Seven reasons why Australian shares are likely to outperform global shares over the medium term

To get a handle on the future, it’s useful to understand the past. The underperformance of Australian shares since 2009 reflects a mix of:

The swings in relative performance can also be seen in the next chart which shows the ratio of Australian share prices to global share prices.

• The slump in commodity prices from 2011 – this weighed heavily on Australian resources shares through much of last decade.
• Relatively tighter monetary policy in Australia for much of the post-GFC period – whereas the US, Europe and Japan had near-zero interest rates and quantitative easing, Australia has had much higher rates and no money printing until the pandemic. In fact, the relative underperformance started in October 2009 when the RBA raised rates post GFC which wasn’t followed by other major countries.
• The surge in the Australian dollar to $US1.10 in 2011 – this reduced the competitiveness of Australian companies which takes time to reverse.
• Property crash phobia – foreign investor fear of a crash in Australia’s expensive housing market has been a periodic theme over the last decade leading many foreign investors to be cautious of Australia.
• Worries about the deteriorating relationship with China – this started in 2018 with President Trump’s trade war but was accentuated through the pandemic. It arguably resulted in foreign investors demanding a risk premium to invest in the $A and Australian shares.
• A low exposure to pandemic winners – like tech stocks, which helped the US share market and hence global shares in 2020 & 2021.

Are high dividend payouts to blame?

In fact, because Australian shares pay relatively high dividend yields (around 4.4%) compared to global shares (2.5%) they should be included in comparisons of Australian with global share market returns. The next chart compares the relative performance of Australian to global shares since 1970 in terms of: relative share prices in local currency terms (green line); relative total returns ie with dividends added in (blue line); and relative total returns with global shares in Australian dollars (red line).

First over long periods of time and when dividends are allowed for Australian shares have had better returns than global shares.

Second, the swings in the relative performance of Australian shares are apparent if dividends and currency movements are allowed for or not - in particular in the big outperformance in the 2000s and underperformance since 2009. Since October 2009, when Australian shares peaked relative to global shares, Australian shares have returned 7.7% pa compared to 9.7% pa from global shares in local currencies or 11.3% pa in Australian dollar terms.

Seven reasons Australia’s underperformance is likely over

1. Mean reversion – after 12 years of underperformance & the reversal of the 2000s outperformance Australian shares are due for a lengthy period of outperformance. Consistent with this, Australian shares are trading on a lower forward price-to-earnings multiple of 14.5 times than global shares on 15.3 times & US shares on 17.1 times.
2. A new super cycle in commodities – the commodity price slump from their 2008-2011 highs looks to be over with commodities embarking on a new super cycle bull market driven by constrained supply after low levels of investment and low inventories for most commodities, decarbonisation driving increased demand for metals and increased defence spending on the back of increased geopolitical tensions which is metal intensive. This will benefit Australia’s resource stocks.
3. The Australian Dollar is no longer expensive - the surge in the Australian dollar to $US1.10 of 2011 has long ago reversed with the $A hitting a low of $US0.57 in 2020 & $US0.62 last year making Australian companies more competitive.
4. Stronger growth potential - Australia’s potential growth rate remains higher than the US, Europe & Japan due to higher population growth.
5. Relatively high dividends - Australian shares pay a higher dividend yield than traditional global shares: 4.4% versus 2.5%. This is important because dividend payments are a big chunk of the return an investor will get and so the higher the better. Franking credits add around 1.3%pa to the post tax return for Australia-based investors.
6. Less aggressive monetary tightening - RBA monetary policy is no longer relatively tight compared to other major central banks, notably the Fed. It has been taking a more balanced approach to returning inflation to target. Higher than expected December quarter inflation is a concern and is now likely to see the RBA hike rates by another 0.25% in February. But it's likely to be the peak in inflation as supply is improving, freight costs have fallen and demand is slowing and its unlikely to see the RBA adopt a more aggressive policy compared to other major countries.
7. A thawing in the China relationship – the risk of a sharp deterioration in the trade relationship with China appears to be receding (at least for a while) helped by a change of Government in Australia.