Australian Equity Insights - Don't confuse the economy with the stock market - UBS
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UBS Asset Management
For professional / qualified /
institutional investors only.
June 2020
Australian Equity
Insights
Don’t confuse the economy with the stock market
Following the ASX 200’s sharp rebound (+31% from the
trough, now -16% from the Feb peak), the market is now
fixated on stretched valuations. The conventional wisdom
is that COVID-19’s damage to the economy is severe
and uncertainty clouds the path to recovery: with the
economy in peril, surely the stock market should follow.
Indeed, even when we look at valuations on a two-year forward basis (looking past
the disruption from COVID-19), the ASX 200 trades at 17-times, 26% above its 10-
Dion Hershan
year average and 4% below what it was at the recent market peak.
Portfolio Manager &
Head of Australian Equities The obvious explanation is that valuations are being pushed higher by structurally
Yarra Capital Management lower interest rates and excess liquidity, with QE perhaps the most important
factor. It has certainly drawn the attention of the RBA, which in its June minutes
noted “various asset purchase programs and backstop facilities put in place by
central banks… had supported investor demand for corporate securities”.
An important distinction, however, is also being forgotten: the stock market is
not the economy! There are actually glaring differences between the two. For
example, the economy and the ASX 200 diverge considerably when looking at
key industries as a proportion of GDP, employment and their market cap
weighting:
• Tourism and education contribute 9% to GDP, but only comprise 0.4% of
the ASX 200 by market cap;
• Mining contributes 10% to GDP, but comprises 20% of the ASX 200 by
market cap;
• Conversely, Financials contribute only 10% to GDP but represent 27% of the
ASX 200.
Figure 1: ASX 200 P/E ratio (2 yrs forward)
20
18
16
14
12
10
8
6
4
2
0
Jun-10 Jun-11 Jun-12 Jun-13 Jun-14 Jun-15 Jun-16 Jun-17 Jun-18 Jun-19 Jun-20
Source: FactSet, June 2020
2
Figure 2: Australian economy vs. ASX 200
Australian economy ASX 200
Proportion Proportion of Proportion of Proportion of
of GDP employment market cap employment
Mining 10.3% 1.9% 19.6% 10.1%
Financial and
10.4% 3.6% 27.3% 13.5%
insurance services
Tourism 3.1% 5.2% 0.2% 1.3%
Health Care 9.0% 13.8% 12.1% 10.8%
Construction 8.1% 9.1% 2.3% 6.9%
Retail trade 4.9% 9.6% 8.1% 26.0%
Education and training 5.6% 8.6% 0.2% 0.8%
Source: FactSet, ABS, June 2020
Another way to show the disparity is through company size: through certain industries (e.g. tourism and education),
organisations with fewer than 20 employees make up 44% those same industries have a very limited presence in the
of the workforce, contribute 48% of profits and represent stock market. Tourism and education face a long road to
34% of economic output. recovery, unlike the retail sector (a larger proportion of the
ASX) which is already on the recovery path as the
And let’s not forget that the stock market derives only 55%
economy re-opens. Australian mining – twice the size of
of its revenue directly from Australia, with the rest
retail in the stock market – has operated without
repatriated from offshore sources (i.e. not exposed to the
interruption and has actually benefited from higher
Australian economy)
commodity prices (e.g. iron ore, gold). We anticipate ASX
The abrupt nature of COVID-19 and the ensuing mandatory 200 mining earnings will fall just 6% in 2020, and for
lock-downs have created liquidity and gearing issues for Industrials ex-Financials earnings to decline 15-20%.
many businesses. Although these pressures have been
By identifying the disparity between the economy and the
broad-based, public companies typically have superior
stock market, we can ignore the noise and position our
access to funding (bank relationships, access to bond
portfolios towards those sectors which are currently
markets) and capital via equity raising (as evidenced by the
performing well or can recover quickly. We continue to
$20bn+ raised so far this crisis). It is another important
avoid tourism, education, travel and travel services
distinction as to why the listed universe is likely to fair better
companies, and are selectively positioned in miners (BHP,
on average than private companies.
Iluka), quality retailers (JB Hi-Fi) and energy businesses
So why call out these differences? Because while COVID-19 (Origin, Santos), where we see valuation support.
is causing severe direct harm to the broader economy
Figure 3: Micro and small companies’ share in Figure 4: ASX company revenues by geography
the economy
50
45
40 7.9
35 17.2
30
% Share of Total
25
20 16.1
12.6
35.8
15
27.0
10
12.7 12.7
5
0
Employment Wages Operating Profit Value Add
Micro Small
Source: YarraCM, ABS, June 2020 Source: FactSet, June 2020
3
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