Australia: Safe Haven Or Just Core Exposure?

 |  Includes: EWA, FXA
by: Roger Nusbaum

The Wall Street Journal ran a piece about Australian sovereign debt and its safe haven status. The bull case has been made here many times since 2004 (the start of this blog) which is that Australia benefits from global demand for natural resources with China being the largest customer. This has created prosperity across the entire economy - there has been no recession in Australia since 1992. GDP only contracted for one quarter during the financial crisis. And as the above linked article points out, Australia is one of the few countries remaining with a AAA rating.

The bear case has evolved to include possible excesses in the housing market that although different than the US housing market could end badly, and the country's reliance on the fortunes of China. China has been confronting the possibility of a hard landing for a while now and this would logically impact demand for resources although I do not believe it would eliminate demand for resources.

For many years now I have been saying that Australia is one of many countries that are dealing with normal cyclical ups and downs and not the type of systemic threats that Europe, the US and Japan are dealing with. I would add that I believe China is also dealing with something much closer to normal cyclical activity which if correct would be less of a threat for Australia.

This other item from the WSJ includes all sorts of factoids about quite a few different foreign countries including that the market cap of the Aussie banks now exceeds the market cap of the European banks. As you can see the Aussie banks have mostly been on a slow steady creep upward for years while the European banks went up in parabolic fashion and then fell even faster during the crisis.

For many years we owned one of the large Aussie banks which we sold a little over a year ago in case the housing market did crack. Obviously a crack in the housing market hurts the banks but this has not really occurred yet. It may never occur but it is one of the threats overhanging the market. A few months ago we bought the Australian Stock Exchange (ASXFF and ASXFY) for most large accounts and RRGR owns this name as well. The stock is up a little since we bought in the winter and paid out a large dividend.

For quite a few years we have owned short term sovereign debt from Australia for most large accounts and probably will continue to roll this over and maintain the exposure. The interest rates are close to what many investors would probably consider being normal but of course the position is vulnerable to a drop in the Aussie dollar.

I don't think of Australia as a safe haven so much as a core country exposure. We were out of that equity market for six or seven months between the bank and the exchange stock and would be willing to do that again if circumstances dictated but I expect to be in both the equity and fixed income market far more often than not.

Australia provides true diversification in my opinion because as a commodity based economy it will often be at different points in its economic cycle than a service based economy like the US and that has generally been true. If the two are at different points in the economic cycle then hopefully they will be at different points in their respective stock market cycles. This has not been universally true as 2008 showed us but I believe it can be correct often enough to warrant maintaining the exposure.