IS THE composition of the Australian sharemarket flawed? And does that explain why the benchmark S&P/ASX 200 Index has shockingly underperformed its peers in the US and to a lesser extent Europe in the past three years?
Since the nadir of the global financial crisis in March 2009 the Australian sharemarket has risen a healthy 40 per cent. This though looks sickly compared with the numbers in the US where the S&P 500 has experienced 107 per cent uplift, while the tech-laden Nasdaq Index has clocked up a stunning 135 per cent gain. This trend of underperformance has continued in the past 12 months with the domestic bourse being outstripped by the US, German and British sharemarkets, despite the patent economic strain being felt in the northern hemisphere.
For offshore investors the Australian market has put in a healthy performance with the robust Australian dollar rising close to 65 per cent since the horror days of early 2009. However, this is cold comfort for the local investors who deal only in Australian dollars. The demoralising nature of this underperformance is compounded by the fact the Australian market fell in lock step with its US counterparts when the financial world imploded in 2008.
The S&P/ASX 200 Index is dominated by two sectors. The financials account for a whopping 35 per cent of the index while the resources sector comes in a clear second with around 25 per cent. A distant third is the utilities sector at just 9 per cent. That effectively means if Australia is going to match the performance of its global peers in the next few years, those two mega sectors will need to carry the load. There is no Apple, Google or any other tech stock to take up the slack.
The prospects of this happening in the short term seem remote. The banking sector is reeling from the de-leveraging of the Australian consumer consigning the banks to a low-growth, high-yield play for sharemarket investors. This would not seem the ideal environment to achieve capital growth.
Meanwhile, the resources sector, which has done most of the heavy lifting for our market for near on a decade, seems to be struggling to continue its upward march. Inspired by the emergence of China as a world economic power, the mining community is still enjoying high levels of activity and buoyant profits.
However, the outlook for investors has dimmed somewhat in recent times as China winds back its overall economic growth forecasts and attempts to replace commodity-intensive fixed-asset investment with greater domestic consumption. Once again this is not a perfect platform for future capital growth.
So, is our index flawed?
The barbell approach of buying the banks and big miners and then sitting back and watching them power higher seems to be over. However, this does not mean you should automatically dump all your Australian shares and go searching offshore for the best place to invest.
Research by Credit Suisse shows that the Australian sharemarket has delivered a real return (the return after taking inflation into account) of 7.2 per cent a year for the past 112 years. This is better than the US or any other major sharemarket in the world. That alone should give investors confidence in the medium to long term. It should also be fertile ground for stock pickers to re-emerge as the big winners after being sin-binned by investors for some time.
Like most aspects of life, the sharemarket and its sectors go in cycles and cycles have transition periods. During the late 1990s, when the Nasdaq was hitting fresh highs every session, Australian investors lamented the lack of a genuine local tech sector. It wasn't long, though, before the tech market collapsed and the resources sector emerged as the hottest investment. This was perfect for Australia with its heavy concentration on resources. This propelled the local market on a long march higher, before topping out in November 2007.
Picking the leaders of the next bull market is not an easy task. You only have to hark back to 2002 when a handful of lonely voices in the wilderness were predicting that Chinese economic growth would trigger the greatest commodity boom of the last 100 years. By 2004 it was becoming common knowledge.
At the moment it looks bleak, with few new stars on the horizon, although economies and business are highly dynamic. History shows the leaders of the last bull market cannot be relied on for the next big drive upwards in share values.
It could well be that companies that are a leveraged play into a recovering US economy might be the superstars of 2012. Beyond that the long-suffering industrial and financial sectors could well surprise, awakening after a decade-long hibernation.
Both the All Industrials and All Financials indices on the Australia market have delivered no capital growth to investors for 10 years. This is remarkable, given the domestic economy has not suffered from a major recession. Given attractive valuations, it could be many of these companies spring back to life. There are always opportunities and there are always stocks that are performing well. You just have to stay alert and realise the world is changing and that creates opportunity.
Ex-fund manager Matthew Kidman is a director of WAM Capital and author of Bulls, Bears and a Croupier.
Picking the leaders of the next bull market is not an easy task.