The case for broadening the range of investments held to include stocks listed offshore is compelling and prompts action.
This is not an argument about a currency play on the declining Australian dollar but rather the fundamental reasons for gaining access to the earnings streams of a range of great international businesses.
While Australia has been fortunate to have been drawn along in the updraft of metal and energy shortages, the period of ever increasing commodity prices is over and investors must look more widely for new sources of earnings growth.
Fortunately the GFC and its associated cautionary investor behaviour have left international equity prices very low and the earnings growth that corporations are generating under-appreciated. Earnings growth has now resumed, despite all negative commentary.
Further, company balance sheets are in an extremely strong position, indeed the amount of cash they hold is astounding - you only have to go through the major technology stocks to find net cash on balance sheets of $20 billion, $30 billion, $50 billion or over $100 billion as was the case with Apple. Difficult economic times have meant that costs have been reduced and corporations are very lean.
Using the US as an example because it is the largest source of attractive investments, but it is also true in other developed markets, despite their domestic economies being depressed. Many investments have global businesses and the location of head office is not the determining factor in their profitability. For example jet engine manufacturer Rolls Royce, while being located in the UK, has a global source of revenue. Conversely, the circumstances of the company override the local economic considerations as is the case of the major retailer.
It might be observed that while the major stock markets are not vastly changed from the levels they were a dozen years ago, earnings have doubled in that period.
As a result, the valuation metrics are at very low levels particularly when compared to the short-term interest rates and bond yields. As Princeton professor Burton Malkiel points out it hasn't been since the early post war years that equity dividend yields have been above bond yields in the US. He goes on to argue, and we strongly concur, that this environment parallels the current circumstances and the medium to long term results will be similar.
Huge government debt is currently being financed at negative real rates or extremely low rates. The result in the post war era was that bond holders paid out the government (in real terms) while the economy recovered. It wasn't until some time had passed that the returns equities were generating was recognised and investors started to feel comfortable. PE Ratios increased and eventually ended up at the wildly overblown levels of the 'nifty fifty' twenty years later.
Importantly, corporate earnings increased at a steady rate, as they have ever since (see graph below). We feel we are at the early stage of a similar period. Earnings have continued to grow and investor confidence is starting to return but valuations do not reflect the differential between corporate earnings yields and bond yields.
Our view is that the opportunities that are on offer are extremely attractive and one cannot simple rely on the domestic pool of investments. We maintain that the domestic oligopolies in banking, telcos, grocery chains, internet portals, and a few other sectors are attractive particularly with the favourable tax treatments of franked dividends but a more rounded strategy demands a broader view be taken.
Source: Hugh MacNally, Director, Private Portfolio Managers
Should you wish to discuss this furhter please contact us.