Updated November 12th 2013

In our last article, we referred to a recent report released by Blackrock that argued that the ASX was undervalued. However, there continues to be a school of thought that questions whether the Australian market truly is undervalued.

The Aussie index has underperformed other major indices around the world in recent times. The ASX is still down 36% from the high in 2007 while the US indices are trading around parity to pre-crisis levels.


There are a number of key reasons why the ASX is underperforming other indices.

1. The high $AUD (the main factor associated to the underperformance)

2. High domestic interest rates

3. The underperformance of the banking and resource sector – Around 50% of the Australian 200 is made up of banks and resource companies, while the percentage is a lot lower for other indices.

4. Declining productivity

5. L ow business and consumer confidence as the household sector repays debt

6. Uncertainty from Government policy (The Carbon Tax, Mining Tax, Fair Work Australia regulations, telecommunication sector intervention, health sector changes, etc)

7. Higher dividend payout ratios from Australian companies (The US S&P 500 companies pay average dividends (yield) of 2.06% without franking credits. In comparison the Australian ASX 100 companies pay out a yield of 4.7% plus franking credits (in many cases).

We will discuss the first two reasons in more detail.


The ASX underperformance can be associated with the rise in the Australian Dollar due to the following:

  • Impact on Profits of Australian Exporters – A high $AUD means that Australian exporters receive less $AUD for each $USD profit made, meaning that if the company maintains the same annual revenue, it will result in declining profits.
  • Decreasing incentive for International Investors – These investors now require a larger discount to compel them to invest in the Australian index. The appreciation of the $AUD has meant that the cost for international investors has risen dramatically, even though the price of Australian shares has been relatively steady over the past few years.


Australia’s cash rate is currently 3.75% while cash rates around the world have remained near 0%. This has compelled investors to keep their money invested in cash accounts, term deposits and bonds. However, once the cash rate and therefore interest rates begin to decline, the returns generated from cash accounts, term deposits and bonds will become less attractive. We would then see a move of funds from the low-yielding cash accounts to the higher yielding investments, mainly equities.

There are clear signs that the RBA will continue to cut rates during 2012. The official cash rate throughout the majority of 2011 remained at 4.75%. The RBA then dropped the rate in November and December by 25 basis points and in May by 50 basis points. It is likely that we could see further cuts contingent on the outcome of the situation in Europe and the subsequent impact on business and consumer confidence.

Of course, many of the factors affecting Australian Equities are inter-related. As the cash rate declines, international currency investors sell the $AUD because of the lower yield. Australian exporters also benefit as profits rise. Australian investors then also start to shift funds from their cash accounts to equities while, at the same time, the value of Australian shares increases for international investors.




The above chart compares the ASX 200 to the S&P 500 if the S&P 500 was denominated in $AUD . The white line represents the ASX 200, the black line represents the S&P 500 index and the red line represents the S&P 500 if it were denominated in $AUD .

When comparing the two indices in the same currency, the Australian index has significantly outperformed the S&P 500.

In other words, if you had invested in the S&P 500 ten years ago, you would have made a loss of 42% whilst during the same period, you would have made a profit of 24.7% investing in the ASX 200.


Should the RBA continue to reduce the cash rate, the $AUD should decrease and the value of equities should rise based on the assumptions above.

As is portrayed in the chart above, the Australian index has clearly outperformed the S&P 500 over the last 10 years. However, due to the appreciation of the $AUD, this has not resulted in capital gains for Australian investors. The RBA has stated that they will not allow the $AUD to appreciate beyond reasonable levels. A dramatic appreciation from current levels could see the demise of many Australian manufacturers and the significant slow down of the mining sector. We are therefore positive about the outlook for the Australian index.