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The Sydney Opera House and harbor waterfront. Analysts expect that Australia's stock market is poised for a rebound as the global economy recovers and mining exports to China boom.   © Reuters
Market Spotlight

Australia investors eye boost for stocks as economic calm returns

Recovery expected after tepid 2020, but China tension and exchange rate pose risks

PRASHANT MEHRA, Contributing writer | Australia

SYDNEY -- Success in tackling COVID-19 has not yet been reflected in Australia's stock market, which badly lagged regional peers last year.

But as global investors seek high-yielding safe assets to park their wealth in, analysts expect that Australia is poised for a rebound, with heavyweight sectors such as financials, resources and industrials set for strong gains as the global economy recovers and mining exports to China boom.

"The Australian market will do quite well, underpinned by a powerful trifecta of factors -- economic reopening, vaccine deployment and fiscal stimulus, all of which will combine to lower unemployment, boost consumer spending and pretty much get the economy back on its feet," said Matt Sherwood, head of multiasset investment strategy at fund manager Perpetual.

Australia has been relatively successful among developed countries in dealing with the pandemic, limiting its spread to about 28,800 infections and fewer than 1,000 deaths. This has allowed the island nation largely to reopen its domestic economy, in contrast to many of its rich world peers that have been forced back into lockdowns.

The 1.9 trillion Australian dollar ($1.5 trillion) economy has revived from its first recession in nearly 30 years as fiscal and monetary stimulus propped up job growth, consumer spending and construction activity.

Australia's economic fortunes have also been bolstered by the speedy recovery of its biggest trading partner, China, helping lift iron ore exports -- which are powering Chinese steelmaking -- to a record high by value.

In addition to government stimulus of over AU$300 billion, record-low interest rates of 0.1% and a commitment by its central bank to maintain an easy-money policy for an extended period have also helped improve sentiment.

Australia's benchmark S&P/ASX 200 share index has been rising since the second half of last year, including a 10% jump in November, its best month in almost 30 years.

But the gains have barely been enough to make up for its 37% plunge during the initial weeks of the pandemic. The index finished 1% lower in 2020.

By comparison, the U.S. S&P 500 and Japan's Nikkei Stock Average ran up 16% for the year, China's CSI 300 jumped 27% and South Korea's Kospi index soared 31%.

If Australia continues to handle the pandemic well -- keeping infections in check, immunizing its population and opening up state borders -- there are big gains in sight for stock investors, said Evan Lucas, head of strategy at adviser InvestSMART.

"If those things remain true, there will be very strong growth in sectors such as tourism and aviation and barometer stocks like Sydney Airport and Transurban, which depend on the amount of people moving around the country," he said, estimating potential market returns of 10% in 2021.

Others also predict that returns will surpass the 7% average in the last five years.

International tourism and education are unlikely to revive in a hurry, though investors are pinning hopes on a successful rollout of COVID-19 vaccines globally to help restart business and leisure travel.

Australia, with its small export-driven economy, benefits heavily from strong global growth, which is forecast to be over 5% this year -- the largest annual rise in almost 50 years.

Economic growth of that magnitude makes it easier for companies to deliver 25% to 30% earnings growth, a boon for stock markets.

"We are likely to see a continuing shift in performance away from investments that benefited from the pandemic and lockdowns, to investments that benefit from recovery -- resources, industrials, tourism stocks and financials," Shane Oliver, head of investment strategy at wealth manager AMP Capital, said in a note.

He expects Australian shares to post returns of 12% in 2021.

But economic success could come at a cost, as the country's currency has touched a three-year high, hurting exporters' incomes. Money managers say a buoyant currency is a big headwind for stock investors.

Gains on the ASX since mid-2020 have been largely driven by health care companies such as ResMed and Healius as well as consumer finance players such as Afterpay and Zip that benefited from an online retail boom.

Sectors such as financials, materials, industrials and real estate -- which make up around two-thirds of the index and had been the hardest hit by lockdowns -- have yet to revive.

Many of these stocks, such as Telstra, Qantas and Australia's four major banks, also offer the highest dividends and are highly preferred by foreign investors and retirees looking for steady income.

Over the last five years, dividend yields on the ASX have averaged around 4.5%, and despite coming under pressure in recent months, the ASX still offers the highest yield among index company MSCI's 24 developed markets, at 3.5%.

This assumes significance for money managers at a time when bond yields are scraping the bottom of the barrel.

A major cloud hanging over the ASX's prospects is ongoing trade tension between Australia and top trading partner China, with some analysts warning that misjudgment on either side could risk slowing Australia's longer-term growth rate.

So far, agricultural exports have taken the brunt of Chinese anger, but these make up just 2% of Australia's annual output. By contrast, iron ore exports, which account for 7.5% of gross domestic product, have picked up.

"A lot of the exports being discussed are in the agriculture sector and are not listed, therefore the pain is seen more [in] economic terms rather than through a market perspective," InvestSMART's Lucas said. 

"The stock market is actually benefiting from iron ore. Prices are so far ahead of expectations that the Chinese demand for that product is not going to wane anytime soon."

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