Using Commodity Moves To Find Opportunities In Australia

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Using Commodity Moves To Find Opportunities In Australia by Christopher Gannatti, Associate Director of Research, The WisdomTree Blog

One of the biggest defining market movements of 2014 was the shocking decline in commodity prices1 —especially oil. The Bloomberg Commodity Index lost almost 20% of its value over the year.

Big Moves Create Big Opportunities

Whenever markets are faced with such surprises, the critical question to ask is whether opportunities have been created. When we looked at the performance of global equity markets—specifically those in the developed international space—we saw that one market that tends to be highly leveraged to commodities has tended to lag others over the past few years, a period strongly influenced by central bank activity.2

That market is Australia.

Australia Lags While Other Developed Markets Deliver Strong Returns (12/31/12–3/2/15)

For definitions of terms and Indexes in the chart, visit our glossary.

Since End of 2012, Developed Market Equities Have Been Strong: Europe—for all its issues—is up nearly 50% cumulatively over this period. The U.S., in nearly a straight upward trend, is up 55%. The impact of Abenomics is quite clear in Japan over this period—up more than 83%.

Australia Up Only 6.4% Since End of 2012: The performance of Australia—definitely a major developed international market in its own right—has clearly been different. One big reason for this is Australia’s currency, which has depreciated 25.3% cumulatively over this period against the U.S. dollar. Another factor most certainly tied into both Australia’s equity market and currency performance has been the lackluster performance of commodities, since the country is a major global commodity supplier.

What about Valuation?

On a forward price-to-earnings (P/E) ratio basis, Australia trades at about 16.9x, which is less than the United States.4 Australia’s dividend yield5 at the end of 2014 was about 5%—more than twice that of the United States.6 For those more worried about U.S. valuations with markets at or near record highs, it’s possible that Australia could be worth a look. Even the euro area7 relatively high dividend yield over 3% was not a match for Australia’s.

We also looked at the nearly 45 years of available history for the MSCI Australia Index, to place Australia’s dividend yield at the beginning of 2015 into a more appropriate historical context. The median dividend yield to end any year was 3.8%, and 2014 ended, as we said, at nearly 5.1%, placing it eighth out of the 44 available data points.8 Years following dividend yields above the median level, historically speaking, have been associated with higher average returns than years following dividend yields below the median level. Of course, there is no way to know what future returns could be, but it is an interesting way to look at where Australia ended 2014 relative to its own historical context.

China May Provide Stimulus in 2015, Which Could Be Good for Commodity Demand

China’s growth slowed to just below 7.5% during 2014, its slowest pace of economic growth in 24 years. Already, 2015 has seen a 0.5% reduction in the required reserve ratio. This is roughly equivalent to injecting $100 billion into China’s economy.9

There have also been reports that Beijing may approve 300 infrastructure projects worth a total of $1.1 trillion in 2015. This could be linked to even larger plans for industry specific stimulus, including oil and gas pipelines, health, clean energy, transportation and mining.10 While anything to do with China’s government is far from certain, we think that the bottom line is that China’s demand for the natural resources that Australia can provide may increase.

Thinking about Australia’s Equity Indexes

All equity indexes are not created equal, and that is very apparent in Australia. On a market capitalization-weighted basis, Australia’s equity market11 is over 50% exposed to Financials.12

Introducing the WisdomTree Australia Dividend Index for Broader Sector Exposures (as of 3/2/15)

Australia Commodity

In our opinion, any time any index has a greater than 50% exposure to a single sector, there is significant risk. We remind investors that Australian equities are more than just Financials and that options exist to be more broadly exposed to this market.

1Refers to the performance of the Bloomberg Commodity Index from 12/31/13 to 12/31/14.
2We looked at the period from 12/31/12 to 3/2/15. This period encompassed quantitative easing from the United States and Japan and announcements of quantitative easing from the European Central Bank.
3European Monetary Union refers to the 19 countries that use the euro as their currency.
4Source: Bloomberg, with data as of 3/2/15.
5Refers specifically to the trailing 12-month dividend yield.
6Source: Bloomberg, with data as of 3/2/15.
7Euro area refers to the universe of the MSCI EMU Index.
8Sources: WisdomTree, MSCI, with data extending from 12/31/69 to 12/31/14.
9Mark Thompson, “China Pumps $100 Billion into Banks to Boost Economy,” CNN Money, 2/4/2015.
10Steven Yang et al. “China Said to Accelerate $1 Trillion in Projects to Spur GDP,” Bloomberg Business, 1/5/15.
11Refers to the MSCI Australia Index universe.
12Source: Bloomberg, with data as of 3/2/15.

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