Australian equities have benefited from a strong economic cycle and the success of the financials and natural resources sectors.
With the Australian dollar recently reaching a 17-year high and stocks trading at 15 times 2008 earnings, only the US and Japan are more expensive among developed countries.
As such, the relative attractiveness of international equities compared to Australian equities offers more compelling investment opportunities with a broader opportunity set in sectors.
Overall, I believe the current economic environment is very supportive of equities.
We have experienced a strong cyclical recovery from the last recession and central banks around the world, including Australia, have adjusted policy from stimulative to a broadly neutral setting over the past several years.
Emerging markets are driving global growth and pulling up the world average. While we see growth and earnings decelerating across markets, that is to be expected at this point in a mid-cycle slowdown.
Despite the recent period of monetary policy tightening across many developed markets, short-term real interest rates around the world remain generally favourable, and inflationary pressures are relatively constrained.
Long-term rates are also attractive, but more importantly, there are powerful forces, such as the predominantly positive view on inflation, holding them down.
In looking at valuations, I notice that price to earnings and price to book valuation dispersion has compressed between the most and least expensive stocks around the world.
The valuation dispersion is likely distorted by the influence of very low price to earnings sectors such as materials, energy and financials.
We have observed multiple compressions in the most cyclical industries and a lack of differentiation between companies with strong long-term growth prospects and those with weaker prospects.
If economic growth decelerates, then valuation spreads may widen. Companies that can maintain growth will experience some multiple expansion as investors bid up their stock, and weaker companies will be de-rated.
Just as the neighbourhood creates the opportunity in a piece of real estate, the industry creates the opportunity in a company.
But in stock picking, change presents the best opportunities. Currently, financials elsewhere in the world offer more attractive loan growth and net interest margins than in Australia. For example, Erste Bank is an Austrian-based retail bank benefiting from fast loan growth in Austria, Czech Republic, Ukraine, Hungary and Poland.
The most recent phase of globalisation is reducing the barriers to the flow of economic inputs and outputs that is resulting in a convergence of best practices around the world.
Globalisation reduces the friction on the allocation of capital and opens up more diverse pools of liquidity. It stimulates greater information flow and spurs investment in infrastructure. It is raising the productivity and the secular growth rate of the global economy and creating new opportunities in various sectors.
While the concept of globalisation is an old story, its scope is much broader as it pushes into Asia and the Middle East, and the benefits are being realised across more industries.
As best business practices continue to permeate, having global insight to industry structure and market trends can provide an information advantage, which can lead to alpha potential.
Robert Gensler is portfolio manager, global equities at T. Rowe Price.
