By Mike Zaccardi
Australia suffered its first recession in 29 years. It’s a remarkable statistic considering all that has taken place in developed markets just in the last 13 years.
Let’s go back in time for a moment. Recall the mid-2000s. It was a bull market for commodities, and Australia was a heavy beneficiary as the nation exports large amounts of natural resources like iron ore, and coal. China was (and still is) a big buyer. Excessive demand from China, and other emerging markets, culminated in a bubble during 2007 and early 2008. That bubble naturally burst and contributed to the global financial crisis in 2008 and 2009. Many no doubt think it was just the US housing and banking crisis that was the downfall – not so. There were many dominos that fell at once.
A reflation trade during 2009 and through the third quarter of 2011 helped Australia bounce back nicely, but the nation’s stock market has not done much since the peak in 2007 (the same can be said for many developed markets outside of the US). A new all-time high was made in the country’s stock market earlier this year, though it is currently far below the 52-week peak currently. But is there still an opportunity now?
Valuations suggest the All Ordinaries, (the broadest index of companies on the Australian Securities Exchange (ASX), is about where it should be with a PE10 in the upper teens – considerably below that of New Zealand and the US. A massive drawdown earlier this year left Aussie equities at very attractive valuations, but the moment was fleeting – the blood on the streets dried up quickly. While absolute valuations don’t suggest Australia is a screaming buy, relative valuations should pique an investor’s interest.
We’ll get into the relative valuation a little later, but let’s dive into some internals of the ASX200 (the biggest 200 companies on the ASX).
The cyclicals versus defensives index has surged off 20-years lows touched during March’s ‘sell everything’ frenzy. This appetite for risk indicates a medium-term bottom for the overall index may be in place, at least that is what history would suggest.
Meanwhile, both earnings revisions and economic confidence readings are at GFC-type lows, indicating general pessimism (which we like to see from a contrarian point of view).
Turning to Australia versus the world. No, I’m not referring to a football match – I am talking about a much more boring topic like market valuations. The ASX200 continues to lag behind the MSCI world index, but that is mainly a function of the valuation premium found in the US (the US makes up the lion’s share of the MSCI World index nowadays).
Australia is at a 20-year low discount versus the US. Compared to emerging markets and developed markets (ex-US), the ASX200 is at a slight premium.
PE10 – A Split In Developed Markets
It doesn’t end there, however. A look at other relative valuation measures reveals a potential opportunity.
Australia trades near its highest equity risk premium going back to the 1980s, admittedly off the highs from March, but still quite elevated.
From a yield spread perspective, the nation’s dividend yield is just shy of 4%, well above credit and term deposit rates.
Using other macro analysis tools, it’s important to see what is happening with the Australian dollar and even copper. The Aussie Dollar was halved from its peak in 2011 at $1.10 to the 2020 low near $0.55. It has bounced to near $0.70 of late (as we flagged earlier in the year), and the currency is now consolidating recent gains. Technically, a sustained move back above $0.70 may indicate additional near and intermediate-term gains.
Copper could have a more difficult time. It is still within its short-term downtrend from the high in early 2018 (recall that is when much of the emerging and developed (ex-US) world topped out). You can pull back the chart and see that copper is arguably still in a downward channel since 2011. Dr. Copper, near $2.60/oz, may need to break above $3.00 to show more explicit signs of life.
Here’s the point – Like most markets in the last three months, Australia’s ASX has snapped back hard. Extremely attractive valuations were not available for long. Nevertheless, Australia offers global equity investors a rather attractive relative play.