Equities to give property a run for its money

Investor/An insider's guide to the market: For several years now the Irish property market has grabbed many of the accolades from investors, as values and rents rose due to the amazing strength of the economy.

During the global equity bear market in the early years of the new millennium, many investors became disillusioned with equities and successfully redirected their cash flows into property investments both at home and abroad.

Indeed, there has been a surge in overseas property investment by Irish investors over the past 12 to 18 months.

In general, property markets remain buoyant, although values are now very high in many markets compared with long-term norms.

Interest in property as an investment medium seems set to grow among institutional and private investors. Ongoing economic growth, combined with cheap and readily available finance, continues to provide a very positive backdrop to property investment.

However, it is probably the perceived lack of alternative investment opportunities that remains as the key driver of new property investment. Low-risk assets such as long-term government bonds represent exceptionally poor value.

Ten-year bond yields in the euro-zone area are now at 3.5 per cent, and would only prove to be attractive if there were a major deflation. Equity markets have made a comeback in the past two years but the scars of the bear market are still not fully healed.

As well as the risk associated with investing in equities, many analysts take the view that equity markets will struggle to deliver annual returns in excess of 10 per cent. So far this year global equity markets have been mixed, with European markets doing better than North American and Asian markets.

In contrast, the Irish equity market has continued to outperform its international peers, and is up 9 per cent so far in 2005. This comes on top of the 26 per cent return achieved in 2004.

If it has not already done so, this performance will soon grab the attention of many investors who have hitherto concentrated on the property market. Of course, the key issue is whether Irish shares can continue to outperform global equity markets and competing assets such as property and bonds.

There are several reasons for taking the view that the recent strength of the equity market is not a flash in the pan. First, the ISEQ Overall index has risen, due to gains across a wide range of companies.

This contrasts with 2004, when the surge in the Elan share price accounted for a large proportion of the rise in the Overall index. This was most noticeable in the first half of 2004, although by the final quarter the 'Elan effect' was waning.

So far in 2005 Elan has in fact underperformed the market.

Analysis of the performance of individual companies reveals a picture that is resolutely upbeat. The index is rising due to the strong underlying business fundamentals of companies across most sectors of the market.

Furthermore, both large capitalisation and mid/small capitalisation companies are doing well. The top-performing companies this year include Grafton Group, Eircom, Ryanair, Kingspan and Paddy Power, with year-to-date gains of close to or over 20 per cent.

Among the large stocks, CRH stands out with a gain of over 10 per cent, although the two big banks have risen by a below-par 4 per cent.

Investor takes the view that the continued robust performance of the economy is a key factor underpinning recent strong gains. In particular, international investors are taking on board forecasts that the economy can grow at annual rates of 5 per cent into the medium term.

The umbrella provided by euro membership means that a sharp rise in interest rates is unlikely to derail such an optimistic scenario. The pace of gains in the market will probably slow in the very near future, as some stocks now appear overvalued on the basis of price-earnings ratios and dividend yields.

However, property markets are also very highly valued on the basis of rental yields on offer, while the yields on government bonds are at historically low levels. Therefore, Investor takes the view that although a short-term pause is likely in the ISEQ's recent heady rate of gain, the medium-term prospects remain bright.

For this year a rise in the ISEQ Overall index in the 15 to 20 per cent range is on the cards, and as long as the economy keeps growing positive returns should continue into 2006.

Equities are, of course, still the highest risk asset class, but evidence is mounting that equities are regaining their mantle as the asset class most likely to deliver the highest investment returns.