Asset allocations

- Editor

International  Equities - reduce

With the US potentially already in recession, other regions are unlikely to be immune and global growth will slow, but remain well short of a global recession. The credit cycle has accelerated causing borrowing costs to rise, which creates a headwind for earnings going forward. Analysts have downgraded earnings forecasts for Q1 and Q208 but are still too optimistic for FY08 overall.

While the news flow in the financial sector is becoming “less worse”, other sectors are at risk of economic and earnings disappointment as business and consumer confidence deteriorates. However, corporates outside of the financial sector are in reasonable shape to be able to withstand this with relatively low levels of debt and plenty of cash on balance sheets. Equities remain cheap relative to bonds and forward PE ratios are “fair”.

Domestic Equities - reduce   

Earnings growth is set to slow further this year as monetary conditions remain tight and cost pressures are not dissipating, although much of this is already reflected in analysts’ forecasts. Market valuations have improved but remain expensive relative to the rest of the world. M&A activity is expected to slow following the recent tightening in global credit markets.

Domestic Listed Property - increase

The underlying fundamentals of the sector remain positive, with rental growth set to continue even in a slower economic environment. Dividend yields are very attractive in New Zealand, particularly on a post-tax basis now that listed vehicles have become Portfolio Investment Entities (PIEs). However the sector is at risk from the tighter credit markets, particularly in Australia where gearing levels are higher.

Global Property - reduce   

Valuations have improved considerably, with listed entities trading at significant discounts to Net Asset Value, particularly relative to bond yields. High occupancy and rental growth are positives for the sector and structural support comes from institutional demand for real estate and regional development of tax efficient structures. However, the sector is not as attractive as domestic listed property.

International Fixed Interest    - reduce

Global bonds will continue to be the safe haven destination in times of crisis, but over the medium term the outlook for government bonds is not particularly attractive. Government bonds are now extremely expensive on a number of valuation measures and have built into prices a sharp contraction in economic growth, with little in the way of inflation risks. Global credit, however, looks attractive and is pricing in well above average default activity.

Domestic Fixed Interest - reduce   

New Zealand government bond yields will be underpinned by domestic monetary policy, which is expected to remain tight for the remainder of the year. Similar to the offshore environment, credit offers a greater opportunity for return than government bonds.

Cash - increase

New Zealand cash offers very attractive risk adjusted returns at present. While it is unlikely that we will see further rate increases this cycle, we expect interest rates to remain high.

NZ Dollar - reduce   

Slowing growth in New Zealand, structurally high inflation and the current account deficit are negatives for the New Zealand dollar over the medium term. However, in the near term demand for yield and strong terms of trade will keep the kiwi above its longer-run “fair value”.