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Australia’s longest bear market?

The performance of the Australian share market in recent years has surprised many not just for how weak it has been relative to the US and other developed markets, but also relative to previous major bear markets in Australia.

Underperformance relative to the US market

The graph below shows how closely correlated our market (orange) was with the S&P500 (blue) on the way down but how relatively tame our market’s recovery has been.

FM Chart1 141114

FM Chart1 141114

So what might the explanation be? One possibility is simply the alternatives available to investors in each country. In the US interest rates available on cash and bank deposits have effectively been zero for 5 years. In Australia, on the other hand, deposit rates have been generous and even at their current lows of around 3.5% at least provide a positive return after inflation. So for those investors who have decided at least for the time being that the ups and downs of the share market are not for them, in Australia there has been a viable income-producing alternative.

It is also worth emphasising that although the correlation between our market and the US equity market can be very strong on a day-to-day basis, over longer periods the markets can behave very differently reflecting the differences in the two economies. So when the tech boom was in full swing around 2000 and Australia’s economy was derided for being ‘old economy’ the US market was very much stronger, but the pecking order reversed with the tech wreck and the resources boom.

Underperformance relative to previous cycles

The performance of the Australian market relative to its own history also looks pretty grim. The chart below shows that seven years on from the GFC, we have still not nearly regained the previous market peak and the recovery looks markedly slower than bear markets that took place in the context of the Depression and the severe recessions of the 1970s and 1990s. While there are complaints about current low levels of growth and increased unemployment, relative to those earlier episodes recent years have been fairly benign.

FM Chart2 141114A couple of major differences in the current cycle that may be relevant are the much higher levels of individual debt and the ageing population.

To begin with, to the extent that individual debt was used to fund investments, it would have increased the effective losses. Secondly, the combination of a sudden reduction in net worth and impending retirement has no doubt persuaded many that they should save more for their retirement rather than rely on the growth of their investments. This is consistent with savings rates that are the highest in a generation.

Valuations now look attractive

One factor which would at least partially explain both aspects of the Australian market’s disappointing performance is that Australian shares may simply be cheap. While the most commonly quoted metric is the price/earnings ratio, it does not take into account the fluctuations in profit margins at different points in the economic cycle. Accordingly, the ‘cyclically-adjusted price/earnings ratio’ (CAPE) developed by Robert Shiller (winner of this year’s Nobel Prize for economics) provides a more reliable guide to valuation by using 10 years of earnings rather than just one. The chart below uses that methodology and suggests that there is plenty of room for Australian equities to rise before they reach long term average levels.

FM Chart3 141114But while valuations are critical when it comes to long term returns, in the short run (say less than three years) other factors including investor attitudes to different asset classes are often more important, so there is no guarantee that our market’s underperformance will end overnight.


Frank Macindoe is an Executive Director at JBWere and a responsible manager of Third Link Growth Fund. The views expressed are his own. This article is general information for educational purposes and not personal financial advice.

This article was first published in Third Link News. The Third Link Growth Fund provides exposure to Australian listed shares by investing in other managed funds run by third party investment managers, as selected by Chris Cuffe. Since inception in June 2008, it has outperformed its index by 3.8% pa. Each of the investment managers rebates all fees, and Third Link donates the management fees to the charitable sector. A description of the underlying fund managers is available on the Third Link website.


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murray cooper

November 15, 2014

Hello Frank,

I think a few other factors may also be at work.
The expensive level of property probably sees more investment requirement reducing the available pool for equities eg. the increase in SMSF's investment property portfolios.
Concern re a repeat GFC probably explains the increase in bond investment and their equivalents.
When the AUD dropped sub USD parity, there were larger withdrawals from AU equities by (supporting) overseas fund managers. Similarly, the increase in availability and ease of foreign investing (diversification; larger portfolio population/universe) helped decision making re investment redirection.
Our equity population is very focussed - couple of banks and large miners (now in commodity retreat) and a scattering of other suitable stocks.
Even our stocks are taking themselves (or their businesses) overseas FOX, WDC, AMC, JHX et al. - some of which are OTC available in their time zones.
So its a shrinking pool chasing a few fish. Most investors already have their fill (of CBA, TLS, WES ... etc)
Re Trevors comment, I was very disappointed when ANZ's capital raising ($700m+)during the GFC was immediately redirected into Indonesia and China. Very little of it (if any) was used to support Australians who were under similar cashflow and tightening pressures.
Just my 2c worth ...
Thank you

