Australia's economy, the world's 12th-largest, has dodged
recession for 21 consecutive years and seems to be on firm
footing. For investors, the environment for Australian equities
may not be as sanguine as it initially appears.
The iShares MSCI Australia Index Fund (NYSE:
) is up 15.2 percent in the past year, but over the past month,
the largest Australia ETF has tumbled 3.7 percent indicating
slack commodities demand among other factors may be hampering
With some obvious headwinds facing the Australian economy,
iShares Global Chief Investment Strategist Russ Koesterich
downgraded the market today from Neutral to Underweight.
Koesterich reiterated a neutral view of Australia in February,
warned at that time he was keeping close
on the market for a possible downgrade.
"While Australia posted a strong fourth-quarter 2012 gross
domestic product report, more recent local business confidence
surveys are pointing to a slowdown in domestic growth," said
Koesterich in a blog post. "At the same time, the economy faces
future growth headwinds including a strong Australian dollar and
easing commodity prices."
EWA's correlation to commodities demand and pricing is
noticeable. The materials sector accounts for nearly 19 percent
of the ETF's weight, trailing only financials at 50.4 percent.
BHP Billiton (NYSE:
), the world's largest mining company, is EWA's second-largest
holding at a weight of 10.3 percent. EWA has risen nearly 150
percent since bottoming in February 2009, a move helped in large
part by a pickup in commodities demand.
However, EWA's track record indicates a high level of
sensitivity to goings on in China. For example, 2011 was a tough
year for Chinese stocks and the iShares FTSE China 25 Index
) fell 17.6 percent. EWA fell 11.7 percent, not surprising as
China is Australia's largest trading partner. Then there is the
matter of valuation.
"Australia's sluggish growth outlook is problematic given that
local equities are expensive compared to those of other developed
. "While most market watchers have been focused on the United
States rally lately, Australia has actually done better over the
last 12 months. Since March 2012, Australian equities have
climbed roughly 16% in dollar terms, outpacing most developed
markets, including the United States."
While the Reserve Bank of Australia went on a scorched earth
campaign of interest rate cuts that started in late 2011 and
lasted through late 2012, the central bank has recently signaled
it will hold off on further rate cuts. Australia's overnight cash
rate is three percent, low by that country's standards but high
compared to much of the developed world.
High interest rates and a credit rating of AAA have increased
the allure of the
Australian investment thesis
while stoking demand for Australia dollars. The Aussie has been
the best-performing developed market currency against the U.S.
dollar since the financial crisis, but that is not good news for
Australian exporters. As Koesterich notes "future growth
headwinds including a strong Australian dollar and easing
EWA, which is home to $2.55 billion in assets under management
and an expense ratio of 0.51 percent, has a P/E ratio of 19.23
and a price-to-book ratio of 2.63,
according to iShares data
. The ETF is up about four percent year-to-date.
For more on ETFs, click
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