Australians love an underdog, especially when they get up. In the Tokyo Olympics last year, despite our relatively small population, we came sixth in the medal tally. In 2011, Sam Stosur cruised past the world’s top tennis players – including playing Serena Williams at her peak, in her home Slam tournament – to take home the US Open.
But perhaps the greatest sporting upset of all time belongs to Australia II, winner of the 1983 America’s Cup. The New York Yacht Club had dominated the race, winning 132 years in a row, which remains the longest winning streak in sporting history. Despite trailing the series 1-3, Australia II managed to come from behind to win 4-3.
One could argue that the Australian stock market has been an underdog for a while now. In fact, the Aussie market, as measured by the S&P/ASX 200, has underperformed the U.S. market, measured by the S&P 500, every year since 2012, as shown below.
Bloomberg. Past performance is not an indication of future performance.
The U.S. market has benefited from a low growth, low interest rate environment for many years. Having said that, a change which may see Australia once again compete against the global heavyweights is upon us. The Australian market has come out of the blocks relatively strongly this year due to macro dynamics that we haven’t seen for well over a decade. Could this be the fork in the road that sees the Aussie market return to former glories?
Why has the U.S. market outperformed the Australian market?
Globally, the past decade has been characterised by anaemic economic growth and falling interest rates.
The notable exception to the low-growth scenario has been the technology sector. The big tech names (the FAANG stocks) in the U.S. have been able to compound earnings as the world moves online and embraces the digital revolution. This has only been exacerbated by Covid-induced lockdowns, forcing the world to further embrace technology.
This has provided tailwinds for the technology-heavy U.S. market, as the market has placed a premium on companies that have been able to grow their earnings, given the scarcity of growth more broadly.
Additionally, falling interest rates have lowered the discount rate at which the market prices the future earnings of technology companies, pushing up their price further. In short, it has been a perfect storm for the technology behemoths, which has lifted the U.S. stock market and left the rest of the world in its wake.
What has changed?
These dynamics have reversed in the post-Covid world. The world has opened from lockdowns, governments globally have spent trillions in fiscal stimulus causing unemployment to fall and the global economy to roar back to life. This has presented tailwinds for the cyclical-heavy Aussie market relative to the U.S. market. The chart below shows the sector weightings, as of 11 May 2022, of the Australian vs. U.S. sharemarkets.
Rising interest rates
On the back of the global economy booming (including here in Australia), we have seen central banks lift interest rates around the world for the first time in a long time, with future hikes a near certainty. Higher interest rates have tended to be good for banks’ profitability, as it increases their net interest margin, the difference between the interest they pay on deposits, and the interest they charge on loans. The Aussie market is dominated by banks, with financials accounting for over 30% of our market, and we have already seen many of the ‘Big 4’ materially increase their dividends this year as a result of this tailwind.
Further to this, higher interest rates typically see higher growth companies, such as the FAANG stocks, come under pressure, as the attractiveness of future earnings is less given an increase in investment opportunities on interest-bearing assets.
Higher demand for resources
The other sector that has tended to thrive in periods of economic expansion is resources. Put simply, people are again building things and going places, notwithstanding lockdowns in parts of China. This has seen a rally of just under 80% from Covid lows within the Aussie resources sector, which accounts for over 23% of the Aussie market.1
There are also geopolitical forces at play, which may further benefit the domestic resources industry. The conflict in Ukraine is clearly a terrible event from a human point of view. Economically, sanctions on Russian oil and gas have limited global supply and pushed up the price, and therefore the profitability, for local suppliers. Additionally, Russia and Ukraine traditionally have accounted for 25% of global soft commodity, specifically grain production. Again, this disruption on production has placed upward pressure on prices and benefited domestic producers.
Despite the relatively strong performance of the Aussie market of late, the Australian market is still trading at a cheaper valuation than the U.S. market in absolute terms. The Australian market’s price to earnings ratio (P/E ratio) has declined to 14.5 on the back of both price declines and stronger earnings, whereas the U.S. market is trading at 17.1. Interestingly, this valuation gap materialised during Covid, which intuitively makes sense as the world moved online, however has not retraced as the world has emerged from Covid, as shown below.
A changing world has seen a change in equity leadership and a return to form for the Australian market year to date, having been a laggard for almost a decade. The dynamics that have buoyed Australia don’t seem to be going away any time soon, and as such, Australia again could be cheering another underdog to victory, and investors may continue to see Australian outperformance.
How can investors gain exposure to the Australian sharemarket?
A200 aims to track the performance of an index (before fees and expenses) comprising 200 of the largest companies by market capitalisation listed on the ASX.
AQLT aims to track an index (before fees and expenses) that comprises 40 high quality Australian companies.
GEAR provides investors with cost-effective geared exposure to the returns of the broad Australian sharemarket. Note that gearing magnifies gains and losses and may not be a suitable strategy for all investors.
There are risks associated with an investment in the BetaShares Funds, including market risk, gearing risk (for GEAR) and non-traditional index methodology risk (for AQLT). An investment in any BetaShares Fund should only be considered as a component of a broader diversified portfolio. For information on risks and other features of each of the BetaShares Funds, please see the applicable Product Disclosure Statement, available at www.betashares.com.au.
1. From 23/3/20 to 17/5/22 as measured by the Solactive Australia Resources Sector Index
2. Past performance is not a reliable indicator of future performance