MELBOURNE AUSTRALIA 23 January 2007 – ‘”Weight Of Money” To Get Weightier’ writes David Cassidy and Dean Dusanic from UBS in Sydney. Whilst minding our own business – as we usually do – over the weekend, the UBS ‘Australian Equity Supply/Demand Outlook’ report dropped into our always open inbox.
We have a tendency to be cautious when we are told that the market will rise higher and higher purely based on the amount of money – ‘weight of money’ – expected to flow into the market.
Cautious because just as easily as the funds can flow in to the market, they can flow out of the market. But despite this, we were more than happy to consider what the two strategists from UBS had to say for themselves.
It is an argument that we have reluctantly subscribed to ourselves. That the compact nature of the Australian equity market has necessitated the investment in a narrow range of stocks. Further, the inability or lack of interest for Australian companies to invest large scale overseas has meant that profits are distributed back to investors rather than being spent on growth through acquisitions or organically.
One of the problems – if you can call it that – is that Australian companies face massive pressure from shareholders to pay out dividends. This pressure is exerted from individual investors and domestic institutions that can benefit from the franking credits. Companies retaining earnings and expanding the company is currently seen as less attractive.
Contrast that to equity markets such as the United States where until recently there had been no tax break on dividends, there was less pressure on companies to pay out a dividend. Therefore, companies were able to retain earnings to invest in growing the company.
Plus, in the US, there is a much more liquid equity market which provides a wider range of investment alternatives, as opposed to the stock standard four banks, two resources, and a couple of retailers. OK, it isn’t quite that bad, but you get the point.
So, in addition to the millions of dollars worth of dividends that need to be reinvested, there is also the small matter of superannuation contributions that need to be absorbed into the market as well. And given the current buoyant nature of the market, it wouldn’t be too surprising if the majority of employees are going massively ‘long’ Australian shares with their investment choices.
But that isn’t all, as the UBS report points out, there is the small matter of the Future Fund, which although it has its Telstra (ASX: TLS) shares locked up for just under two years, it will have seen the value of those shares increase by 30% since they were listed. That means there is even more money to reinvest when the Future Fund is eventually allowed to dump some of that Telstra stock.
In their outlook for 2007, UBS suggests there will be around $27 billion invested in the Australian equity market by superannuation funds plus another $14 billion from the Future Fund. On the supply side there will only be around $46 billion worth of shares issued, and not all of them will be in the blue-chip category either meaning that funds will have to pay up in order to take the positions that they need to.
And we haven’t even mentioned the private equity boom. There are still billions of dollars worth of shares that haven’t been cashed in yet. The majority of this, less any tax liability, should see itself reinvested straight back into the market.
A further problem for funds is that they generally benchmark themselves against the ASX/S&P200 which means if they do not want to risk underperforming the index they will need to increase their positions in the companies that comprise the larger weightings in the index, therefore pushing stock prices up even further.
In a nutshell, the Aussie market is still roaring away, however, the more it seems as though the market can only climb higher the closer we are to its eventual fall. But not just yet.