THE BIG PICTURE: The disparity between US and Australian sharemarkets

Why is the US Dow Jones index so near to record highs and why is the Aussie sharemarket so far away? Simply for Australian investors, it just doesn’t seem right.

The Global Financial Crisis emanated from the US – more specifically the lending practices of banks and the poor supervision of the financial system by US regulators.

The Dow Jones is just under 7%, or just over 960 points, away from the high set on October 9, 2007. In contrast the ASX 200 index is around 2500 points or 36.5% away from its record highs.

In part, it gets down to the currency. Since the ASX 200 hit its highs on November 1, 2007, the Aussie dollar has appreciated US12 cents or just over 13% against the greenback. So, in global terms, the purchasing power of Australian shares has risen substantially.

However, that still means that Aussie shares are around 23% down from the record levels. The problem is that the lift in the Aussie dollar over the past four years, and its consistent strength, has turned away foreign investors. It’s not just the value of the currency at two points in time but the trend over time.

Foreign investors hold over 40% of Australian shares and they have been driving prices with domestic investors on the sidelines.

That brings us to domestic investors who have been reluctant to invest in shares over the past four years. In part, investors have been worried about losing capital. But the caution is also driven by the attractiveness of alternate investments.

Australian property prices have posted solid gains with dwellings up by 13.5% in 2009 and a further 5.1% in 2010 before easing slightly in 2011. Special term deposit rates from major banks have also been well above the cash rate since late 2009. Even if an investor opted for the security of a 10-year Australian government bond, the yield has been relatively attractive, averaging 5.3% since late 2007.

Contrast the Australian situation with the US. In the US, home prices have been consistently falling over the past three years in response to an oversupply of new and existing stock. Depositors have done little better on cash deposits. The US Federal Reserve has left the federal funds rate effectively at zero since December 2008. And US government bond yields have been falling over the past four years, with 10-year government bond yields falling as low as 1.67% before settling near 2.20% currently. So US investors have had few alternatives to shares, although interest in shares has also been boosted by prospects of economic recovery.

The week ahead

The start of the month is usually a busy time for economic data and events and April is no different. More than half a dozen key economic indicators will be released over the coming week with a decision on interest rate settings thrown in for good measure. In contrast there is only a spattering of key economic indicators to be released in the US, but headlined by the monthly employment data on Friday.

On Monday, the TD Securities/Melbourne Institute monthly inflation gauge is released together with data on building approvals, the RP Data/Rismark home price index and the Performance of Manufacturing Index. At present there is no inflation threat to speak of, with the inflation gauge currently growing at a 2.0% annual pace – at the bottom of the Reserve Bank’s 2-3% target band. Another month of negligible growth would keep the Reserve Bank in the box seat to cut rates – should the economy continue to soften.

The RP Data/Rismark home price series has started to show signs of turning the corner. Australian home prices are still down 4.4% on a year ago, but it was encouraging to see that prices rose by 0.8% in February. And while that may not sound like much, it is the biggest monthly increase in property prices in 19 months. In addition, prices rose in six of the eight capital cities – highlighting the underlying demand for residential property. The building approvals data is likely to highlight the ongoing weakness in new building. Approvals are expected to have eased by 3% in February – further compounding the lack of affordable housing.

The Reserve Bank Board meets on Tuesday and while there is an array of reasons why it should cut rates, recent rhetoric from central bank officials seems to suggest that policymakers are comfortable with current interest rate settings. We certainly see the value of a modest 25 basis point rate cut – a move that would boost confidence without overly stimulating the economy. But it is unlikely that the Reserve Bank will move before the next round of quarterly inflation data released at the end of April.

Retail trade figures are also released on Tuesday. The household savings ratio is holding near 24-year highs, and given that household balance sheets are in good order, it is likely that the increased savings will eventually lead to a pickup in spending. But that is unlikely to take place in the near term with consumers remaining inherently conservative, and as such a 0.5% lift in sales is expected for February.

The international trade figures (released Wednesday) should show that Australia is back in the black. After a deficit of $673 million in January (due to the timing of Chinese New Year) a surplus of around $1 billion is tipped for February.

Other data to watch over the week includes the Performance of Services index (Wednesday), tourist arrivals/departures and engineering construction (Thursday) and the Performance of Construction index on Friday.

In the US, the spotlight is clearly focused on the March jobs report (non-farm payrolls) to be released on Friday. US activity indicators have been improving, companies are starting to put additional cash to work and this has translated through to a sustained pickup in hiring.

Overall, economists tip a 230,000 lift in private sector jobs in March with total non-farm payrolls up by 225,000. But despite the gain, unemployment is expected to remain stable at 8.3%.

Apart from the jobs report, most interest is in the ISM reports for manufacturing and services – on Monday and Wednesday respectively. Modest gains are expected with the manufacturing gauge tipped to lift from 52.4 to 53.5 while the services gauge may have edged up from 57.3 to 57.8.

Elsewhere in the US, construction spending figures are released on Monday, while, on Tuesday, factory orders and auto sales are released and the Federal Reserve releases minutes from the March 13 policy-making meeting.

On Wednesday, the ADP employment report is issued. And on Thursday the ICSC chain store sales result for March is released together with the Challenger job layoff series. Closing out the week on Friday, consumer credit figures are released for February and are expected to show around $14 billion in new borrowings.

Sharemarket, interest rates, currencies and commodities

With the first quarter of the 2012 coming to an end it is an opportune time to see how the Australian sharemarket has stacked up against key overseas counterparts. European sharemarkets have outperformed, especially Germany’s Dax, up by 20%. In Asia the Japanese Nikkei has gained 21.3%. North American markets have also recorded healthy gains with the Nasdaq up almost 20% while the Dow Jones has gained 8%. Similarly the broader S&P 500 index has lifted by 12.3%. Australia, by comparison, has lifted just 6% (ASX 200; All Ordinaries up 6.8%).

The underperformance of Aussie equities is clearly due to an array of reasons. The sluggish economy is making conditions difficult for retail-focused business while the strong Aussie dollar is providing headwinds for export-oriented sectors and also keeping foreign investors at bay. In addition domestic investors are spoilt for choice with the high term deposit rates on offer. As such we remain comfortable with our sharemarket forecasts. CommSec expects the ASX 200 to reach 4450 by mid-2012 and 4650 by end 2012.

 

Craig James is the chief economist at CommSec.

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