MARKETS SPECTATOR: Rising tide

Australia's outperformance, especially the mining sector, looks set to continue as money flows from US stocks towards Australia and China facing markets.
It started mid-year, the beginning of what looks to be a period of gains for the Australian market. After the best part of two years underperforming the US and other developed markets, the tide appears to be flowing the right direction for the outperformance to continue.

Source – Iress

The chart above shows the spread between the S&P/ASX 200 and S&P 500 over the last 10 years. Over the last six months, the Australian market has started to outperform its US peers.

One of the major reasons we see continued outperformance is the demand for high, sustainable yields. The Australian market is one of the highest yielding stock markets globally, and with interest rates very low offshore and falling locally, we can expect to see a continuation of money flowing into high dividend paying stocks.

Think about it. If you can borrow money in the US at less than 1 per cent and invest in stocks yielding north of 7 per cent, you'd do it. It's a no brainer. And with cash yields falling locally, investors who need a real return on their money are going to be forced into stocks sooner rather than later too. It's a simple supply/demand game. Just look at the recent performance of Australia's high yielding stocks.

Another key reason why I think this Australian outperformance is set to continue is due to recent developments in China. The last six weeks have provided a lot of evidence to suggest that Chinese growth most likely bottomed during Q3, yet everyone in the investment community had basically written China off.

The above chart paints a very interesting and positive picture, in my view. It shows that forecasts for 2013 operational earnings have been downgraded the most in Australia and China. This means that heading into 2013, earnings expectations are the lowest in these two nations.

So much market action is driven by expectations and we know that expectations nearly always get stretched too far to the upside and downside. With the bar set so low domestically, we can see that it's going to be much easier for Australian companies to beat expectations when compared to S&P 500 or NASDAQ companies.

All you need is for participants to realise that something isn't as bad as forecast and whooshka, the market readjusts its expectations and surprises to the upside.

The recent move lower in US equities over the past month is a classic example. It's been due to the fact that earnings forecasts were too high heading into the Q3 reporting season. Hence, companies disappointed and came under selling pressure.

Now the investment community is realising that they became too bearish on China and are being forced to rethink their underweight or short positions. Price action in China-facing ETF's, and to a lesser extent in the Shanghai Composite back up this view that things are beginning to turn for the economic superpower.

And this is positive for Australian equities as the world realises that they need to reweight back towards Australian commodity names like BHP, Rio Tinto, Fortescue Metals and Newcrest Mining, just to name a few.