Back the dogs

Wednesday 1st May 2002

Why last year's stock market darlings might not add up to much in 2002

Share market pro David McClatchy tells an interesting story about punting on investment markets. Imagine, says McClatchy - who runs funds manager ING - that back in 1982 you took $100,000 and invested it in the previous year's best performing asset class. Then, for the next 19 years, you did the same thing and backed the previous year's winner. By the end of 2001, your money would have grown to $701,601 - an average annual return of 10.23%. That's not bad going.

Now imagine, McClatchy says, that you invested the same $100,000 for the same 20 years, but instead you put it in the previous year's worst performing sector. That $100,000 would now be worth a whopping $2.07 million - an average annual return of 16.36%.

This "back the dogs" investment strategy isn't one McClatchy recommends. After all, as a funds manager he earns his living by offering slightly more sophisticated investment strategies. But he makes his point well: the people who make big money in investment markets are those with the guts to go against the crowd.

An independent mind, along with a strong stomach, will definitely come in handy for investors in the New Zealand share market this year. That's because last year's market darlings - smaller Kiwi companies able to cash in on 2001's strong domestic growth - might well turn out to be has-beens in 2002. Meanwhile, last year's dogs - top 10 stocks such as Telecom - might turn out to be the year's winners.

The 18-month good run for blessed second-tier Kiwi stocks such as Sky City and Baycorp may well be coming to an end. Their share prices, which looked cheap two years ago compared with profit forecasts, have shot up to such a level that they already take account of future profit windfalls. Some, such as Fisher & Paykel's healthcare and appliance stocks, have already fallen from last year's highs after signs future earnings might not live up to heightened market expectations.

Meanwhile, some of our top 10 stocks, particularly Telecom, are so out of fashion with investors that their long-ignored share prices look cheap, particularly compared with the second-liners. Brokers say many second-tier stocks did well last year because they paid high dividends at a time when bank deposit rates were low. With interest rates now rising, those dividend yields don't look as flash.

In fact, AMP funds manager Chris Wozniak believes rate rises might cause a big re-think about who's in and who's out in the share market this year.

Higher rates tend to eat into companies' cash flows. They also lower the value analysts put on that cash flow, reducing their final estimate of what a company's shares are worth. Those most vulnerable to this re-rating are firms with steady cash flows, such as utilities, Wozniak says. Less affected are growth stocks - firms like The Warehouse and Briscoes - that are able to expand by opening more stores.

Another big influence on the market this year will be the value of the Kiwi dollar. A rise in the dollar, predicted in response to higher interest rates, will depress farm incomes and be a kick in the guts to agriculture-related stocks such as Williams and Kettle, and Wrightson. To a lesser extent, meat companies Affco and Richmond might be affected.

On the flipside, a higher dollar would be a bonus for importers such as Sky TV, which buys much of its programming in US dollars. The Warehouse might also benefit, though increased competition from Briscoes and a revitalised Farmers might see any gains competed away.

The dollar will also have an impact on forestry stocks, such as Carter Holt Harvey (CHH) and Fletcher Forests. However, the outlook for the tree growers will be clearer when the Northern Hemisphere spring kicks in and industry watchers are able to get a handle on the level of supply coming out of Eastern Europe. There's already a lot of good news priced into CHH's shares, meaning the stock could tumble if things don't go its way.

A third big change that could sweep through the market is that investors might finally get their taste back for technology stocks. Since the tech wreck in early 2000, investors have been flocking to safe-haven shares such as Port of Tauranga and Auckland Airport - straight-forward businesses you don't need a software PhD to understand.

But with the share prices of those meat-and-two veg stocks now uncomfortably high, interest is returning to the tech sector. In New Zealand, of course, the big technology play is Telecom, whose share price languished under $5 at the start of April, down from $7.50 in June 2000. For the last 18 months most professional stock-pickers have been decidedly cool on our biggest data and phone company - partly because they aren't sure if its latest venture into Australia will be a success. But in recent weeks feelings have warmed, though no one's committing themselves wholeheartedly yet.

"Telecom might be a performer this year", is typical of the broker views heard by Unlimited. The stock's suffered as investors around the world turn off telcos, one says. And there's a question about whether it paid too much for Australia's third largest telco AAPT. "But a lot of the things that put people off telco stocks overseas don't apply to Telecom - it didn't pay too much during spectrum auctions and hasn't overspent laying [fibre optic] cable," he says.

Another analysts says that even if AAPT is eventually deemed over-valued in Telecom's books, the company's New Zealand assets are under-valued, meaning its balance sheet still looks pretty healthy. Telecom's sensible approach to capital expenditure and costs deserves to be rewarded, another analyst adds.

Of course, any investor who finds all those investment ifs, buts and maybes make their head hurt could resort to McClatchy's "back the dogs" investment plan. That would mean avoiding the Kiwi share market altogether and putting their money into international shares, which lost 13.10% of their value last year, on top of an 8.28% drop in 2000.

Frances Martin has a financial interest in some of the stocks mentioned in this column

Frances Martin
frances.martin@paradise.net.nz

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