It underperformed on all developed markets on fear that has been gathering momentum for years but is really coming to a head in the current cycle – emerging market (EM) risk.
Australia has always been seen as a derivative trade of EMs (particularly China) for obvious reasons of mining and our terms of trade with this part of the world.
The reason it’s coming to a head so fast is the fact that the Fed told the world on Friday morning it couldn’t raise interest rates because of global growth factors, which were squarely being levelled at China. Those nations and indices with high levels of China exposure will clearly be used as a funding source over the interim period.
Not a new statement, nor is it something domestic investors are blind to over the years. However the trade in the ASX since April has been more about the flight of international investors and their fear around EMs.
Fund mandates have being altered drastically, seeing exposure to risk diminishing, leading to high growth indices (or derivative indices such as the ASX) underperforming defensive peers.
From an ASX perspective the changing mandate has seen an interesting development, blue chips have now lost over 7% year-to-date compared with the total market’s decline of 4%. The banks have taken the biggest hit of this 7% decline and have seen individual volatility gauges at levels seen during the Euro-crisis. ANZ is the one taking the biggest hit, its 20% revenue exposure to Asia is counting against it and by year-end it is likely to be the only major Australian bank with international banking exposure of more than 10%. NAB is still on track to sells out of Clydesdale by December 31, limiting its international exposure to New Zealand only.
This gets to the crux of the post-GFC world – risk is no longer rewarded like it used to be. A firm’s ability to invest for the long term to take a risk is now limited by shareholder constraints or an increasingly invasive amount of regulation, which brings me back to country risk.
Of Australia’s top ten trading nations (or zones in the case of Europe) the ones that are forecasted to see GDP growth in 2016 are those that have facilitated and even accelerated investment through fiscal and monetary policy changes.
The US is forecasted to grow at 2.8% in 2016 from 2.5% in 2015, Japan at 1.3% from 0.6%, and the Eurozone at 1.9% from 1.3%. These nations have pumped huge amounts of liquidity into their respective economies and have used markets to fund growth initiatives. That will always benefit equities which is why these markets have outperformed over the past three years.
However, Australia has been reluctant to enter into the same level of funding due to its exposure to high growth EMs coupled with solid domestic growth. Australia has traversed the current cycle well, earnings have been maintained but revenue has slowed. We don’t have the population of these nations nor the ability to use monetary policy in the same way.
Therefore, if Australia is to continue to traverse the current cycle we are going to have to collectively work on taking moderate growth risks. That will mean remaining a derivative of EMs even in the current environment, using the current low in the cycle to invest in this region and rewarding those that do. The risk will come to fruition over the next decade. The longer term revenue streams from these regions are still as attractive as they were post-GFC. We need to stay the course – from a corporate and country perspective, Australia will remain a derivative of EMs.
We are calling the ASX up 36 points to 5102.