As a result of the ongoing slowdown in the decade long commodities boom and very rich equity valuations, I see significant headwinds for most Australian assets in general and for the country's currency in particular. Although mining Capex growth is still in positive territory (its growing at a 2% year-over-year pace), its tough to disagree with the Reserve Bank of Australia. Mining Capex is set to fall and this poses a significant challenge to the Australian economy since up to 40% of the country's GDP growth has been accounted for by mining Capex alone. Besides, domestic demand excluding mining Capex has been weak and its tough to see the private sector filling up the GDP growth gap since its already highly leveraged. How could you benefit from Australia's slowdown?
(A) Go short the Australian dollar.
The easiest way to go short Australia's currency and long the US dollar is through selling Australian dollar's ETF, the Currency Shares Australian Dollar Trust (FXA), which is still held by John Keeley. Even when the ETF is down by 15% since 2013 started, I believe there is still significant downside potential for the currency.
Australia's monetary authority should keep on lowering rates (the country is running a significant current account deficit) and this will trigger carry traders to reverse their long positions on the currency. Moreover, the Australian dollar has outperformed the global mining sector significantly and, on the basis of the OECD's estimate of PPP, Australia's currency remains 40% overvalued against the US dollar. I would short FXA with a $75 target, which represents a 17% depreciation of the Australian currency against its US counterpart.
(B) Shorting Australian equities.
On both P/E and P/B relatives, Australian equities trade at a 20% premium to their US counterparts. Hence, it looks like a good idea to sell those companies that (1) Trade at the highest premium to US peers and (2) Generate most of their reven! ues within the country – in the relatively expensive Australian currency.
Most Australian banks seem to comply with (1) and (2). On the other hand, Australian banks have a loan to deposit ratio of 120% and around 9% of their funding is short term foreign funding. This means that their results shall be severely damaged by a steep depreciation of the local currency. A good example of a bank that is easy to short from the US (since it trades in the New York Stock Exchange) is the Westpac Banking Corporation (WBK). Westpac generates 90% of its revenues domestically and sells for 2014 13.1 times earnings and 2.1 times its 2014 expected book value. That said, there is one problem that you will find when you short Westpac's shares: The bank pays a +5% cash dividend yield.
Bottom line.
Given that both Westpac's shares and the Australian dollar should under-perform the US market in 2014, I would short only FXA. The reason? Westpac's huge and sustainable dividend yield. FXA also pays a 2.4% cash yield but this yield should decline as the Australian monetary authorities keep on lowering interest rates. The biggest risk to shorting FXA is related to a strong rebound in commodity prices but this seems unlikely, at least in 2014.
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