Why Australian Equity Market Is Prone To Violent Corrections

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The Australian stock market has performed well so far this year. The benchmark S&P/ASX All Ordinaries Index is up 5.77% on a price basis and 9.67% on a total return basis YTD. Due to the fall in commodity prices the index has not regained the level reached before the global financial crisis. However the long-term return of the index since is pretty impressive as shown in the chart below:

Click to enlarge

Australia-All-oridnaries-Index-Since-1985

Source: Yahoo Finance

The Australian economy is a resource-based economy similar to Canadian and South African economies. The country is called the “The Lucky Country” for the weather, lifestyle and history, it can also be said that the country is lucky due to the vast amount of natural resources available that can be exploited. For example, some of the major commodity exports of Australia are: coal, iron ore, gold, meat, wool, alumina and wheat.

Until last year, the Australia enjoyed 20 years of continued economic growth as a result of the boom in commodity and energy demand from Asia especially China according to CIA’s The World Factbook. During the 20 year period economic growth averaged 3.5% a year. The services sectors accounts for 70% of the economy with the rest split between manufacturing and agricultural sectors.

An economy based on simply digging up stuff from under the ground and selling to other countries has two major risks. First there must be demand for the stuff. Secondly the prices that buyers are willing to pay must be high enough to make a profit. If  the demand declines and/or prices plunge then the economy will adversely impacted. The Australian economy is facing this scenario. The Australian’s economy’s high dependence on China makes it vulnerable to any slowdown in China’s growth.

Though the Australian equity market has been on a upward trend for many years now the chances of a strong correction are high. When corrections do occur they can be very violent. The chart below shows that the FTSE Asfa Australia All-Share Index plunged 50% or more with little prior warning:

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Australia-All-Share-Index-Since-1965

Source:  Australian exposure: an interesting opportunity?, Gray Issue, April 26, 2013, Allan Gray, South Africa

Hence investors in Australian equities have to be cautious and monitor their investments. However depending on an investor’s profile and goal, a moderate to low exposure to Australia in a well-diversified portfolio would not hurt.

Five Australian stocks trading on the US markets are listed below for further research:

1.Company: Westpac Banking Corp (WBK)
Current Dividend Yield: 4.88%
Sector:Banking

2.Company: Australia and New Zealand Banking Group Ltd (ANZBY)
Current Dividend Yield: 4.72%
Sector:Banking

3.Company: National Australia Bank Ltd (NABZY)
Current Dividend Yield: 5.27%
Sector:Banking

4.Company:Commonwealth Bank of Australia (CMWAY)
Current Dividend Yield: 4.98%
Sector: Banking

5. Company: BHP Billiton Ltd (BHP)
Current Dividend Yield: 3.37%
Sector:Metals & Mining

Note: Dividend yields noted are as of May 3, 2013. Data is known to be accurate from sources used.Please use your own due diligence before making any investment decisions.

The iShares MSCI Australia ETF (EWA) offers a simple and easy to invest in Australian stocks. The fund has total assets of over $2.60 billion and a distribution yield of 5.02%.

Disclosure: No  Positions

A Review Of The Long-Term Benefits of Diversification

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Diversification is an important strategy to follow when investing in equity markets. It is especially important for retail investors who can least afford to lose hard-earned money. To be sure even professional money managers who run other people’s money for a living use diversification to reduce risks. For example, many equity mutual fund managers hold 50 or even 100+ stocks in their fund portfolios to take advantage of diversification. However whether diversification can be only be achieved by holding that many stocks is beyond the scope of this article. In general, it is a wise idea to diversify one’s portfolio across sectors, countries, asset classes, etc. This is especially important for long-term investors monitor their holdings but not trade often based on the gyrations of the market.

In order to fully gain the benefits of diversification it is important to hold a mixture of stocks and bonds of various types. An article by T.Rowe Price quoted an in-house study showed that a well-diversified portfolio easily outperformed a basic portfolio by a significant margin. The basic portfolio held just U.S. large cap stocks and investment-grade bonds.

From the Spring, 2013 edition of T.W.Rowe Price Report:

Over the entire 13-year period, the total annualized return of the more diversified portfolio was 5.1%, compared with just 3.8% for the basic portfolio.

That 1.3-percentage-point annual gap in performance meant that $100,000 invested in each of these portfolios at the start would have grown to $190,609 with the more diversified portfolio, compared with $162,086 for the basic portfolio.

In other words, greater diversity would have translated to a total gain of roughly 46% more than that of the more basic portfolio.

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Diversificaiton-benefits-Chart-1

Even when the study period was extended to all the way to January 1994 when all the index data was available, the well-diversified portfolio generated a total annualized return of 7.8% versus 7.3% for the basic portfolio.

