In 2011 the share markets were driven by fear that the world was going into a recession, or worse, depression.

The US economy did not enter a double dip recession as had been predicted by some economists earlier in the year. The International Monetary Fund (IMF) is predicting a modest 1.8% growth in 2012. The US is going through a 60 year depression in new housing construction and it may take up to 3 years to work through the housing surplus in some areas.

China did not suffer a hard landing as had been predicted. China moved to tighten monetary policy with the result that inflation is under control and dropping.

Europe's debt levels, while high, appear to be manageable provided politics can be set aside. Europe is headed for a decade of low growth and probably recession for the next two years. The IMF is predicting a recession in Europe with a GDP growth of negative 0.5% in 2012.

The IMF is predicting global growth of around 3.25% for 2012 down from their recent forecast of 4%.

Australian and New Zealand economies are in a strong position with relatively low debt levels compared with other major western economies.

Corporates in western economies are generally sitting on strong balance sheets and cash reserves. A number of Corporates in the US are using their strong cash positions to buy back their shares.

During 2011 share markets experienced high volatility with some daily movements of 4-5% up and down. Currently share market volatility has dropped back to more normal levels. This may be due to the "January effect" where there may be an unrealistic expectation of euphoria that "this year is different", "this year is going to be a good one".

The VIX index is a key measure of market expectations of near-term volatility compared with the S&P500 share index.  S&P500 is the share market index for the top 500 US companies. Since its introduction in 1993, VIX has been considered by many to be the world's premier barometer of investor sentiment and market volatility.
Note: The scale on the right of the graph below is the percentage change in the daily return.

At Lyford Asset Management we are optimistic that share markets are cheap and the fundamentals are in place. If you look at the Farrelly's tipping table below you will notice the share markets are either in the 'cheap' or borderline 'fair value' areas. Farrelly's growth forecast returns are calculated as return = income + growth in income + effect of changing valuation ratios.

Overpriced (red) - Bonds expected to outperform equities
Fully Valued (yellow) - Equities outperform bonds by up to 2.5%pa
Fair value (blue)- Equities expected to outperform bonds by between 2.5 to 5% pa
Cheap (green) - Equities to outperform bonds by more than 5% pa.

The Three Signs of Improving Markets
There are three major signs that the market is beginning to look healthy again. The lagging sectors in 2011 were financials, homebuilders, industrials and materials, during January these sectors have become the market leaders.

The three bullish signs since the important low in early October 2011 are:
1) There is a rotation out of defensive stocks such as utilities and consumer staples
2) Fewer downtrends in World markets. Volatility in share markets has dropped from some days a daily movement of 4-5% up and down to more normal 0.2-0.3% daily movements.
3) Renewed speculation in small-cap stocks

New Zealand Interest and Mortgage Rates
In NZ the expectation was that the Reserve Bank would start to raise interest rates from June 2012, however the December quarter inflation figures showed a drop and with international interest rates low, NZ interest rates are expected to remain low well into the third and possibly the fourth quarter 2012. Inflation for the last 12 months was 1.8% dropping from 4.6% for the 12 months ending the September quarter. The OCR (official cash rate) target will remain at 3.5%.

Interestingly, the US Federal Reserve in December reconfirmed the interest rate target of 0%-0.25% and that this should remain exceptionally low until mid 2013.

December and January were eventful months for tragedy and a reminder of the role that life, trauma and income protection insurance can have in providing financial support at a time of trauma for loved ones.

At Lyfords we experienced a particularly tragic time with friends and with clients. Fidelity Life's Christchurch Business Development Manager (BDM), Warren Day whom we have been friends for 17 years died of a heart attack while watching TV on Christmas Eve. He was aged 58. Fidelity's Wellington BDM narrowly escaped drowning in Foveaux Strait (the chilly waters between Invercargill and Stewart Island).

Dave Wallace, aged 65, a Christchurch financial adviser died on the golf course only 3 hours into his retirement.

We had two clients diagnosed with prostate cancer (one was 32 the other 59), one with breast cancer and one with terminal pancreatic cancer.

What annoys Alison most is that she had four prospective clients who delayed taking out the insurance that she had recommended and were diagnosed with breast cancer, heart attacks and prostate cancer and are now uninsurable when they were then. Alison worked out that this was a gain to the insurance companies of $1.8 million in claims that were not made.

