The Australian dollar has fallen sharply in recent
weeks against the US dollar, where it had been trading above parity for an
extended period. As a consequence, the currency movement presents a number of
opportunities for investors in the Australian equity market.
The Reserve Bank of Australia (“RBA”) has
maintained a relative higher level of official cash rates relative to other
developed economies. As can be seen below, even after the RBA reduced the
official cash rate (“OCR”) to 2.75% in May and to 2.50% in August, Australian
rates continue to remain elevated relative to other economies. This interest
rate differential has been one factor that has supported a strong Australian
dollar in recent years.
Source: RBA Chart Pack, June 2013
However, what has changed is market expectations
for future monetary policy and quantitivate easing settings. The USD is likely
to benefit from an improvement in the US economy and the US Federal Reserve
will begin unwinding its stimulatory monetary policy measures which will see
interest rates rising. Conversely, the RBA is facing a domestic economy with
below trend growth, low inflation and scope for further OCR easing. In this
scenario, the Australian dollar should continue to weaken against a stronger
USD.
Within the Australian equity market, approximately
40% of company earnings are derived from offshore. In addition, profits will be
impacted by the composition of the dollar denomination of assets, liabilities
and costs. Analysis suggests that for the 2014 financial year Australian equity
market earnings will increase by 5% to 9% for an AUD/USD exchange rate of $0.95
and $0.90 respectively. These figures assume no deterioration in earnings. With
the Australian dollar already at $0.91, currency translation alone is providing
an earnings benefit to Australian investors.
The beneficiaries to an improving US economy and
weakening AUD can be found in the Insurance, Information Technology, Building
Materials, Media, Retail, Tourism, Bank and Healthcare sectors. However, within
Resources, one needs to assume that commodity prices have found support. At
current commodity prices, those mining operations with USD earnings and AUD
cost bases will also be well positioned to benefit.
Indices:
The
Australian All Ordinaries Index has moved down decreasing -1.0%
since closing last Friday to 11:00 am today.
The
rest of the world as measured by the MSCI index decreased -0.7%
in A$ from closing last Friday to end of trade Thursday.
Have
a great weekend,
The Team at IPS
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