Threats and opportunities for investors

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Expectations that inflation will veer close to the top of the range tolerated by the Reserve Bank during the next few years could see the current high interest rate environment persist for some time.

Tuesday, June 26th 2007, 6:50AM

In its latest Quarterly Strategy Update, fund manager Arcus Investment Management Chief Economist Rozanna Wozniak says the Reserve Bank has no room to relax.

High inflation expectations have become particularly entrenched in the housing market, where there is a stubborn belief that property prices will always rise, and in the labour market, where low unemployment and a severe skills shortage mean that wage pressures are unlikely to abate.

Wozniak says many other parts of the world, like New Zealand, are dealing with their own inflation problems. "But the risks they face are less severe. New Zealand's interest rates are among the highest in the developed world, yet consumers are behaving as though interest rates were stimulatory."

"While we are encouraged by the resilience of the local economy to the high interest rate environment, we expect conditions to deteriorate. Businesses are already feeling the pressure of rising costs, and with equity valuations currently at around historical highs, we believe that other parts of the world offer better value for less risk. Corporate earnings growth is stronger in other parts of the world and equity valuations are generally more attractive."

The global outlook for equities is positive, although the gains experienced over recent years may be difficult to match. However, investors with offshore assets should benefit as the New Zealand dollar retreats to a lower value against the US dollar and other leading currencies.

Emerging market equities also continue to provide attractive opportunities for investors. Sharemarket valuations in many emerging markets are not excessive, company profit growth remains strong, and corporate governance continues to improve.

Short-term risks such as another possible correction in the overheated domestic Chinese equity market and/or a sudden unwinding of Yen carry trades could result in periods of increased volatility for investors in this asset class, but fundamentals remain positive.

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