Why Investing In Australia Is A Good Idea Now

July 21, 2017

Why Investing In Australia Is A Good Idea Now

  • Positive demographics, strong economic growth, a good business environment, and relative cheapness is what you should look for when investing abroad.
  • Australia has it, and on top of it, Australia offers a high dividend yield and a large potential currency tailwind.
  • The ETF is highly skewed toward financials but a decent stock picker can find a few great picks on the Australian stock market.

Introduction

Before investing in a country, I first like to check the demographics because it’s an easily predictable trend that has a huge impact in the long term.

Because demographics are a long-term trend, it’s usually shunned by most analysts, but a population that grows at 3% per year adds at least 30% to a country’s GDP over 10 years in comparison to a country without population growth (think some European countries).

The Australian Bureau of Statistics has three forecasts for the Australian population. The base case scenario is the most probable where the Australian population will double by 2075 which translates to an approximate growth rate of 1%.


Figure 1: Projection for the Australian population. Source: Australian Bureau of Statistics.

The second thing I check is the potential economic growth. The higher, the better. For Australia, the forecasts look better than those for other developed countries as growth is projected to be consistently over 3%.


Figure 2: OECD’s Australian economic growth projections. Source: Knoema.

It’s important to note that Australia hasn’t witnessed a recession in the past 25 years which makes it the longest uninterrupted economic growth streak among developed countries.

All of the above makes an investment in Australia extremely attractive from a currency perspective. The AUD is in a small upward trend against the USD, but still has plenty of room to grow.


Figure 3: USD vs. AUD in the last 10 years. Source: XE.

As Australia is one of the strongest commodity exporters in the world, it’s very interesting to see how its currency fluctuates alongside the commodity index. By comparing the charts above and below over the last 10 years, the correlation is clear.


Figure 4: Commodity price indexes. Source: World Bank.

Just as a reminder, here is the Australian export breakdown.


Figure 5: Australian export components. Source: Harvard University.

As commodities are a cyclical asset in the purest form and China has recently shown positive economic signals while India continues to grow at an amazing speed, it’s highly likely that the Australian currency will appreciate against other developed currencies.

Another reason for the weakness in the AUD is that the Reserve Bank of Australia has taken its interest rate to a record low in the last few years.


Figure 6: Reserve Bank of Australia interest rate. Source: Trading Economics.

Interest rates can be kept low as long as inflation isn’t ramping up which has been the case lately.


Figure 7: The inflation rate in Australia is picking up. Source: Trading Economics.

All of the above indicates that we could see a strengthening of the AUD coming from high economic growth, higher commodity prices, or higher interest rates due to higher inflation levels, all of which are upside risks.

Dividend Investments

On top of the positive currency risks, what Australian stocks offer is a relatively high dividend yield which can get much higher for foreign investors when the AUD eventually appreciates.

As you can see, there are plenty of interesting stocks with a market cap over AUD$1 billion that offer dividend yields of above 5%.


Figure 8: Australian dividend yielding stocks. Source: Market Index.

An important note here, the Australian dividend withholding tax goes from 0% to 30% and investors must check how they will be personally taxed on that. Nevertheless, even a 30% tax on a 6% dividend yield still leaves a nice 4% yield on the table which is double what the S&P 500 offers and has the benefit of a huge currency gain.

If you want more diversification, there is always the iShares MSCI Australia Index (NYSEARCA: EWA) which gives exposure to a broad basket of stocks and has a dividend yield of 4.77%. However, the ETF is heavily exposed to financials.


Figure 9: iShares MSCI Australia Index top holdings. Source: iShares.

The Australian ETF has done well in the past year and a half, but there is still plenty of room to grow and the dividend is always a nice addition.


Figure 10: EWA 5 year performance. Source: iShares.

I wouldn’t venture into Australian bonds because the yields are between 2.26% for the 5 year government bond, and up to 3.01% for the 15 year bond. Thus, the yield is too small for the risk of a potential increase in interest rates.

For those interested only in the currency play, there is always the CurrencyShares Australian Dollar Trust ETF (NYSEARCA: FXA) which tracks the performance of the AUD currency.

Conclusion

I really think Australian assets are a must own for a well-diversified international portfolio because the country offers much more positives than negatives and is exposed to strong positive long-term trends like growth in demand for commodities from India and China, higher inflation that will lead to higher interest rates and a stronger currency, and a positive demographic and economic trend. All of this in a stable, developed business environment.