History repeats

By Rebecca Macfie

Saturday 1st November 2003

Got money in the sharemarket? You might want to grab yourself a nice cup of tea and a comfy chair before you read on. Christchurch investment adviser Charles Drace reckons - wait for it - equities will drop 80-85% from current values before the sharemarket bottoms out in around 2018. Yep, Drace sees nothing but a downward slide for the next 15 years or so, based on his analysis of historical economic cycles.

American-born Drace - a former Green Party candidate who's about to publish a book panning GE - has lived in New Zealand for 30 years and has been a financial planner since the 1980s. These days he's got around $30 million under management in five funds, and 300 clients aged from 10 to 94.

Since September 1999 none of his funds have held shares. Back then he made the bold call to pull out of equities because he reckoned the market was in a state of "exuberance" that couldn't last. Over the next six months the Nasdaq doubled in value. "Everyone thought we were crazy," says Drace. Did he doubt himself? Yes, sir. "One of my biggest strengths is that I doubt myself and everyone else. You have to be constantly re-evaluating."

Drace shifted his funds into a mixture of cash, bonds and trading funds. The result has been a rate of return of 4.5% a year over the last three years (net of management fees). Hardly spectacular, but by contrast FundSource data shows the average balanced diversified fund in New Zealand returned negative 2.81% over the last three years.

"What I'm trying to do with my clients is save wealth," says Drace. "Don't expect property to go up. It's more likely to go down. Don't expect the sharemarket to go up. It's more likely to go down."

One of the factors that convinces him of this is an historical review of price earnings (PE) ratios. The average PE on the US stock market right now is around 35, he says. History shows that PE ratios at bull market peaks (such as 1929, 1966 and 1999) tend to reach an average of around 28. But the average PE over the last 100 years has been just 15, and over the last 400 years it's been 14. In short, Drace reckons shares remain overpriced and that there's plenty more downside in the market yet.

But what of the oft-repeated claim that in the long term investors will always do better in the sharemarket than anywhere else? He whips out a chart published by Yale economics professor Robert Shiller in his 2001 book Irrational Exuberance, which depicted the sharemarket as grossly inflated and heading for a fall. Shiller's chart of the Standard and Poors composite stock index, adjusted for inflation, shows the peaks and troughs of the market dating back to 1880, with each cycle occurring over a roughly 30 year time frame.

The point, says Drace, is that it all depends on where in that 30 year cycle you buy in. "If one had invested somewhere near the peak in 1906 it would have taken 20 years just to get back to where one started, in inflation adjusted terms, as the bear market wiped out 92% of the bull market gains. From 1929 it would have taken 24 years to recover losses of 94%, and from 1965 it would have taken 28 years to recover 74% losses. Therefore, anyone investing in sharemarkets today can expect to have to wait 20-25 years to recover losses of 74-94%."
Maybe it's whiskey you should be drinking.

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