The statistical facts are that one in three of us will be diagnosed with cancer, one in four with heart attacks before the age of 75. Its important to review your insurance as your circumstances change and to implement and not delay getting those medical tests or completing applications.

Her Majesty’s Revenue and Customs (HMRC) has issued draft proposals affecting Qualifying Recognised Overseas Pension Schemes (QROPS) intended to take effect from 6 April 2012. Whilst only proposals at this stage, changes include extending the QROPS reporting requirements to ten years from transfer. Existing reporting requirements are five full UK tax years from the member being non UK tax resident. Also, it is proposed to restrict the lump sum available so that 70% of the initial transfer value must remain invested to provide an income for life.

We do not know at this point whether HMRC intends these changes to be retrospective or whether they will only affect transfers made after 6 April 2012. We can be certain of one thing, however: it is HMRC’s intention to tighten QROPS rules and reduce the accessibility of funds after transfer so any changes will mean less flexibility.

If you have funds invested in a NZ Superannuation QROPS fund and have concerns as to how these proposed changes may affect you, please contact our office.

If there is an investment or insurance term that you wonder what it means a good place to start is our web site at investment jargon explained.

What is a Bond?
A bond is a generic term for a long term debt instrument. Commonly a bond had a fixed and finite maturity date and carries an interest payment (referred to as a coupon) for the periodic payment of interest. Normally the bond has a fixed coupon but variable coupon bonds are not uncommon. Other names for bond type instruments include: notes, debentures or stock. Bonds are generally issued by governments, banks or companies to finance investment projects.

At the moment Corporate bonds have a coupon rate of around 7.0% for a 5 year bond. This contrasts with bank fixed interest rates of 4.5% for 1 year, 5.85% for 5 years.

One key difference between bank fixed interest and bonds is that there is a secondary market for bonds which means they tend to have liquidity.

How is a bond valued?
All bonds in our client portfolios are valued at the current secondary market price.

A bond has three components face value, coupon and maturity term.

Take the Vector bond issued in December 2006. This had a face value of $10,000, a coupon of 8.0% and a maturity date of 15/6/12. An investor is paid 8%pa interest at 6 monthly intervals for the life of the bond and at maturity will be returned their initial $10,000 investment. At the moment on the secondary market an investor would pay a premium of 1.13% to buy this bond. The interest rate is slightly above new issues but there is only 6 months to go before maturity.

Compare the Vector bond with the Credit Agricole Perpetual Bond issued 20th December 2007 at the start of the Global Financial Crisis. Credit Agricole had a triple A credit rating and there was a lack of quality bonds on issue. The bond face value was $10,000, coupon 10.04% and first credit review 19/12/2017. At the moment this bond is trading on the secondary market at $0.465. This is a 53% discount to the face value. Why?

With the recent credit downgrade of European banks and the exposure of French banks to Italian debt this bond is not an attractive investment prospect. This is the reason why the market has discounted the price.  If you have these bonds then unless you require access to your money the best action to do is to hold these until the review date in 19/12/2017 when its very likely Credit Agricole will repurchase the bonds at face value.

A bond has several components that affect the price on the secondary market. Inflation, credit outlook for the issuer and a flight to safety by investors.

If there is a bond with a coupon at 6.0% and another at 7%, both with the same credit rating, then investors will want the higher interest rate bond. The 6% bond will trade at a discounted price.

Generally when interest rates are dropping market pricing will lead to a capital gain if the bond is sold before maturity, if interest rates are rising then market pricing will lead to a capital loss if the bond is sold before maturity. Provided the issuer does not default before maturity regardless of the movements in interest rates or current market pricing if the bond is held to maturity then the investor will get back the face value of the bond.

A client commented that he liked the comment by Winston Churchill at the bottom of our e-mail template:

If I had my way, I would write the word 'insure' over every door of every cottage and upon the blotting pad of every public man, because I am convinced that, for a sacrifice that is conceivably small, families can be secured against catastrophes which otherwise would smash them forever.

This is profound and true. It's so important to have an excellent risk protection plan in place. Remember to contact us to review yours.

The client said he likes another quote by Winston:

After the war Winston Churchill was on an Italian cruise liner in the Mediterranean. Reporters asked him about his choice, given the recent conflict. He answered "I have three reasons for selecting an Italian ship: firstly, the cuisine is superb; secondly, the service is exemplary and, thirdly, if there is an emergency there is none of this nonsense about women and children first."