Sent: 25-10-2011 13:32:02
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Minister Says Buy Australian Shares
The guardian of Australia's superannuation system, Minister Bill Shorten, thinks Australian shares "are a good bet". His attempt to shore up retirees' optimism might also reflect some misunderstanding about how macroeconomic outcomes are translated into share market returns.
Speaking on the ABC television Insiders programme on Sunday, Financial Services and Superannuation minister Bill Shorten attributed the weakness in Australian stock prices to a loss of confidence due to what was happening in Europe and "the antics of the Tea Party" in the USA but affirmed they were "a good bet".
Shorten's position on Australian shares raises a question about whether ministers should speak about share prices at all. Generally, ministerial comments about interest rates and exchange rates are eschewed despite ministers having a mass of experts on those subjects at their call every day.
Ministers are far more prone to give personal equity investment advice despite having far less insight into the drivers of share prices and proscribing other similarly unqualified people from expressing views.
Shorten's argument about share prices is based on Australia's relatively strong macroeconomic position. We do more trade with India and China than Europe, according to the minister. Australia's relatively low unemployment and a big stream of projects, including $82 billion worth of projects this year, he claimed, were added reasons.
There is a continuing confusion among more experienced strategists, not just the minister, about the connection between GDP growth and share price performance. This shows up especially among commentators talking about investing in emerging markets.
Unfortunately, empirical evidence in favour of there being better returns in quicker growing economies is hard to find. Edition 67 of the AllThingsConsidered Digest discussed the connection between GDP growth and market performance. The article referred to research on the relative performance of the USA, the ultimate twentieth century emerging market, and the UK, the ultimate advanced economy being overtaken.
Based on growth rates alone, one would have expected the US market to have outstripped the UK market by a wide margin but the US return of 9.3% a year was within 0.1% a year of the UK market return.
NewsCorp, in the news recently because of attempts to oust its octogenarian chairman and his cronies from the board, has a track record of outstanding growth but the share price is half what it was a decade ago. It shows how, at a company level, the connection between growth and share price is also often shaky.
In any case, Australia's future profit growth could be lower than its historical growth rates despite the current prominence of China and India. Total profit growth is going to be driven by a combination of population expansion, productivity improvements and higher prices. In Australia's case, each of these measures is likely to be less strong over the coming two decades than the two decades before.
Before we draw too many inferences about the direction of equity values from the surrounding macroeconomic conditions, we also have to ask how much investment is needed to sustain the growth.
Part of Australia's growth potential rests on investing in new projects. Just as with any company investing, dilution works against returns. A basis for higher share prices exists only if new funds invested can generate a return which exceeds the cost of the new funds employed. Without that we could have (perhaps quite outstanding) growth but no share price appreciation.
If the anticipated growth were to be filtered through existing companies, a stronger GDP-share market nexus could be expected. However, the company base is not static. New companies will innovate and help drive the growth. The more new companies are responsible for the growth, the less value will be attributed to the existing company base with correspondingly less attractive returns from the stock market indexes dominated by them.
The Australian market does have a lopsided bias in favour of large, well established companies. In retail, Coles/Wesfarmers and Woolworths come to mind. Four dominant banks occupy the financial services space. Telstra is the giant in the telecommunications sector. In resources, BHP Billiton is the monster.
For the Australian market to perform well, all of these would have to show strong gains. But size can be an impediment. One challenge for well established companies is the need to spend large amounts of capital simply to preserve their positions. All of those mentioned above face this predicament.
The best investment returns might come from more innovative companies that, at least initially, have little weight in our market indexes. Overseas owned companies or privately held companies could also account for a disproportionate share of the growth, again limiting the gains available to portfolio investors engaged in Australia's public markets.
In short, Australia can be growing more strongly than the economies of other countries without the Australian stock market necessarily being 'a good bet'.
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