Why The ASX Will Remain a Two-Speed Index

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What’s the biggest problem with the ASX? If you asked most investors, there’s one thing they’d all agree on. Mining and banking stocks dominate the Aussie share market. Together they make up 63.1% of the entire index. That’s a disproportionate share whichever way you spin it.

Is this reliance on two sectors bad for investors? Well, it could be. If nothing else, it suggests the ASX is performing below its full potential. We can see this by measuring it against global markets.

The US-based S&P500 is far more diverse compared to the ASX. Its index representation is less reliant on a few sectors for its success. Industries like healthcare and technology play a prominent role on US markets.

They’re partly the reason the S&P500 has grown by 200% since 2009. In contrast, the ASX rose by only 79%, not including dividend payouts.

Including dividends, the ASX gained 130% over the last six years. That’s still well below the S&P500’s gains.

While dividends are important, they’re not the be all and end all. If anything, bigger dividend payouts suggest an underlying problem of profitability. Aussie blue chip stocks are pandering to investors by maintaining progressive dividend policies. They’re doing that more often these days because earnings and profits are flat lining.

Technology stocks: the difference between US markets and the ASX? 

This comparison between US and Aussie markets was the subject of a recent Sydney Morning Herald article. In it, John McDuling asks why the S&P500 outperforms the ASX. McDuling’s conclusions are revealing; they also bode poorly for the future of the ASX. He writes:

‘[It’s down to] a lack of truly disruptive, global businesses. [Australia has a] glaring absence of a technology sector.

The three biggest contributors to the S&P500 rise [sic] are Apple, Google and Microsoft. Giant tech stocks have been a major part of the US market recovery. These companies are truly global. As a result [they] are having a significant effect on economies like Australia’s. [They disrupt] established industries, often paying very little in tax.

‘This invariably feeds through back to both stockmarkets. There is a huge global appetite among investors for exposure to tech. [That] can’t really be found in Australia’.

The diversity of US markets is an advantage over the ASX. The fortunes of these tech giants are a major boost to the S&P500.

Yet, what exactly does it tell us about the Aussie markets? Are we to assume that Australia needs to develop a tech sector?

Well, you can’t grow a technology sector out of thin air by wishing it into existence. That’s true of any single industry or sector. A tech sector can only grow within specific parameters and environments.

No one has yet managed to overtake Hollywood as the global epicentre of moviemaking. Technology is no different in that respect.

Silicon Valley is a renowned tech hub the world over. That’s because it’s a petri dish for technological innovation.

It draws the right kinds of people for innovation to flourish. Its expertise, and its reputation, attracts the brightest scientific minds to California.

But it’s taken a long time for Silicon Valley to become what it is today. Every success it’s had builds on the one before. This kind of virtuous circle is difficult to displace or overtake. It’s also the reason why few nations have replicated its success.

Australia isn’t in a position to buck the trend. We can’t just lay the groundwork for a tech sector to rise to such prominence. At least not to the level where it would have a significant impact on the stock market. Not that it’s stopped other nations from trying.

Israel has one of the most developed technology sectors in the world. There’s a simple reason for this.

Israelis take their science and technology seriously. They’ve done so for a long time. Israel is second only to the US in the amount of money it spends on research and development, relative to GDP. The number of people working in the tech and science sectors is impressive too. Relative to its population, Israel’s workforce is geared towards tech. It has the second highest representation of workers in technology in the world.

But Israel’s institutions weren’t built overnight. They took decades to get to the point they’re at today. And even this doesn’t necessarily guarantee success. Israel still has to compete with the giants of Silicon Valley.

Building a tech industry

Building a tech sector from the ground up is both time and capital intensive. But how would Australia go about it if we tried?

We could look to the Russians for an example.

Russia is active in building their own Silicon Valley. They’ve been doing so since the turn of the decade.

