Heading into Tuesday's trading session, the iShares MSCI Australia ETF (NYSE: EWA) was up 7.1 percent year to date. That performance sounds solid, but when noting Australian stocks are more volatile than their U.S. equivalents and broader benchmarks of ex-US developed market equities, Australian stocks are disappointing this year.
The widely followed MSCI EAFE Index, which allocates about 6.8 percent of its weight to Australian stocks, is outpacing EWA by a 2-to-1 margin this year. Muddling the near-term outlook for stocks in Australia are lingering concerns about a housing bubble there. The Reserve Bank of Australia has previously taken steps to avoid a housing bubble, as highlighted by Australia long having some of the highest borrowing costs in the developed world. In 1990, Australia's benchmark interest rate was a staggering 17.5 percent.
As recently as 2008, Australian rates were just below 8 percent, but RBA has been aggressively paring borrowing costs. Australia's benchmark lending rate is now a record low of 1.5 percent — high against the standards of other developed markets, but well below Australian norms. Recently, shares of Australian have been displaying eroding relative strength against the broader market there, a problem for many of the Australia ETFs — including EWA — that trade in the U.S., as these funds feature large exposure to financials.
“Now, to be fair, part of the sell-off in banks is related to new capital requirements being repriced,” Rareview Macro founder Neil Azous said in a Monday note. “That has been well-flagged locally by investors and analysts.”
The $1.75 billion EWA allocates 41.6 percent of its weight to financial services stocks, nearly triple the ETF's exposure to materials, its second-largest sector weight. Five of EWA's top 10 holdings, including the top four, are financial services stocks, underscoring the point that this ETF is sensitive to RBA policy and Australia's housing market.
“But the key point here is that concerns about the property market are becoming more mainstream to the point where investors are giving money back, the issues are on the front-page, and the banks, or the stocks with the most mortgage risk, are reacting well beyond their normal seasonality pattern,” said Azous.
By virtue of Australia's higher-than-average interest rates, EWA's trailing 12-month dividend yield is 3.6 percent, but the ETF's three-year standard deviation is 500 basis points above the MSCI EAFE Index, which yields almost 2.8 percent.
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