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Going Short Australia
Posted by: Fede Zaldua (IP Logged)
Date: December 27, 2013 05:10PM

As a result of the ongoing slowdown in the decade long commodities boom and very rich equity valuations, I see significant headwinds for most Australian assets in general and for the country's currency in particular. Although mining capex growth is still in positive territory (it's growing at a 2% year-over-year pace), it's tough to disagree with the Reserve Bank of Australia. Mining capex is set to fall, and this poses a significant challenge to the Australian economy since up to 40% of the country's GDP growth has been accounted for by mining capex alone. Furthermore, domestic demand excluding mining capex has been weak, and it's tough to see the private sector filling up the GDP growth gap since it's already highly leveraged. How could you benefit from Australia's slowdown?

1) Go Short the Australian Dollar

The easiest way to go short Australia's currency and long the U..S dollar is through selling Australian dollar's ETF, the Currency Shares Australian Dollar Trust (FXA), which is still held by John Keeley. Even when the ETF is down by 15% since 2013 it started I believe there is still significant downside potential for the currency.

Australia's monetary authority should keep on lowering rates (the country is running a significant current account deficit) and this will trigger carry traders to reverse their long positions on the currency. Moreover, the Australian dollar has outperformed the global mining sector significantly and, on the basis of the OECD's estimate of PPP, Australia's currency remains 40% overvalued against the U.S. dollar. I would short FXA with a $75 target, which represents a 17% depreciation of the Australian currency against its U.S. counterpart.

2) Shorting Australian Equities

On both P/E and P/B relatives, Australian equities trade at a 20% premium to their U.S. counterparts. Hence, it looks like a good idea to sell those companies that (1) trade at the highest premium to U.S. peers and (2) generate most of their revenues within the country – in the relatively expensive Australian currency.

Most Australian banks seem to comply with (1) and (2). On the other hand, Australian banks have a loan to deposit ratio of 120% and around 9% of their funding is short-term foreign funding. This means that their results shall be severely damaged by a steep depreciation of the local currency. A good example of a bank that is easy to short from the U.S. (since it trades in the New York Stock Exchange) is the Westpac Banking Corporation (WBK). Westpac generates 90% of its revenues domestically and sells for 13.1 times 2014 earnings and 2.1 times its 2014 expected book value. That said, there is one problem that you will find when you short Westpac's shares: The bank pays a 5% cash dividend yield.

Bottom Line

Given that both Westpac's shares and the Australian dollar should under-perform the U.S. market in 2014, I would short only FXA. The reason? Westpac's huge and sustainable dividend yield. FXA also pays a 2.4% cash yield but this yield should decline as the Australian monetary authorities keep on lowering interest rates. The biggest risk to shorting FXA is related to a strong rebound in commodity prices but this seems unlikely, at least in 2014.

Stocks Discussed: FXA, WBK,
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