Don't let great expectations get in the way of the facts 12th August 2000

Annette Sampson - Sydney Morning Herald

Hands up if you are one of those investors who was just a wee bit disappointed with NRMA's sharemarket listing this week. Be honest. We all know we got the shares for nothing and should be happy that they came on to the market at a premium to the facility price, but how many of us were hoping for that little bit more? Something a little more ... well, spectacular?

Sure, we can blame the greedy institutions for dumping their shares once the share price exceeded $3 - and with some justification. These institutions, as we all know, are the same types that lecture long and hard to retail investors on the merits of long-term investing and the pitfalls of chasing easy profits. But the truth is that while the vast majority of retail investors this week took that view, the big guys were chasing the fast bucks.

But that's really by the bye. With broker valuations of NRMA shares ranging from around $2.60 at the low end to about $3.20 at the high end, we should expect some volatility while the shares find their trading range.

What is more of a long-term concern is our expectations from the sharemarket and the way these have changed following a decade of sharemarket growth and largely successful privatisations and demutualisations.

With a couple of notable exceptions (GIO and, so far, Telstra 2), being part of the big listings has been money for jam over the past decade. And a bull sharemarket has simply added to the euphoria, leading us to believe that while prices of around $3 this week for NRMA shares were OK, they really should have performed a little better.

This is where a presentation this week by Merrill Lynch Investment Managers gets interesting. The firm had its central strategy group chairman, Ewen Cameron Watt, out from Britain to talk to local investment institutions. His theme? "The triumph of hope over experience."

Watt reckons it's not just small Australian investors who are starting to expect too much from their share investments. He has taken a hard look at the US market and is about as negative going forward as a pro-shares house can be. In other words, his view is "neutral". "I don't think anyone should expect in the near term anything like the 20 per cent returns we've seen in the US market in recent years," he says. "You can't extrapolate what's happened in the past going forward."

On the positive side, Watt says, the US economy is strong and productivity is rising. Economic volatility has declined, making the outlook for company profits more certain. This has led many analysts to argue that shares are now less risky and to justify higher valuations because of this reduction in risk.

But, Watt says, even if you accept that all of this is the case, the assumptions are still overly hopeful.

The graph shows the earnings growth expectations built into the S&P 500 index. As you can see, investors are assuming earnings will grow around 17 per cent a year - or well over double the growth in US GDP.

Over the past few years, says Watt, just 30 per cent of the growth on the US sharemarket has been due to growing profits. The rest has been due to "re-rating" - analyst-speak for investors deciding they will pay more for the shares.

"In a sense, share prices have been leading profit expectations," Watt says. "And that's illogical."

It's important to stress that Watt isn't a doomsayer. In fact, he's quite positive on the market and the US economy. It's just that he doesn't believe we'll continue to see shares returning around five times the inflation rate or three or four times the returns on "risk free" assets such as bonds.

"If you look back at the last 100 years, shares have returned a real return over bonds in the order of 4 per cent per annum," he says. "That's before costs. I would suggest we mustn't expect much more than that going forward over the long term."

At the core of Watt's argument is the basic notion that an economy is made up of the activity of businesses, consumers and governments. While businesses can grow faster than the overall economy, it's impossible for all of them to do it on a consistent basis and certainly not by the extent that the market is assuming.

NRMA is a respectable company in an industry with a respectable outlook, but a turbo-charged growth stock it isn't. While analysts say the insurer has some bullish forecasts on its ability to grow its business, its price will ultimately depend on its future profit potential.

The principal of Motivated Money, Peter Thornhill, also offered an interesting insight into investor thinking this week. When investors receive shares for nothing, he says, they tend to develop something of a love/hate relationship with them.

"They usually set as their benchmark the previous high the shares have reached," he says. "If the company is trading below that price, they think they've lost money."

What's out of whack here? The performance or the expectations?


Back