Capital Markets Guy

November 16, 2014

To make the comparison significantly less misleading, the two return series:

* need to include dividends and franking credits - this difference is worth about 4% p.a. to Australian investors

* take into account the large difference in weights for various sectors, particularly technology vs resources and energy

* the massive recovery in US financial share prices since the GFC compared to the very good share price increases in our (significantly safer) banking sector

Of course, in some sense all of this is irrelevant: it is more appropriate to focus on future rather than historical returns. And most investors should be thinking along CAPE-like timeframes (ten years).

On that basis, Australian shares seem reasonably priced and likely to deliver returns of 8% to 10% p.a. whilst US shares are more likely to produce returns of 2% to 4% p.a.

Managers such as GMO, AQR and Research Affiliates are suggesting the coming ten years are going to be extremely UNrewarding for the average US investor compared to the last ten and compared to long-term history.

As always, please undertake your own due diligence before investing.


November 14, 2014

Hi Frank
These comparisons can be fraught with danger; there is no specific reason why our market should perform in line with any other bar the historic correlation in asset classes. The point on equity raisings made before is very valid, along with the large buyback progamme in the US in recent years.
Add to that our weighting in resource companies, low weight (non existent really) in IT, modest healthcare and lack of meaningful global discretionary consumer companies. Our financial stocks held up relatively well, no surprise, but then had less of a recovery cycle too.
The question on whether our market is still good value is debatable. The index is after all only as good as its component parts and the prospective free cash flow of each stock should determine its value rather than being caught up in an index.


November 14, 2014

What about the huge amount of equity raising after the GFC in Australia? Surely this is responsible for some of the performance difference. Some listed companies raised so much capital that existing shareholders were heavily diluted, at a time when their shares were already at multi-decade lows.

In many cases equity was raised merely to pay back debt (no different to a margin call), thereby smashing the company's ROE moving forward.

Warren Bird

November 15, 2014

There was a huge amount of equity raising globally after the GFC, especially among the banks. I doubt this was a factor unique to our market.

The fact that our companies pay high dividends explains most of the apparent shortfall. Compare accumulation indices and the gap is much smaller. US companies expect people to sell shares for income, whereas ours are willing to pay out their earnings. This has the effect of slowing the rise in share prices.

Certainly the All Ordinaries Accumulation index is well above its Nov 2007 level now.

Jerome Lander

November 14, 2014

The US has been a strongly performing market in the last few years. Low cash and bond rates have incentivised risk taking in asset markets.

Could Australia simply be behind the curve? Financial repression looks here to stay.Indeed it is hard to envisage a significant rise in interest rates being a possibility in the near term. The economy is relatively weak and confidence in Australia - and related trading partners such as China - appears lower than in other economies. A reasonable case can be made - contrary to expectations - for the next interest rate change in Australia being lower rather than higher, particularly if the broader economy doesn't pick up. Certainly a reasonable base case here continues to see interest rates remaining where they are for some time. In that situation, dividend yields and shares look relatively attractive.

Alternatively, if the economy improves a little, corporate profits should also improve helping justify confidence in shares. Interest rates in this situation could rise. Bonds are arguably more at risk in this situation (given their total dependence on yields and their relative expensiveness) than shares. However, given the underlying vulnerabilities of global economies, interest rates are still unlikely to rise by much. Investors would do well to remember that we are in a period of financial repression.

While no one should rely on very high returns from here, the Australian sharemarket should continue to outperform bonds and cash. Furthermore, there are some very attractive opportunities in Australia for good active managers to add value to the return of the market as a whole meaning potential nominal returns are attractive. Selective alternatives are also attractive in an environment such as this.

Matthew Holberton

November 14, 2014

Hi Frank,

If you graphed the Australian and the US markets with dividends what would it look like?

It good to see the CAPE applied in an Australian context. Thank you for your insights.



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