It seems that almost every morning, we wake to the news that the US stock market has reached another record high. With these leads, you would think that local Aussie investors would be rocking and rolling, but the opposite has been the case. Our market has been in the doldrums, massively underperforming compared to Wall Street.
Prior to last night’s trade, Wall Street is up around 6% this month. The Dow Jones by 6.03%, the S&P 500 by 6.19% and the NASDAQ by 8.07%. But the poor Aussie market is down, yes down, by 0.17%.
So, why has the Aussie market de-hitched from the US stock market and underperformed so badly?
Here are my 4 reasons.
AUSSIE DOLLAR TOO HIGH
Firstly, the Aussie dollar is too high at around 80 US cents. Aussie dollar strength (up from around 75.5c in mid-December) is partly a function of a globally weaker US dollar, but also a function of strengthening commodity prices.
A high Aussie dollar impacts the earnings of key growth companies such as CSL, Amcor, Cochlear, Macquarie, Boral, Brambles, Treasury Wine Estates and Aristocrat Leisure. Moreover, it deters foreign investors from putting new cash into the Australian market, who in the main have accepted the conventional wisdom that the long-term value of the Australian dollar should be closer to 70 US cents. At 80 cents, this is around the top of the range.
The next problem is market composition. As the following table shows, the Australian share market is massively overweight in financial and material stocks, with the former representing 35.6% of the entire market, when weighted by market capitalization. Materials in Australia weigh in at 17.9%, compared to just 3.0% in the USA.
On the other side of the ledger, Information Technology (IT) is the largest sector in the USA accounting for 23.8% by market capitalization. In Australia, it makes up a paltry 1.9%. The Aussie market is also underweight in healthcare, consumer discretionary and industrials.
This year, the biggest sectors in the US market are among the best performing sectors. IT comes in second place in performance, being up 8.4%; healthcare is fourth, being up 7.2%; and consumer discretionary is the best performing sector, up 9.2%. Financials comes in fifth place, up 6.7%.
While materials has been one of the better performing sectors in Australia (up 1.4%), the largest sector, financials, is down 0.6%, held back by bearish sentiment relating to the Royal Commission.
LOCAL FUNDIES ARE BEARISH
Some years back, local fund managers were typically bullish when asked about the stock market. They “talked their book”, knowing that retail investors (who drove new investment flows) responded to positive outlook statements.
Today, the flows are largely institutional super monies, with the asset allocation already determined. Also, with boutique managers needing to differentiate their expertise, it seems to have become fashionable to be bearish, or at the very least, being able to point to how much cash is being held so as to demonstrate how actively the money is being managed.
Whatever the reasons, all the data says that local fundies are overweight cash. They have a vested interest to “talk the market” down.
LACK OF EARNINGS GROWTH
Most importantly, many of Australia’s largest companies are “growthless”. Earnings growth at the banks are low single digits as APRA’s clampdown on home lending impacts volumes and business credit growth remains weak; Telstra is challenged to replace revenue lost to the advancement of the NBN rollout; Woolworths and Wesfarmers are locked into the supermarket wars battling Aldi and others; discretionary retailers are being impacted by the arrival of Amazon; and weak wages growth is impacting other consumer facing stocks. There are bright spots with some of the resource companies, but the bottom line is that overall earnings growth is moderate at best.
Compare this to the USA, where earnings growth in 2017 has been strong, and the current quarterly earnings season has gotten off to a really good start. And this is before the impact of President Trump’s tax cuts.
Ultimately, a share price is today’s valuation of a company’s future earnings, and if earnings aren’t growing, it’s hard for the price to go that much higher.
CAN IT TURNAROUND?
Of course it can. While the composition of the market is not going to change, the Aussie dollar could easily pull back (particularly if US interest rates move higher) and if the economic data continues to show an improving trend, our local fundies could get bullish.
In the short term, company earnings are the key. Reporting season in Australia gets underway in a little over a week, which will see around 75% of our companies report either full year or half year earnings for the period to 31 December. If the reports are ok, and the outlook statements for the next period positive, our market could easily get a push along and “close the gap” on the US market.
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