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Australia for income, the rest of the world for growth?

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By Paul Rickard

Australia for income, the rest of the world for growth, is an investment thesis that is growing in popularity. Firstly, because it is borne out by the simple fact that the Australian share market is small on a global scale, concentrated, and heavily skewed in terms of companies represented.

At less than 2% of global stock market capitalisation, the Australian market is just a minnow. This also means that 98% of investment opportunities lie outside Australia. And because the top 10 companies in Australia make up 45% of the local market capitalization, our market is heavily concentrated.

However, it is on an industry sector basis that our market stands out. The two largest sectors, financials and materials, account for 54.3% of the total market, with the other 9 sectors making up the balance. In the USA, these two sectors make up just 17.6% by market capitalization.

Moreover, it is the under representation in growth sectors like information technology and consumer discretionary that really highlights the differences. In IT for example, the Aussie market comes in at a paltry 1.4% compared to the USA’s 23.2%. We simply don’t have the Facebooks, Googles, Alphabets or Amazons.

The following pie charts show the composition of the Australian and US stock markets at 30 September by the 11 industry sectors (same colours).

Australia for income, the rest of the world for growth as a thesis is also supported by the long term data. The following chart from the RBA compares Australian and world share prices over a 23 year period since 1994 using a common base and logarithmic scale. Australia has underperformed quite considerably compared to the USA.

On the income side, Australian dividends over this period have typically been around 2% higher than overseas markets - producing an average dividend yield of around 4% for the Australian sharemarket compared to 2% offshore.

And that’s before the impact of franking credits is taken into account. The dividend imputation system, which is unique to Australia, effectively incentivises companies to pay high dividends and maintain high payout ratios as undistributed franking credits aren’t of any value in the hands of the company, but are of value to Australian resident shareholders. It therefore shouldn’t come as any surprise to learn that Australian companies pay higher dividends than their offshore counterparts.

To be fair to Australian companies, there are some terrific growth companies. Companies such as CSL, Ramsay, Seek, Cochlear and Dominos are world class companies with consistent records of growth over many years. The problem is that they are in the minority - too many companies are growth challenged, with Directors feeling obliged to favour paying dividends over potentially re-investing profits back into the business.

The question investors need to consider is whether this thesis Australia for income, the rest of the world for growth is likely continue in the short to medium term.

2017 so far

Before I address this, let’s have a quick look at how 2017 is shaping up. As the table below shows, it is the same old story.

To the end of September, the US market is up by 12.5% compared to a dismal 0.3% for Australia. For the September quarter, the US market rose by 4.0% compared to a fall locally of 0.7%, and for the month, the US added 1.9% while Australia lost 0.6%.

The picture if dividends are included (total return) is a little better, but directionally the same. For the year, Australia has returned 3.9% compared to a total return of 14.2% in the US.

Can Australia get a growth spurt

The Australian market’s lack of recent performance is due to several factors. Chief amongst these is the perceived “high” aussie dollar up near 80 US cents, which is stopping foreign investors from getting their cheque books out and also undermines the earnings outlook for companies such as CSL, Macquarie and James Hardie. Other factors include the wash up from of an underwhelming profit reporting season in August, anemic top line revenue growth at many major companies (banks, grocery retailers, telcos etc) and a lack of confidence amongst institutional fund managers.

Then there is also the September/October effect, traditionally interesting months and often turning points in the stockmarket calendar. While it is true that October can often be a good month for stocks, memories of October 1987, October 1997 and October 2007 have some investors worrying about the next October ending in a ‘7’ - October 2017 .

Can the Australian share market get a growth spurt? I think that the weight of money looking to invest will eventually be that catalyst, but it will require a positive lead from US markets, strong local employment growth and some of our company CEOs being a little more upbeat on their prospects. This may come in the Company AGM season which kicks off later this month.

That said, I am still betting on Australia for income, rest of the world for growth over the medium term.

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Published: Thursday, October 05, 2017

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