Surf's Up: Ride the Australian iShare Wave

| About: iShares MSCI (EWA)

On the back of record highs for gold, copper and nickel, the Australian stock market has overcome concerns about higher oil prices, consumer debt and real estate slowdown.The Australian iShare ETF (NYSEARCA:EWA) started the year slowly as international fund flows pulled back but has rebounded nicely up 23% for the year.

The perception that Australia is nothing but a commodity and China play is wrongheaded. The Australian economy is well diversified with 5% of GDP attributed to mining, 5% to tourism and 80% to services. It also represents the third largest stock market in the region and is a leading regional financial center.

While labor rigidities and the growth of government could slow down Australia’s juggernaut economy, it is taking some measures to address these issues. It recently enacted a $17 billion cut in personal income taxes over three years and the independent central bank is raising rates. The leadership has also introduced a package of “radical” labor reforms which if enacted would also be a big plus. The aim is to give employers more flexibility and to bring labor negotiations down to the local level. The measures would increase probationary period for new employees from 3 to 6 months, exempt businesses with less than 100 employees from unfair dismissal laws and favor individual contracts over collective bargaining. All of these measures will be fought by the Labor Party and trade unions.

The market is not especially expensive – 12-month forward p/e ratio is about 16x, in line with average over past three years and below high of 18x. However, keep in mind that this low multiple is based on forward and aggressive forecasts of corporate profits.

The Australian iShare is an excellent play on continued Australian growth. Its largest exposure is to the banking sector followed by the materials area. BHP Billiton, Ltd. (NYSE:BHP) is its largest holding at 12.6% and it has also reached a record high this week. The company is the largest mining company in the world, has a larger market capitalization than Coca-Cola Company (NYSE:KO) and earned $6.5 billion in profits in fiscal 2005. BHP the company recently announced plans to return some $2 billion to shareholders in the form of stock buybacks. It also increased its dividend by 30%.

Unlike past boom and bust cycles, companies like BHP are trying hard to avoid the risks of over-expansion and overcapacity. The consolidation in commodities has resulted in just a few companies controlling the bulk of trade in minerals such as iron ore. BHP’s advantage over rival Rio Tinto (RTP) is that it has oil and gas operations benefiting from higher prices.

The MSCI All Country Index weights Australia at just 2.27%, I suggest that you consider doubling this allocation for your own global portfolio.

EWA 1-yr chart
EWA 1 yr chart

Disclosure: Author is long EWA