A Bullish View On Australia

A day after one strategist issued a less-than-enthusiastic call on Australian stocks, new research indicates there are still some reasons to be bullish on equities down under.

What's Fueling The Inflow?
High interest rates relative to other developed market economies, a strong currency and an AAA sovereign credit rating are among the factors that have fueled inflows to Australian stocks, bonds and the country's dollar. Those factors may also be among the reasons that some market participants view Australian equities as richly valued, but those frothy valuations could be overstated.

Looking at historical valuations of Australian equities, we conclude that Australian equities are currently selling at relatively low valuations based on historical ranges, said WisdomTree research analyst Chris Gannatti in a new research note.

To The Contrary
That view stands to contrast to what iShares Global Chief Investment Strategist Russ Koesterich said in a note Monday when he downgraded his view on Australia to Underweight from Neutral.

Australia's sluggish growth outlook is problematic given that local equities are expensive compared to those of other developed market, said Koesterich. While most market watchers have been focused on the United States rally lately, Australia has actually done better over the last 12 months. Since March 2012, Australian equities have climbed roughly 16% in dollar terms, outpacing most developed markets, including the United States.

Indeed, Australia ETFs have been impressive performers over the past year. Heading into the start of trading Tuesday, the iShares MSCI Australia Index Fund (EWA) is up 16.2 percent in the past year while the WisdomTree Australia Dividend Fund (AUSE) is higher by 16.4 percent over the same time.

High Dividend Year
Gannatti notes that Australian stocks could continue to rise because they are coming off a so-called high dividend year. As of February 28, the trailing 12-month dividend yield on the MSCI Australia Index was four percent while the median value for all 42 available year-end values for the MSCI Australia Index is 3.71%, according to Gannatti.

Values above that number are considered high dividend years and below are viewed as low dividend years. That bodes well for further potential upside for AUSE and EWA.

The average return for High Dividend Yield Years was more than 17% better than the average for Low Dividend Yield years, and nearly 9% better than the average of all 42 available calendar years, said Gannatti. Of course, there is no guarantee that this result will repeat itself, but we believe it worth mentioning, especially since it is based on more than four decades of return history.

Significant Differences
As of March 28, EWA had a trailing 12-month yield of just over five percent while AUSE has a distribution yield of just over six percent. There are significant differences between the two ETFs investors should be aware.

For example, EWA is weighted by market capitalization and allocates over half its weight to financial services firms. Materials are next at nearly 19 percent. On the other hand, the WisdomTree Australia Dividend Index weights the 10 largest qualifying companies from each of the industry sectors on the basis of their dividend yields, resulting in a combined weight to the Financials and Materials sectors of less than 35%, Gannatti said.

Actually, AUSE's current combined weight to financials and materials is below 34 percent. In addition to financials, consumer discretionary, industrials and staples also receive double-digit allocations within the ETF.

AUSE's lower exposure to materials names could prove important at a time when the stronger Aussie dollar is seen crimping profits for Australia's miners. Additionally, the Reserve Bank of Australia has said it expects the country's mining boom to peak this year and after voraciously cutting interest rates from late 2011 through late 2012, RBA appears content to stand pat. Even with those interest rate cuts, the Aussie has been one of the top-performing developed market currencies in the world.

For more on Australia ETFs, click here.