Bull run — is it the 1980s all over again?
Media speculation about a potential sharemarket crash has increased in recent weeks. Commentators are quick to point out that this is the longest bull market on record, stocks are overvalued and a crash is imminent.
This column looks at the major differences between the NZX at present and the frenzied 1980s, when the domestic sharemarket had its last major bull market. Readers can draw their own conclusions on the outlook, either positive or negative, from these comparisons.
Performance
The accompanying table compares the NZX’s performance in the decade before the October 1987 crash and over the past 10 years. The performance figures for the two periods are all based on the same NZX50 Capital Index, which excludes dividends.
It is important to note that the capital index declined by 6.0 per cent and 36.5 per cent in 1977 and 2008 respectively, the two years before our comparative periods.
The data clearly shows that the NZX’s performance was far superior three decades ago, with the benchmark index surging 1093 per cent between December 1977 and October 1987. By comparison, the index has risen only 116 per cent over the past decade, while the REINZ House Price Index has expanded by
86 per cent over the same period. The 2012 calendar year, when the NZX rose 18.0 per cent, has been the best year in the current cycle, while the market surged 116.8 per cent and
99.2 per cent in 1983 and 1986 respectively.
The latest bull market is impressive but the NZX has delivered an annualised compound capital return of 8.3 per cent since December
2008 compared with a massive 30.0 per cent per annum between December 1977 and October 1987.
Companies
The 1980s were dominated by investment companies, which represented 26.2 per cent of total market capitalisation just before the market collapse. They were followed by forestry companies (19.9% of total market value) and property (10.0%).
The five largest investment companies were Brierley Investments (11.5% of total market value), Chase (2.9%), Equiticorp (2.6%), Renouf Corporation (1.5%) and Rada (1.0%).
These companies invested in other listed companies and their reported earnings mostly comprised capital profits, both realised and unrealised. These profits disappeared when the market collapsed.
Many of the other major listed companies, including Fletcher Challenge (12.2% of total market value) and Goodman Fielder (6.7%), also had aggressive debt funded acquisition strategies. A principal supplier of these funds was the newly listed Bank of New Zealand, which represented 3.0 per cent of the total NZX market capitalisation in early October 1987.
By comparison, the largest listed companies at present are in the following order: Fisher & Paykel Healthcare; a2 Milk; Auckland International Airport; Meridian Energy; Spark NZ; Ryman Healthcare; Fletcher Building; Mercury NZ; Contact Energy and Air NZ.
These companies, most of which have reasonably sustainable operating earnings, are a stark contrast to the highly speculative, highly geared companies that dominated the NZX in the 1980s.
Governance
In 1987, the 10 largest listed companies had 94 directors and only one of them, Karrin Vautier at Fletcher Challenge, was a woman.
The country hadn’t had a woman Prime Minister at that stage.
Since then, New Zealand has had three women as Prime Minister and 24 of the 71 directors on the 10 largest NZX companies are now women. Fletcher Building, which has been the worst performing top 10 company, is the only large company to have fewer than two women directors.
The three largest investment companies — Brierley Investments, Chase and Equiticorp — had 28 directors, none of whom were women. Only two of these 28 directors were non-executives; the other 26 directors were company employees.
Many listed company boards in the 1980s were controlled by testosterone driven male executive directors while boards are now much more diversified.
Obviously, New Zealand’s corporate governance structures, and society in general, have changed dramatically since the mid-1980s.
Ownership
There has also been a dramatic change in share ownership over the past three decades.
In the 1980s, listed companies were owned mainly by individual investors, with almost no overseas fund manager ownership and minimal domestic fund manager involvement. The AMP and National Mutual were notable exceptions as far as the latter group was concerned.
New Zealanders were seduced by the sharemarket as they invested most of their surplus cash in the market, often with an unsophisticated and undiversified approach. Many investors borrowed heavily and invested all this money in one company, for example Robt. Jones Investments, Judge Corporation or another hot stock.
Others believed they had adopted a diversified approach when they put their money into just three companies, such as Brierley Investments, Chase and Equiticorp. That approach offered as little diversification as a spread of investments in three finance companies in the early 2000s.
There has been a dramatic change in share ownership over the past few decades, with individual investors now playing a minor role while fund managers and overseas investors have become the dominant market participants.
The introduction of the PIE regime and KiwiSaver in October 2007 has resulted in a huge switch in investment decision making, from individuals to fund managers. Investors are now much more likely to ask what PIE or KiwiSaver fund they should invest in, whereas in the past they were more interested in seeking advice about individual companies.
Fund managers can make mistakes but they are heavily regulated, operate diversified portfolios, have a strong focus on risk mitigation and have access to considerable information that should enable them to make better decisions than most individuals in the 1980s.
Overseas investors now own 47.2 per cent of NZX listed companies according to Forsyth Barr, with 18.2 per cent Australian owned and the remaining 29.0 per cent held by other international investors.
These global investors have been attracted to the NZX because of the defensive qualities of many of our major companies, their relatively high dividend yields and improved corporate governance.
In addition, the Crown holds a controlling stake in three of the 10 largest NZX companies, Meridian Energy, Mercury NZ and Air NZ, whereas the Bank of New Zealand was the Crown’s only top 10 shareholding in 1987.
Valuation
Valuation is a key consideration when making any investment decision and on that basis the NZX looks overvalued compared with 1987.
Just before the October 1987 crash, a leading broker had a prospective market P/E multiple of 10.1 and a forecast dividend yield of 3.4 per cent. The latter figure compared with the six-month term deposit rate of 17.2 per cent per annum at the time.
The same broker now has a prospective market P/E multiple of
25.9 and a forecast dividend yield of
5.4 per cent compared with the current six months term deposit rate of 3.25 per cent.
However, we should be careful with these figures because the 1980s forecasts were partly based on unsustainable capital profits that disappeared after the October 1987 crash.
Meanwhile, the current forecasts are more realistic, operating cash flows are strong and sustainable while the average dividend yield is higher than current term deposit rates. By comparison, dividend yields in the
1980s were significantly lower than term deposit rates.
Conclusion
It is extremely difficult to compare the NZX with the 1980s because New Zealand and the sharemarket have changed dramatically.
However, we can say with certainty that there will be a market correction at some time in the future. But it is important to note that KiwiSaver and other superannuation monies will continue to flow into equities after any downturn, whereas individual investors in the late 1980s deserted the market and switched to residential property.
This continued flow of KiwiSaver and superannuation monies suggests that any market downturn will be relatively subdued, particularly compared with 1987.
Brian Gaynor is an executive
● director of Milford Asset Management which holds shares in all the currently listed NZX companies mentioned in this report on behalf of clients.