UniSuper's Chief Investment Officer, John Pearce, provides a market update for UniSuper members.
Returns are for periods to 28 February 2013. Past performance is not an indication of future performance.
|| % CHANGE
|| 1 YEAR
|| 3 YEARS P.A.
|| 5 YEARS P.A.
|Australian Shares (ASX 300)
|US Shares (S&P 500)
|Asian Shares (MSCI Asia)
|Australian Dollar (AUD/USD)
|Australian Fixed Interest (UBSA Composite)
|Cash (UBSA Bank Bill)
|Balanced Option (*)
(*) Visit our Options and Performance page for performance information on all options.
February was another month of very strong returns in global share markets and, as was the case in January, the Australian market (ASX 300) was a standout performer. Given the natural tendency for investors to have a home-country bias in their asset allocation preferences this is good news for Australian superannuation funds. We are hopefully starting to see the Australian market catch up to the US share market (S&P 500), having underperformed quite markedly since the GFC. For the current financial year the Australian market is up 28.3% while the US market is up 13.0%. However, since March ’09 when the markets were at their nadir, the US market is up 120% while the Australian market is up ’only’ 62%.
Time will tell whether or not our market can catch up to the US, although one can only hope that history repeats, because over the very long term the Australian equity market has been one of the best performers. From 1900 to 2012 the real return from Australian equities was 7.3%. This compares to the USA (6.3%), UK (5.2%), Germany (3.1%) and Japan (3.8%)*.
Of course past performance is not an indicator of future performance, and we don’t plan to forecast the performance of the Australian market relative to other markets. However, determining the factors which have driven the recent outperformance may provide some clues. Three factors (interest rates, exchange rates, and company profits) have played a critical role in driving relative performance.
Narrowing Interest rate differential
Graph 1 shows the conduct of monetary policy of the US Federal Reserve (“the Fed”) compared to the Reserve Bank of Australia (RBA). While both central banks have been accommodative since the GFC, the Fed has been far more aggressive. After interest rates (the price of money), were effectively reduced to zero, the Fed then resorted to quantitative easing, which effectively increases the supply of money.
Graph 1: Monetary Policy: Fed vs. RBA
In contrast, the RBA actually tightened policy in late 2009 by increasing interest rates, and for most of 2011 the difference in interest rates was about 5%. After a series of RBA cuts in 2012, the interest rate differential is now down to 3%, and the RBA is maintaining an easing bias.
Lower interest rates are generally a positive for shares because they increase the relative attractiveness of shares compared to more defensive asset classes such as cash and bonds. Also, for the more technically minded, a reduction in interest rates will generally lead to a reduction in the rate at which future company earnings are discounted: i.e. the present value of future earnings are increased and share prices should reflect this increase in value.
Lower Exchange Rate
The strength of the Australian dollar (AUD) has been well documented. Since hitting a low of 0.60 during the GFC, the AUD has appreciated by more than 70%, while the terms of trade has only increased by approximately 20% over the same period.
The disproportionate increase in the AUD has mainly impacted the competitiveness and profitability of non-resource oriented companies that have not directly benefitted from rising commodity prices. It is no surprise that the recent outperformance of the ASX has coincided with a weaker currency.
A lower currency also makes Australian companies cheaper for foreign investors, which is particularly important given that about 40% of the Australian share market is owned by offshore investors. Graph 2 gives some indication of the offshore investor’s sensitivity to changes exchange rates. This graph was kindly provided to us by a major global bank with large Australian operations, and we have been permitted to distribute it on the proviso that no names are mentioned as the information is proprietary. While it only represents the flows of one bank, it is reasonable (in my experience) to assume that other banks would be experiencing similar activity. Graph 2 shows offshore flows have had a reasonably strong tendency in the recent past to flow in when the currency has dipped and flow out when the currency has risen.&
Graph 2: Offshore Flows vs. level of AUD
For the first time in approximately three years the Australian reporting season finished slightly ahead of expectations, with market earnings ahead of consensus by +0.2% for the first half of the 2012/13 financial year.
Around 44% of companies beat earnings expectations with the banking (+1.1% better) and insurance (+3.3% better) sectors being the key drivers. Both sectors experienced margin expansion, and the banking results also saw improving credit quality, which gave the market increased confidence in the their yield sustainability.
Market earnings were dragged below consensus estimates by the resources sector, missing guidance by 1.6%. Another point of note is that the potential for profit margin expansion in Australia is slightly more positive than other markets, particularly the US.
Graph 3 shows the operating profit margins of Australian and US companies. The Australian market as a whole generally enjoys higher margins than the US due to the oligopolistic industry structure, in which a large part of the market (resources and financials) operate. It’s one of the reasons the Australian market is one of the best performing markets in the world over the long term.
Graph 3: ASX300 vs. S&P500 – Operating Profit Margins
After the GFC, total profit margins expanded quickly when commodity prices appreciated in response to globally co-ordinated fiscal and monetary stimulus. Our resource companies were obvious beneficiaries. However for most of 2011 and 2012, Australian profit margins declined as commodity prices fell, while US companies were benefiting from productivity improvements (mainly reduced labour costs) implemented in response to the GFC. Towards the end of 2012, however, evidence started to emerge of improving profit margins in Australia, while in the US margins have slightly declined.
Global share markets around the world have enjoyed very strong rallies over the past year. Since the GFC the Australian market has underperformed other global markets, and this Market Update identifies three key factors (relatively higher interest rates, strong currency, and lower profit growth) that have contributed to Australia’s underperformance compared to the US.
More recently, however, the same factors have moved in Australia’s favour and we have seen this reflected in the respective performances of the share markets. This financial year to–date, the ASX 300 has outperformed the S&P 500 by about 15%. If the RBA maintains an easing bias, the AUD remains around current levels, and Australian corporate profits grow in line with expectations, it is certainly possible that our market can continue to perform better than global peers for some time to come.
(*) Credit Suisse Global Investment Returns Yearbook 2013
Past performance is not an indicator of future performance. This information is of a general nature only and may include general advice. It has been prepared without taking into account your individual objectives, financial situation or needs. The above material reflects UniSuper’s view at a particular point in time and may change as further information becomes available. UniSuper’s investment strategies and analysis will not necessarily be appropriate for other investors. Before making any decision in relation to your UniSuper membership, you should consider your personal circumstances, the relevant product disclosure statement for your membership category and whether to consult a licensed financial adviser. This information is current as at 8 March 2013.