The single most common question (and frustration) we are asked is why the Australian stock market continues to lag every other world stock market. How can this be? After all, our economy is in better shape, our government less indebted, our major trade partners are growing at a healthy 8%, interest rates are low and our housing market is in reasonable shape.
Over the past six months, the US S&P 500 has rallied 21.1%, the MSCI World Index by 17% and the Aussie market by a measly 6.7% (yellow line below). The US market is now just 10% off its pre-GFC peak, whilst the ASX 200 is still 35% lower. What gives?
We believe a range of factors are at play.
i) US corporate profits margins are at record highs; Australian margins are close to record lows. Our last Strategy Note looked at the alarming decline in Australian productivity. This has led to a situation where wages are growing at 4% p.a. whilst productivity growth languishes at a paltry 1%. Conversely the US is benefiting from a resurgence of manufacturing activity resulting from a much lower US$. Contrast the graphs…..
ii) The strength of the Aussie dollar has been a major negative for exporters, manufacturers, retailers and the tourist trade. It is also making foreign investors more nervous about investing in our equity and property markets. Taking the currency into account closes some of the underperformance gap with the S&P 500 but far from all (see blue line in the top graph).
iii) The Australian economy is slowing; the US is growing once again. First quarter 2012 GDP in the US was an impressive 3%, unemployment is falling and the housing market appears to have finally bottomed. In contrast, growth in the Aussie economy will fall to a little over 2% this year and unemployment is rising (albeit from a lower level).
iv) Australian interest rates are much higher than those in the US. The US Federal Reserve has been aggressively pursuing a policy of quantitative easing or ‘money printing’. They have achieved this by buying vast quantities of government bonds and lowering the Fed Funds interest rate to 0%. This has allowed US companies to refinance their debt at record low rates. In contrast, the Reserve Bank of Australia (RBA) has been more cautious in lowering rates.
v) Australian consumers and businesses have become extremely cautious in their spending patterns. Not only are consumers hoarding cash and rebuilding battered personal balance sheets… but so are companies.
vi) Politics. The shambles that is Canberra, and the anti-business rhetoric of the Greens, is delaying investment and putting off foreign investors.
Conclusion
Our firm view is that the lowly rated Australian stock market more accurately reflects the volatile and low growth times in which we live. We are becoming concerned by the rapid run-up in US and European equity prices and believe it is more a reflection of their respective Central Banks flooding the market with liquidity (via QE and the LTRO respectively) rather than the start of a new bull market. The debt is still there.
However long term (10 year) returns from owning Australian equities look appetising (annual double digit returns look comfortable) . There are many buffers in-built into the system; the RBA has plenty of scope to cut rates if the economy worsens, the government can abandon or extend its goal of a balanced budget, consumers will open their wallets once again, companies will eventually have to do something with their cash mountains, and the politicians can’t get any worse… can they?
Our advice for 2012 remains the same; turn off the TV, only read the sports and travel sections of the papers, and focus your energies on what and who you love.
