Last month I mentioned that global indices had gained ground but were at important technical levels. There has been a steadiness over the last month, so that at the quarter end, the Dow was down 0,9% for the 3 months, and the broader S&P 500 up just 1,3%. Compared to bond yields, global equities remain cheap, but this is largely due to the exceptionally low interest rates. In absolute terms, global equity markets, especially in the US and Europe are at expensive levels.

The US dollar has fallen back marginally in 2004, and together with strong demand, this has pushed up commodities even further. In the first 3 months of the year, platinum has gained 12%, palladium 48% and oil 28%. Gold has been lagging other metals but touched a new 15-year high last week in US dollars at $432,35/oz. It is very likely to continue up to at least $450/oz into 2004.

There is no doubt that the declining interest rate environment has been a major driver of global asset prices over the last 10 and 20 years. The next 10 years are not going to be against a similar backdrop.

Bonds

Bond managers, Pimco, say that the Federal Reserve created conditions for a "rational" bubble in asset prices, when it started using the phrase "considerable period", which was taken to mean time based. It has since changed to being "patient with respect to its accommodative policy".

Investors don't really have a choice. They either place their investments at nominal interest rates or subject them to some risk and back into equities. The mass market has opted for the latter, thus perpetuating the expensive prices.

For investors currently in so-called low risk global funds, which are typically weighted towards global money market and global bonds, the time to move out is now. Maintain your exposure to global currency, but away from global equities and bonds.

Locally taking a current 3% dividend yield and adding an annual real growth rate of 2% provides a prospective real rate of return of around 5%. Selected equities may indeed provide better results than a real 5%, but my advice is to set realistic expectations.

Comparing the yield on bonds to the earnings yield on shares, gives a very good indication of the relative value of these two main asset classes. While in March 2003, the comparison got to extreme levels, its still worth noting the following:

• Yield on bonds - 9.5% giving an after tax of around 5,7%

• Dividend yield on equities - overall 3%, but removing the dual listed provides around 4% to 5% after tax.

For balanced portfolios I am generally looking at remaining largely neutral in first world countries, (i.e. out of equities and out of bonds). Locally depending on risk profile there is continued merit in remaining invested in equities, which still continue to provide better value than alternatives such as bonds, cash, listed property etc.

In my view, balancing the higher local risk with globally lower risk makes the most sense.

For the detailed Market Focus newsletter, please click here ?

Posted: 2004/04/07 22:06 View Archive

Email this article to a friend