With the US equity market at all-time highs, the Australian share market has been recently struggling to maintain levels above the psychologically important 5000 barrier. In fact, in July it remained close to 40% below the all-time high achieved in 2007.
Following the global financial crisis (GFC), Australia became an economic poster child, benefiting from a commodities boom, low government debt and a sound banking system. However, as the global economic recovery has gained momentum, the “lucky country” has waned.
But there should be good news ahead.
Prospects for Australian shares from here
In our opinion, we are in a long-term secular bull market in shares, led by the US. Since the stabilisation of the GFC, the S&P500 has rallied 45%. The market has been underpinned by two pillars: the economy is in reasonable shape and interest rates are low and likely to remain so.
What of the Australian economy? The local economy is struggling with ongoing restructuring as the investment phase of the resources boom tails off and interest rate sensitive segments are slow in taking up the slack. The Reserve Bank has attempted to assist by reducing interest rates by 1.75% in the last year and a half, however neither the consumer nor business seems to be responding.
The reasons for this are well understood. The high $A has been a drag, impacting the competitiveness of companies and squeezing exporter profits. In addition, there has been a toxic political environment, with uncertainty sapping sentiment. Lastly, the savings rate spiked to 10% during the GFC and has been sticky at that level, impacting consumption.
Importantly, we believe that at least one of these headwinds is unwinding. The currency has declined by 15%, boosting domestic competitiveness and export earnings. We see the recent declines as fundamentally based. Commodity prices are expected to continue to drift lower and the currency should mirror that decline. Most likely, the political gridlock in Australia will be resolved via the upcoming election. This would be unambiguously bullish for business sentiment and investment.
What does all this mean for the Australian share market?
We believe that the Australian share market is in the later stages of a consolidation phase that will help support a new bull market.
At the moment, though, we are still seeing the effect of the headwinds previously mentioned. Recent downgrades in companies such as AMP, Wesfarmers, Coca-Cola, Aurizon, Caltex and Orica all point to a weaker domestic economy and a subdued resources sector.
However, on a broader level, investors are becoming more optimistic about the prospects for the stock market, paying more for earnings than they have for a number of years. We agree with the market – risks are diminishing, and the earnings outlook is improving.
Key to our view is our assumption that the currency will continue to drift lower over the next two to three years, and this will flow to company earnings. Another positive tailwind will be the consumer. Low interest rates, combined with a high savings rate, should lead to improved consumer confidence. In fact, higher quality franchises (such as JB Hi-Fi) are already beginning to see improved earnings and earnings growth.
In essence, we believe that the headwinds that our share market has experienced are dissipating. This will feed directly through to company earnings, which will support share prices over the longer term.
*Platypus Asset Management – Pty Limited ABN 33 118 016 087 AFS Licence No: 301294, a joint venture partner of Australian Unity Investments.
Donald has over 13 years’ experience in Australian and international financial markets, in trading, research and funds management. He is also a co-founder of Platypus Asset Management.
