It’s been a stunning start to 2018 in global equity markets, with investors in a very bullish frame of mind driven by the outlook for synchronized global growth. The MSCI World Equity Index in US dollars is currently up 6% year-to-date.
The US earnings season has also been solid, but it’s fair to say Australian equity market investors have broadly been left out of the 2018 party, with the S&P/ASX 200 currently a massive underperformer, in fact, the worst performing developed market in the world so far this year.
As I always say, “Australia for income, international for growth”, however, the outperformance of international equity markets is stunning and driving strong returns for global funds.
Stuck in the doldrums
Just to put this in context, I thought it worthwhile looking at year-to-date global equity market performance in US dollars and Australian dollars to illustrate the stark underperformance of Australian equities.
It is interesting that the two worst performing markets are Australia and Canada. Both are commodity-based economies with clear housing bubbles. Both have high weightings of resource stocks and mortgage banks in their benchmark equity indices. Canada has been raising interest rates to cool the housing bubble and the next move from the RBA will be up. While commodity stocks have done well, this has been offset by falls in domestic interest rate sensitive sectors.
The broad underperformance of Australian and Canadian equities is in complete contrast to the performance of Chinese equities. Mainland Chinese equities and Chinese equities listed in Hong Kong have had a tremendous start to the year, reflecting a more bullish assessment of Chinese GDP growth and equity earnings growth. The fact Chinese equities will be added to the MSCI World Equity Index this year is also driving demand from passive global investors.
Clearly, there is stronger earnings growth available in Chinese equities over Australian or Canadian equities, but it’s a touch odd to see our main trading partner exploding on the upside and our own share market stuck in the doldrums.
Perhaps the answer is that a strong China means a higher Australian dollar and higher Australian/global interest rates. For the non-China facing Australian industries, these are both headwinds and playing a role in the underperformance of non-resource, non-Chinese consumer facing Australian equities.
The Chinese consumer
I have been maximum bullish China for some time, as you know from these notes. The Chinese consumer is emerging, and I believe owning direct exposure to the Chinese consumer via Chinese financials, Chinese technology, Chinese tourism and Chinese healthcare stocks is the pathway to outperformance. But you can’t buy those themes directly in Australia outside of Treasury Wine Estates (TWE) and the baby milk/vitamin stocks. To buy those themes directly you need to invest in stocks listed on the Hong Kong or New York stock exchanges.
Similarly, buying an Australian iron ore stock is NOT how to buy direct leverage to the Chinese consumer. This is about pure Chinese industrial exposure to the consumer, and most Australians would be better off outsourcing that to a fund manager with skill and experience in the region. Don’t get me wrong, Australian resource stocks are a play on China, but there are many better direct and lower risk ways of getting proper leverage to the emergence of the Chinese consumer.
The question obviously for most readers is: “what should I do?”.
A vast majority of SMSFs are under-exposed to global equities. That under-exposure to global equities, but particularly Asian equities, will continue to drive relative underperformance for SMSFs, which own the traditional basket of large-cap Australian stocks. The fully-franked dividend income from that basket will remain attractive, but capital growth will lag what international equities offer. That’s the trade off in the “Australia for income, international for growth” equation.
Global exposure via a local investment
My suggestion, other than investing alongside me in the AIM Global High Conviction Fund which is performing well, is to add some global exposure listed on the ASX. As you know over the last few years, I’ve recommended Aristocrat (ALL), Treasury Wine Estates (TWE) and CYBG (CYB) as my three key global ideas listed on the ASX. All three have delivered solid returns to investors and will continue to do so in my opinion.
At current prices, I think that both CYBG and Aristocrat are worth adding to. Treasury has had an almighty run, and we don’t need to add to that one up here. I’ll write about CYBG next week, but today I want to reinforce my high conviction buy case for Aristocrat while it remains (just) in its historic trading range.
Aristocrat (ALL). A cheap structural global growth stock that I think is headed to $30.00
My view is Aristocrat will break through $24.00 technical resistance and move into a higher trading range as investors get a greater understanding of their latest acquisitions and attribute a higher P/E multiple to the companies more diversified and repeatable earnings streams.
ALL: $24.00 technical resistance will break in my view (5th time lucky)
The $24.00 technical resistance will break driven by consensus earnings upgrades (red line).
Those consensus earnings upgrades have started, led by Citi last week. Below I quote direct from the Citi report. This is a good summary I agree with.
Now let’s look at the earnings forecasts and valuation metrics.
Let’s focus on FY18 and FY19. Citi forecasts back-to-back back years of plus 25% EPS growth. You are currently paying 21.5x FY18 and 16.8x FY19 estimates. My view is those consensus estimates will prove conservative.
On price to growth multiples, Aristocrat is cheap. It is a good way, in my view, of adding higher quality global exposure to Australian portfolios via an ASX-listed stock. I believe there are strong capital gains ahead and Aristocrat is now the third largest holding in the AIM Global High Conviction Fund, as we used recent weakness to increase our position.
All in all, I continue to favour global over domestic equities for growth and Aristocrat is a leading global growth stock that is listed on the ASX.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.