MARKETS SPECTATOR: The winds of change

The Australian stock market has been underperforming its peers for some time. But with a more stable political environment and numerous cuts to the interest rate, this trend looks to be changing.

Australia’s underperformance versus overseas peers looks to be changing as the prospect of significantly more accommodative financial conditions boosts stocks.

In the chart below, we can see the since the beginning of 2010 that the Australian market, as measured by the benchmark S&P/ASX 200 index has underperformed the US S&P 500, in Australian dollar terms by 20.45 per cent.

It’s no coincidence that 2010 ushered in a period of real uncertainty, on both a political and economic level as there was a leadership spill in Federal Parliament, a hung parliament as a result of the August election and news that Australia’s biggest miners would be taxed more heavily under the Resources Super Profits Tax, which later became the Mineral Rent Resources Tax.

On top of this, the Reserve Bank of Australia had significantly tightened financial conditions as they raised interest rates six times or 150 basis points between October 2009 and May 2010.

In response to the above factors, vast amounts of foreign money departed our shores on the premise that there was simply too much uncertainty on a political and economic level; hence the underperformance started.


Source: Iress

Fast forward two years and things look to be changing; the RBA has cut interest rates by 100 basis points in the last six months and the political environment looks relatively stable. There could also be some thoughts that there is likely to be a change of government at next year’s election.


Source: Iress

The above chart shows that the local index has begun to match and slightly outperform the US index, although it still has a lot of catching up to do. Since the beginning of Q2 2012 the S&P/ASX 200 is up 4.7 per cent while the S&P 500 is only up 3.9 per cent.

The obvious reason behind this shift in sentiment and ultimately markets is the easing in official interest rates. Interestingly, since the RBA surprisingly cut rates two weeks ago the outperformance has really stepped up a gear, with the local index up 2.3 per cent versus a gain of only 0.5 per cent for the S&P 500.

And the thinking is that the outperformance will continue, especially given the widely held view that interest rates will be cut further. In fact, there’s a pretty good chance they will be cut to record lows, which will in turn usher in the most accommodative financial conditions since September 2009.


Source: Iress

In terms of sector performance, the main drivers of the market since the end of Q1 and Q2 have been the typically high yielding, defensive sectors like the financials, property trusts, healthcare and consumer staples.

These have been driven by the global demand for a real yield compared to ridiculously low cash rates on offer. However, for this outperformance to really gain traction we’re going to need to see the big miners and associated indexes come to the party.

The good news is that that looks to be happening. As I wrote on Monday (Is China due for a rebound, October 15) the global investment community appears to be realising that they got too bearish on China and that now is the time to start reversing short and or underweight positions.

With demand for high yielding, defensive stocks unlikely to fade anytime soon, the prospect of further rallies in China facing resources names could be the fuel needed to really light up the Australian market and see the underperformance gap narrow further.


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