Gregg Greenberg

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Stocks Sizzle Down Under

Gregg Greenberg

It's been really hot down under, and not just on Sydney's sandy beaches.

Australian and New Zealand stocks sizzled in 2004, posting a return nearly triple that of the S&P 500. Aussie gains were mostly powered by mining companies capitalizing on the global spike in commodity prices, as well as financial services companies taking advantage of the region's sublime economic conditions.

For more insight on Aussie stocks in 2005, TheStreet.com tracked down Steve Robinson, co-portfolio manager of the Aberdeen Australia Equity (IAF) fund. Aberdeen Australia is a closed-end fund listed on the American Stock Exchange and is one of the few funds available dedicated to holding just Australian and New Zealand stocks.

The fund has returned 30% annually over the past three years and 14.6% over the past five, a period that includes the global bear markets of 2001 and 2002. In 2003 and 2004, Aberdeen returned a not-too-shabby 57.5% and 39.6%, respectively.

What are your projections for Australian and New Zealand stocks in 2005, coming off a highly impressive 2004?

The Australian equity market reached new all-time highs in 2004, with a return of 28% for the year including dividends. Although we don't think the market will achieve similar gains this year, the equity market does not look overly expensive and is still trading at a P/E discount to the U.S. and U.K. markets. Furthermore, the market is paying an average dividend yield of 4%.

Economic conditions remain solid, with consumer sentiment close to decade highs and the unemployment rate at 20-year lows. Leading indicators continue to point to solid growth in the domestic economy. The New Zealand economy is in a similar situation.

Australian mining stocks have become very popular with U.S. investors, as commodities prices have risen. What do you project for commodities prices in 2005? What stocks do you like in this sector?

After a number of years of underinvestment in the mining industry worldwide, it will take some time for supply to catch up following the current surge in demand for metals. This is likely to support prices over the next few years. Bulk commodities such as iron ore and coal are achieving strong price rises in the current round of price negotiations, and companies with exposure to these will benefit significantly. BHP Billiton (BHP) and Rio Tinto (RTP) are the largest producers of iron ore in Australia and have significant exposure to coking and steaming coal. We have significant holdings in both companies.

Aside from mining stocks, what else do you like?

Besides BHP and Rio Tinto, we have large holdings in QBE Insurance, Leighton Holdings, Fosters Group and Telecom New Zealand (NZT). QBE is a diversified general insurer with global operations. QBE has strong management and continues to benefit from the positive environment for general insurers. Leighton is an engineering and construction company with a large contract mining division and engineering operations throughout Asia. Fosters is Australia's largest beer and wine company, with a strong position in the Australian beer market and the potential to grow strongly in the wine industry. Telecom New Zealand is New Zealand's largest telecom company, operating in a duopoly situation in the domestic market with strong cash flows and a high return on equity.

How is the weak U.S. dollar affecting Australian companies and the Australian economy?

The weak U.S. dollar has translated into a strong Australian dollar. This has had a mixed impact on Australian companies, generally being negative for exporters and positive for importers. Therefore, retailers importing from Asia have benefited from lower costs, while exporters have had lower export prices. High commodity prices have offset the higher Aussie dollar for mining companies, while other industries have not been so lucky.

Australia/New Zealand bonds have also become very popular in the U.S. because of their stable currency and strong economy. Is this popularity in America deserved? What are your forecasts for Australian interest rates?

The Australian economy is currently in its 14th consecutive year of expansion, with annual GDP growth averaging a healthy 3.7% over this period. Thanks to extensive microeconomic reforms in the 1980s and 1990s, a flexible currency and a highly credible central bank, Australia's growth performance in the past two decades has been significantly more stable than in the 1960s and '70s. The credibility of the central bank and, more specifically, its success in implementing a formal inflation target have been particularly important.

The Reserve Bank of Australia first indicated an informal objective for inflation in 1993, and formalized this into the current target of "keeping underlying inflation between 2% and 3%, on average, over the cycle" in 1996. The annual pace of core inflation has averaged 2.4% over the past decade, right in the middle of the RBA's target range.

All these factors have led to a reduction in the risk premium accorded to Australian long-bond yields -- the ultimate gauge of the effectiveness of Australia's efforts on structural reform and policy. We have seen spreads between long-dated bonds in Australia and the U.S. average just 1% in the decade between 1994 and 2004 compared to 3.5% in the prior decade.

Our assessment of the inflation outlook still points to core inflation approaching the top of the RBA's target band during 2005. That said, the better-than-expected September-quarter inflation data and some softer-than-expected real activity data recently mean the RBA probably has time to continue its wait-and-watch approach to policy-setting. Accordingly, our forecasts incorporate a final rate rise in the first quarter of 2005.

How is the overall political situation in Australia? The country is much closer to some political trouble spots like Indonesia than the U.S.

The political situation in Australia is extremely stable. The conservative government was re-elected last year, so there are not likely to be any major political surprises. With recent events like the tsunami disaster, Australia is providing aid and support to Indonesia, which assists in developing a positive relationship.

Australia is also far closer to China than the U.S. How is Australia handling China's emergence?

Australia has benefited from increased trade with China and the rest of Asia over a number of years, but this has obviously increased significantly over the last few years. Australian resource companies are benefiting from increased sales of commodities to China. Throughout this period Australia has maintained a strong relationship with the United States that goes beyond economic trade and which has strengthened in recent times.