutely. However, when KiwiSaver was introduced in 2007, the initial incentives were rather spectacular. In my view, the proposed changes have only reduced the incentives from ‘spectacular’ down to ‘excellent’. In other words, even these modified incentives are still very worthwhile.

So, how can the attractiveness of KiwiSaver be measured? The best way is to consider an example. For simplicity, the numbers I will use here have been rounded to the nearest thousand dollars, and calculations are all based on someone joining KiwiSaver in 2013, after the notified changes have come into effect.

Let’s consider Tom, a 21 year old who starts working in 2013 on an initial salary of $30,000pa. He immediately joins KiwiSaver and commits to paying 3% of his annual salary (as per new minimum contribution rules in 2013) as his employee contribution. Let’s also assume his salary only advances by $2,000 every five years and he retires at age 65 on a salary of $46,000pa.

Over the course of Tom’s working life, he would contribute $51,000 to his KiwiSaver account. His employer, matching his 3% contributions would contribute an additional $42,000 (taxed) and the Government, via the $1,000 kick-start payment and subsequent annual tax credits, would contribute a further $24,000. So for every $1 that Tom contributes, a total of another $1.29 is added by his employer and the Government.

It gets even better when we also consider the potential underlying investment performance of Tom’s KiwiSaver account. If he was to stay in a default scheme which will generally comprise of very conservative and, (on average) lower returning investments, Tom might only achieve an average investment return after fees and tax of say 2%pa. On this basis, he would see another $69,000 of market returns added to his KiwiSaver account by the time he retires. All-up the lump sum available to Tom on his retirement would be $186,000. By any measure, this seems like a wonderful return on the $51,000 that Tom personally contributed.

But what might happen if Tom decided to move out of the low risk default fund and into a growth-oriented fund? A growth-oriented fund is generally regarded as being suitable for most long-term investors. Such a fund would definitely experience more ups and downs than a default fund and periodically some returns would be negative. However, over Tom’s 45 year investment horizon, it is also highly likely that a growth-oriented fund would significantly outperform a default fund.

How important is this? Well let me show you what would happen if Tom could improve his average return after fees and tax to 5%pa from a growth fund instead of 2%pa from a default fund. Tom’s $51,000 of contributions would be unchanged and so would the $66,000 jointly contributed by his employer and the Government. The difference is the total market returns would jump from $69,000 to $296,000. Tom would no longer have a lump sum of $186,000 available on retirement, he would have $413,000. The significant difference between these outcomes clearly demonstrates the potential power of compounding returns over a long term horizon.

The scenario outlined for Tom may or may not be suitable for others. Everyone’s personal circumstances, investment timeframes and risk tolerances are unique in some way and this will lead to different investment approaches. For example, people hoping to access the ‘first home buyer’ subsidy via KiwiSaver will probably want to avoid taking too much investment risk while they build up their future home deposit funds.

At the end of the day, someone’s strategy needs to reflect their personal circumstances and while Tom had the time horizon and risk tolerance to accept higher risk investments, your situation may be different. However, in view of the strong incentives still on offer for KiwiSaver members, I definitely recommend taking advantage of the savings opportunity that KiwiSaver provides.

To contact Damon, phone 0800 102 100, or email damon.obrien@spicers.co.nz

Disclaimer
Damon O'Brien is an Authorised Financial Adviser. His article provides general information and opinions and it should not be considered personalised financial advice. Damon is not liable for any loss suffered by those who follow the information provided in his article. A disclosure statement is available on request and free of charge.

Your feedback is welcome

Financial Update is a regular publication published by Spicers Portfolio Management Limited. It discusses topical investment and financial planning issues. A disclosure statement is available on request, and free of charge from you adviser.

Please provide feedback directly to your adviser or email spicers@spicers.co.nz

Disclaimer

The information in this publication is of a general nature only and is no substitute for personalised advice. If you would like advice that takes into account your particular financial situation or goals, please contact your financial adviser.

The information has been published in good faith and has been obtained from sources believed to be reliable and accurate at the time of publication (13 February 2012). The opinions contained in this document reflect a judgment at the date of publication by Spicers Portfolio Management and are subject to change without notice.  Past performance is not indicative of future performance and is not guaranteed by any party.