Is there value to be found in the Australian equity market for the high net worth investor? According to the country's stock analysts, there is. In fact, they say investors without an exposure to the market are late to the party. Australia's stockmarket has delivered a total return, including dividends, of just over 20% in the past 12 months. In general, the Sydney-based exchange has been far less affected by the bubbles and crashes that have battered other regional exchanges, making Australia a safe haven in the Asian timezone. In the past decade, market liquidity has gone from 40% of market capitalization to 80%, and the market itself has almost tripled in size.
In early November the stockmarket was repeatedly hitting new highs with the benchmark S&P/ASX200 index trading around 3,750. So is it still a viable buy? Yes, says Shane Oliver, head of investment strategy and chief economist at AMP Capital Investors, because it still remains attractively valued. Oliver says while share prices have gone up dramatically, so too have earnings and dividends. "The price earnings multiple calculated using 12 month ahead earnings for Australian shares is 14.3 times which is below its five-year average of 15.4," says Oliver. "While PEs at this level might sound high they reflect the fact that inflation is low and hence so too are interest rates and bond yields." These forward projections also compare favourably to global shares which are expected to trade at a PE of 15.1 times in the coming year.
The future health of the market is guaranteed by the fact that companies will continue to perform well. Corporate Australia has had a dream run in the past five years. "The terms of trade have been very favourable for local companies," says Stephen Halmarick, co-head of economic and market analysis for Citigroup. "Exporters have received a big income boost from rising commodity prices while importers have benefited from lower prices for manufactured items." Alex Large, head of equity capital markets at JPMorgan, says a drop in the value of the Australian dollar early in the year has also helped exporters. "A lot of companies have beaten consensus estimates in the last reporting season," says Large. "Those that can be singled out for outperformance are in the metals and mining sector - companies such as BHP Billiton, Blue Scope Steel and Newcrest Mining are obvious standouts."
This dream run is likely to continue following the re-election in October of the Liberal government for a fourth term. The government has offered tax cuts, family benefits and other handouts that will increase consumer spending. Meanwhile, global demand for Australian products will remain reasonably solid. "The combination of continued solid growth and reasonably constrained wages growth suggests that although profit growth for companies should slow from the 17.5% growth in earnings per share of 2003-04, it should still remain reasonable over the next 12 months," says Oliver.
Short-term analysis aside, there are other fundamentals that make holding Australian equities a prudent endeavour. The practice of adhering to international accounting standards and keeping communication lines open with investors brings peace of mind, says Alex Ding, a partner at law firm Allens Arthur Robinson. "The tradition of corporate governance and transparency in this country means that this is a market where there are no surprises." While there have been some isolated bankruptcies - such as OneTel and HIH - Australia hasn't experienced a corporate collapse with the same market consequences as an Enron.
Another attraction is the high divided yield on Australian shares of 3.7%, compared to 2.1% for global equities. Once franking (tax) credits are allowed for this brings the cash flow yield generated by Australian shares to 5.2% which is only just below long-term bond yields (see graph). This dynamic means that it only requires a very modest rise in share prices for Australian companies to provide a better income return for investors than bonds. And payout ratios are increasing. In the most recent earnings season companies like Commonwealth Bank, CSL, Unitab and West Australian News used their strong cash flows and strong balance sheets to pay higher dividends than last year.
Australia also gives investors access to listed infrastructure - a unique asset class in which trusts hold shares in privately operated works projects such as roads, bridges and airports. "These trusts traditionally own long-term revenue-generating assets in OECD countries," says Neil Watson, executive director of equity capital markets at Macquarie Bank, one of the country's more prolific trust managers. "Australia has one of the biggest concentrations of these investment vehicles which means there are a lot of analysts based here that follow and understand how to value such long-term assets."
Listed property trusts are also a well-established investment vehicle in the Australian market. At last count there were 53 property trusts listed on the Australian Stock Exchange (up from 45 two years ago), delivering investors an average of 17.2% over the past 12 months. Over the past five years the S&P/ASX300 property trust accumulation index has delivered 14.1%. Returns on the trusts are made up of rental yields on the long-term leases of the underlying properties which remain relatively steady, and capital appreciation from the share price which moves in-line with investors' expectations of how the property sector will perform. The trusts have proved popular with investors because their structure means that every cent of operating cash flow is handed to investors by way of tax-deferred distributions.
In a sense, Australia also provides investors with a proxy China investment. Some of the countries largest stocks have big projects or investments on the mainland. These include BHP, Rio Tinto, Zinifex, WMC Resources and steel stocks such as Blue Scope.
Just how much upside is left in the Australian equity market for the high net worth investor looking to make an allocation depends on a few factors. Market liquidity is key and Oliver at AMP Capital Investors says Australian investors are still not displaying the bullish extremes normally associated with market tops. "While the proportion of Australian consumers who rate shares as the wisest place for savings is above its early 2003 low it is still way below levels of four or five years ago and inflows into Australian share funds are also well below boom time levels," he says. "The lack of investor euphoria suggests that there is still plenty of money sitting on the sidelines that can come into the Australian share market." Liquidity will also continue to flow from mandatory superannuation contributions made by the country's workforce.
This positive liquidity backdrop for Australian shares should see the market provide returns in the high single digits over the next 12 months. The biggest threat to this performance is if oil prices stay above $50 a barrel for too long and knock 0.5% off the country's economic growth. Other threats - though less likely to manifest - are a return to global recession and / or a hard landing in China, or a sharp fall in Australian house prices. "Although annual returns are likely to slow to high single digits, once franking credits are allowed for, Australian shares will probably outperform global shares over the next year and they look more attractive than bonds, cash and housing," concludes Oliver.
