Analysts expect the Australian stock market to outperform many of its bigger peers even in the face of slowing economic growth and a fading bonanza from commodities exports in coming quarters.
“It’s got a good defensive characteristic. It is high dividend yielding. It’s supported by a significant downturn in the Australian dollar, which has increased the value of our foreign earnings,” said Matt Sherwood, head of multi-asset strategy at investment manager Perpetual. “And our central bank probably doesn’t have to increase interest rates as much as global peers.”
Australia’s benchmark S&P/ASX200 is down 6% so far this year. By comparison, the US S&P 500 has lost nearly 20% of its value, the EuroStoxx 50 index is down 15%, and the MSCI World index has tumbled 21%. Closer to home, New Zealand’s NZX 50 has given up 13% over the same period.
Australia’s central bank has some part to play here as it treads a narrow path between inflation and economic growth, unlike the US Federal Reserve which has acknowledged the risk of a recession as a consequence of its resolve to cool prices.
The divergence has also raised Australian bond prices and weakened the Australian dollar to well below its usual range against the US dollar.
“The Aussie dollar isn’t something we talk about very often, but for international investors wanting to trade in Australia, that’s an important consideration,” says Julia Lee, equity investment strategist at State Street Global Advisors. “If you are looking at a medium to long-term aspect and you think that’s low, then it could start to be an attractive entry point.”
The Australian Securities Exchange is weighted toward commodities companies, which account for almost a third of its main indexes. As prices of iron ore, coal and wheat surged this year due to supply constraints magnified by Russia’s war in Ukraine, Australian exporters minted money.
The windfall combined with a weaker Australian dollar improved Canberra’s finances by AU$48 billion over the last six months, making the country’s fiscal position among the best in the developed world.
The S&P/ASX200 is still cheaper than peers, trading at 13.9 times forward earnings compared to its long-run average of around 15 and much lower than the 18.8 times forward earnings for the S&P 500.
Dividends have always been a significant driver of returns for most Australian equity investors, with a 4.8% dividend yield for the benchmark index compared with just 1.7% for the S&P 500.
A key consideration for investors of all stripes is whether Australia can avoid recession. The Reserve Bank of Australia (RBA) has repeatedly said it is trying to keep the economy “on an even keel” in the tightening cycle. It also pivoted to smaller 25 basis points hikes last month as it assesses the economic situation.
American and European central bankers are less mindful of driving a contraction in their economies. The varying approach has caused a sizable yield differential between US and Australian 10-year bond yields.
US 10-year yields have risen to 29 basis points above Australian rates – the largest premium since March 2020.
A looming risk is the possibility of an extended rate-hike cycle, as inflation remains uncomfortably high despite rate tightening hitting 2.75 percentage points so far.
“In order to sustainably bring down inflation, central banks may face no choice but to keep raising interest rates until there is a clearer slowdown in economic growth – which is usually not great news for equity markets,” says David Bassanese, chief economist at exchange-traded funds provider BetaShares.
For now, money markets expect RBA’s cash rate, its main policy rate, to peak at just under 4% by mid-2023.
Analysts say the focus is how those high rates impact the economy, especially given the risks of a steep downturn in the housing market. Property prices have fallen for six months in a row and the RBA has estimated home prices could tumble as much as 20% from their peak in a worst-case scenario.
Australia’s high household debt-to-income ratio of 187% is another concern. “Over the past 33 years, Australian household debt has increased 31 times. So it doesn’t take a lot of interest rate increases to have a significant impact on disposable income,” said Perpetual’s Sherwood.
The RBA estimates growth in the AU$2.2 trillion economy will slow to 1.5% in both 2023 and 2024, down from the 3% forecast for this year.
Another cloud hanging over ASX’s prospects is weaker economic growth in its biggest market – China. The Asian giant’s Covid-zero policy and the debt-fueled overhang on its construction sector have continued to cause intermittent disruptions to Australian suppliers of iron ore, grain and other commodities.
“Slowing global demand poses downside risks to China’s strong exports, while consumers remain cautious of the property market,” said Rio Tinto, one of Australia’s largest mining groups, in its quarterly earnings report on Oct 18.
“All up, while there are some grounds to believe Australian equities could do well over the coming year, it still really depends on global economic growth and the path of interest rates and commodity prices,” Bassanese said.