Skolkovo, as it’s called, is an ambitious innovation centre. It sits just outside Moscow. A vast amount of public and private funds are flowing into Skolkovo. Russia’s ambition is to have a comparable hub to Silicon Valley.

They’re not mucking about either.

In 2012, Russia spent over $500 million on Skolkovo. They backed that up the following year, investing a further $500 million. As you can see, it takes a lot of money to build a technology sector from the ground up.

That makes it hard to see Australia following in Russia’s footsteps. Can you see the government setting aside such sums to build something similar? Especially with little immediate reward? Me neither. The government has other budgetary pressures to worry about.

But even money doesn’t guarantee success in the long run. You still need to attract the best minds to make use of the infrastructure you have in place. Right now, it’s nigh on impossible to compete with Silicon Valley.

And it’s not just the infrastructure, or the expertise, that we’d need to consider. Australia would need to train a new generation of scientifically-oriented minds. That kind of shift, as you can imagine, is generational. And there’s no guarantee Silicon Valley wouldn’t sweep them out from under us.

Rate cutting, stimulus spending, and ASX stocks

Following in the footsteps of Silicon Valley is easier said than done. But the US hasn’t just relied on its tech sector to boost its stockmarkets.

Unlike Australia’s RBA, the US Federal Reserve was very active between 2009 and 2015. The Fed pumped hundreds of billions of dollars into the financial system in this period. As is the case with most credit expansion, this capital has found its way towards stock markets.

That makes it harder to gauge the tech sector’s true influence on the S&P500. After all, stock markets do grow faster when there’s more money floating around in general.

What about our own Reserve Bank then? Has the RBA’s monetary easing helped the ASX as its done for the S&P500? Not exactly. McDuling explains:

Although the RBA has been cutting interest rates, Australian’s experienced anything like this. Yet’.

Interest rates are at a historic low of 2%. But we haven’t seen the same outcome from this influx of money into the economy. That’s understandable.

The amount of capital in the US dwarfs anything seen in Australia. There’s also the small difference of direct stimulus spending versus rate cutting. Our government hasn’t injected the equivalent of a trillion Aussie dollars into the economy. Differences like that add up.

And we can’t discount the changing preferences among investors. Unlike the US, Australia never really had a housing collapse. Aussie investors aren’t scarred by any real estate crash.

Much of our free capital remains reserved for the property market. The more money investors leave aside for real estate, the less they’ll have to buy shares.

But that’s not the end of it. Once you throw in the uncertainty surrounding the economy, you can see why investors are iffy about liquid assets.

So what can we take away from all this?

One conclusion is that the ASX will remain the domain of banking and mining stocks for some time. Banking in particular should remain a darling of investors. Mining stocks could struggle to maintain confidence as profits drop. But dividend strategies are likely to keep investors onside nonetheless.

That means that diversification on the ASX is, for the foreseeable future, unlikely.

Any suggestions that Australia needs a comparable tech sector are wildly optimistic. It will take a substantial amount of money and effort to realise anything of the sort. The amount of time that, quite frankly, investors probably aren’t all that interested in waiting.

What’s more, there is an asterisk next to the S&P500. We can’t really compare the performance of the two without considering stimulus spending. From that perspective, the ASX has done as well as one could expect.

Mat Spasic,

Contributor, The Daily Reckoning

 

PS: With or without a diversified index, the Aussie sharemarket faces a bumpy road. The Daily Reckoning’s Vern Gowdie predicts the ASX is heading for a major correction in the near future.

Vern is the award-winning Founder of the Gowdie Family Wealth advisory service. He’s been ranked as one of Australia’s Top 50 financial planners. Not only does Vern see a major crash, but he thinks the ASX could lose as much as 90% of its $1.8 trillion market cap.

Vern wants to help you avoid the coming wealth destruction. That’s why he’s written ‘Five Fatal Stocks You Must Sell Now’. In this free report, he’ll show you which five blue chip Aussie companies could destroy your portfolio — and you almost certainly own one of them. To find out how to download the report, click here.

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