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.
Frequently Asked Questions about this Article…
Why has the S&P/ASX 200 underperformed US and other global markets in recent years?
The article says the S&P/ASX 200’s heavy sector concentration is a key reason. Financials (about 35%) and resources (about 25%) dominate the index, and there isn’t a large local technology sector like the US (eg Apple/Google) to drive growth. Banks have become low-growth, high-yield plays as consumers deleverage, and resources face a dimmer outlook as China slows and shifts away from commodity‑intensive investment. Together these factors have held back the ASX compared with the S&P500 and Nasdaq.
How much of the Australian sharemarket is made up of financials and resources?
According to the article, the S&P/ASX 200 is dominated by two sectors: financials account for about 35% of the index and resources make up roughly 25%, with utilities a distant third at about 9%.
Does the absence of big tech stocks on the ASX explain its weaker performance?
Partly. The article points out there is no Apple, Google or equivalent large tech stock on the ASX to pick up slack, so when global tech markets surge the Australian index lacks that driver. That lack of a major local tech sector helps explain some of the ASX’s relative lag.
Should Australian investors sell local shares and move offshore because the ASX has underperformed?
The article advises against wholesale dumping of Australian shares. Credit Suisse research cited shows the Australian sharemarket has delivered a real return of 7.2% per annum over the past 112 years, suggesting confidence in the medium to long term. Instead of fleeing, the article recommends being selective: cycles change and stock pickers can still find opportunities at attractive valuations.
How has the Australian dollar affected returns for local versus offshore investors?
The article notes the Australian dollar rose by almost 65% against the US dollar since early 2009, which boosted returns for offshore investors holding ASX stocks. For local investors dealing in Australian dollars, however, that currency gain is irrelevant and offers cold comfort when domestic share returns lag global peers.
Are banks and miners still likely candidates to drive the next big rise in the ASX?
Not necessarily in the short term. The piece explains banks are constrained by consumer deleveraging and look like low‑growth, high‑yield investments, while the resources sector is finding it harder to sustain the rapid gains of the past decade as China moderates growth and shifts policy. That makes them less certain engines for near‑term capital growth.
Which sectors or companies might lead the next Australian bull market?
The article suggests the leaders are hard to predict. It speculates that companies leveraged to a recovering US economy could emerge as winners, and that long‑suffering industrial and financial stocks — currently offering attractive valuations after a decade of weak capital growth — could surprise on the upside. Ultimately, stock pickers may uncover the next stars as cycles change.
How should everyday investors approach opportunities on the ASX given its sector concentration?
The article recommends staying alert and recognising that markets and sectors move in cycles. Rather than abandoning the ASX, investors should look for value and be selective: attractive valuations in beaten-up industrials and financials, and individual stocks performing well, can present opportunities for medium‑ to long‑term investors.
Call 1300 880 160
Start a chat
Schedule a call