The well-diversified portfolio also outperformed the basic portfolio in both bull markets and in one of the two bear markets as shown in the chart below:

Diversification-benefits-Chart-2

Source: T.Rowe Price Report, Spring 2013, T.Rowe Price

Related ETFs:

  • SPDR S&P 500 ETF (SPY)
  • Vanguard Dividend Appreciation ETF (VIG)
  • SPDR S&P Dividend ETF (SDY)
  • iShares Dow Jones U.S. Select Dividend ETF (DVY)
  • SPDR Gold Shares (GLD)
  • iShares iBoxx $ Invest Grade Corp Bond (LQD)
  • SPDR KBW Bank ETF (KBE)
  • SPDR KBW Regional Banking ETF (KRE)

Disclosure: No Positions

The 8 Largest Brazilian Companies By Revenue 2012

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The largest Brazilian firms by revenues that appeared in the Fortune Global 500 list for 2012 are listed below:

Country RankCompanyGlobal RankCityRevenues($ millions)
1Petrobras23Rio de Janeiro145,915
2Banco do Brasil88Brasilia81,887
3Banco Bradesco136Osasco65,137
4Vale159Rio de Janeiro58,990
5JBS286Sao Paulo36,921
6Itausa-Investimentos311Sao Paulo34,701
7Ultrapar Holdings380Sao Paulo29,073
8Brazilian Distribution399Sao Paulo27,839

Source: Fortune Global 500, Fortune

The current dividend yields of some of these firms trading on the US markets are shown below:

1.Company: Petrobras (PBR)
Current Dividend Yield: 6.44%
Sector: Oil and gas

2. Banco do Brasil SA(BDORY)
Current Dividend Yield:  6.86%
Sector: Banking

3.Company: Banco Bradesco SA (BBD)
Current Dividend Yield:  3.10%
Sector: Banking

4.Company: Vale SA (VALE)
Current Dividend Yield: 4.86%
Sector: Metals & Mining

5.Company: Itau Unibanco Holding SA (ITUB)
Owns Itausa-Investimentos
Current Dividend Yield: 3.44%
Sector: Banking

6.Company: Ultrapar Participacoes SA (UGP)
Current Dividend Yield: 2.23%
Sector: Oil, Gas & Consumable Fuels

Related ETF:

iShares MSCI Brazil Capped Index (EWZ)

Disclosure:  Long ITUB and BBD

Japan: The Best Performing Equity Market YTD

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Japanese stocks have had an incredible run so far this year. The benchmark Nikkei 225 index is up 32.7% as May 1st. Compared to this, only a few of the developed indices are up by double digit percentages. The year-to-date (YTD) performance of major developed indices as of May 1st are listed below:

  • DAX: 4.0%
  • FTSE 100: 9.4%
  • CAC-40:  5.9%
  • S&P 500: 11.0%
  • Dow Jones Industrial Average: 12.2%
  • IBEX 35: 3.1%
  • Swiss Market: 15.9%

Note: Except the U.S. and UK markets, the rest of the markets were closed on May 1st for Labor Day holiday.

I wrote an article about investing in Japanese stocks back in January. Since that time the Nikkei has surged to outperform the U.S. indices.

The chart below shows the 2-year performance of  Nikkei against the S&P 500 and Dow Jones indices:

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Nikkei-vs-Dow-SP500-Indices

Source: Yahoo Finance

A significant portion of the gains in the Japanese equity markets can be attributed to foreign investors. After the asset bubble burst in the early 90s,  domestic investors avoid stocks have continued to avoid stocks and the country has one of the lowest stock market participation among developed countries.  Due to the steep rise of Japanese stock prices this year, investors may want to tread cautiously before initiating any new positions. In the past two decades Nikkei rallied many times only to lose all the gains.

The best way to gain exposure to Japan is via ETFs. The iShares MSCI Japan ETF (EWJ) is the country-specific ETF for Japan. It has an asset base of over $10.0 billion and  total holdings of 313 companies. The other two Japan-focused iShares ETFs are iShares Japan Large-Cap ETF (ITF) and iShares MSCI Japan Small-Cap ETF (SCJ).

Update:

From Mrs. Watanabe Strikes Out, The Wall Street Journal (May 3, 2013):

Japanese stocks have been on a tear; the Nikkei index rose about 50% between November and mid-April. That is thanks to the pledge by newly elected Prime Minister Shinzo Abe to reform the country’s economy and more importantly the central bank’s plan to stoke 2% inflation.

But it isn’t clear Japanese investors are confident the good times will last. While foreign investors bought a net $77 billion of stock during that period, Japanese individuals and institutions sold a net $74 billion, according to the Oriental Economist. (emphasis added)

Disclosure: No positions

Update: SABESP ADR Splits Again

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On January 26th of this year I wrote an article discussing the stock split of Brazilian water and sewage services utility Companhia de Saneamento Basico do Estado de Sao Paulo also known as SABESP (SBS). After an incredible run in 2012, the stock was split in the ratio of 2:1 on January 24th. After the split, SBS opened at $44.31 on that day and closed at $44.62.

Since the split in January, the stock has mostly remained stable and reached a high of $49.05 in March. However unlike the last time when the stock was split when the price hit over $90.00 , this time the stock was split into 3 for 1 on Apr 30, 2013 when the price was in the low 40s. After closing at $42.06 on April 29th, SBS opened at $14.03 the next day on a split-adjusted basis. Today it closed at $14.31.

The following chart shows the 2-year returns:

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SBS-2-Yr-Returns

Source: Yahoo Finance

Currently SABESP has a market cap of $9.80 Billion and a dividend yield of 2.27%.

Disclosure: No Positions