Unbalanced index drags on local performance

Financials and resources dominate the S&P/ASX200 but there could be value in other sectors, writes Matthew Kidman.

Financials and resources dominate the S&P/ASX200 but there could be value in other sectors, writes Matthew Kidman.

Is the composition of the Australian sharemarket flawed? And does that explain why the benchmark S&P/ASX 200 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 by a healthy 40 per cent. However, this looks sickly compared to the US, where the S&P500 has risen by 107 per cent. The tech-laden Nasdaq has clocked up a stunning 135 per cent gain.

This underperformance has continued in the past 12 months, with the domestic bourse outstripped by the American, German and British sharemarkets, despite the obvious economic strain in the northern hemisphere.

For offshore investors, the Australian market has performed well, with the robust dollar rising by almost 65 per cent against the US dollar since early 2009. However, this is cold comfort for local investors who deal only in Australian dollars. The demoralising nature of this underperformance is compounded by the fact the domestic market fell in lockstep with its US counterparts when the financial world imploded in 2008.

The S&P/ASX 200 is dominated by two sectors: financials account for a whopping 35 per cent resources come a clear second with about 25 per cent. Utilities are a distant third at 9 per cent.

This effectively means that if Australia is to match its global peers' performance in the next few years, these dominant two sectors will have to carry the load. There is no Apple, Google or other technology stock to take up the slack.

The prospect of this happening in the short term seems remote. The banking sector is reeling from consumers' deleveraging, consigning them to a low-growth, high-yield play for sharemarket investors. This would not seem an ideal environment to achieve capital growth.

Meanwhile, the resources sector, which has done most of the heavy lifting for the sharemarket for almost a decade, seems to be struggling to continue its upward march.

China's emergence as a world economic power means there are still high levels of activity and buoyant profits in the mining sector, but the outlook for investors has dimmed somewhat recently as China winds back its economic growth forecasts and attempts to replace commodity intensive fixed asset investment with stronger domestic consumption.

Again, this is not a perfect platform for capital growth. So is the S&P/ASX 200 flawed?

Undoubtedly the days of buying the banks' and the big miners' stock, then sitting back and watching them power higher, seems to be over. However, this does not mean investors should dump all their Australian shares and go searching offshore for the best place to invest.

Credit Suisse research shows that the Australian sharemarket has delivered a real return (the return after taking inflation into account) of 7.2 per cent per annum 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.

It pays to remember that the sharemarket and its sectors go in cycles, and cycles have transition periods. During the late 1990s, when the Nasdaq was hitting a record 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 worldwide.

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 easy. One only has to think back to 2002, when a handful of voices in the wilderness were predicting that Chinese economic growth would trigger the greatest commodity boom of the 21st century. By 2004 it was becoming common knowledge.

At the moment it looks bleak, with few new stars on the horizon. However, economies and business are highly dynamic. History shows that the leaders of the last bull market cannot be relied on for the next big surge in shares' values.

It could well be that the companies which are leveraged plays into a recovering US economy might be the superstars of 2012.

Beyond that, the long-suffering industrial and financial sectors could well surprise by awakening after a decade-long hibernation.

Both the Australian stock exchange's industrials and financials indices have delivered no capital growth for investors for 10 years. This is remarkable given the economy has not had a major recession.

Given attractive valuations, it could be that many of these companies will spring back to life.

One thing is certain: there

are always opportunities and there are always stocks that are performing well. Investors just have to

stay alert and realise that the world is changing, and that creates opportunities.

Former fund manager Matthew Kidman is a director of WAM Capital and the author of Bulls, Bears and a croupier.

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