Comparative Analysis Of S&P/ASX 20 Index And Australian Government Bonds: An Essay.

The S&P/ASX 20 index includes majority of the country’s business houses and can be said to be a representative of the economic performance of the country. The company’s listed in the index are exposed to country’s economic health, economic growth and financial performance, hence a rise in the index would indicate favorable performance of the country an vice versa. Government bonds can be defined as a financial instrument which are issued by the government the proceeds of which are used by governments for funding spending. Treasury inflation protected securities, treasury bonds and savings bonds are some of the examples of government bonds. It is important for an investor to assess various risks that are associated with the bonds like interest rate risk, political risk, inflation risk and several other risks. When the central bank buys government bonds, the funds are distributed to the bondholders' banks. As a result, the reserves of the commercial bank are increased. This will become the non-borrowed reserves of commercial banks, as well as the surplus reserves of commercial banks. The non-borrowed reserves of commercial banks will be assessed using the central bank's bond auction. Banks' loanable capital decreases when reserves fall, resulting in a decrease in the multipliers level of the money in the economy. As a result, demand for federal funds will increase, raising the fed funds rate and vice versa. I predict the S&P/ASX20 to outperform Australian 10-year government bonds from 30 April to 31 December 2022. The explanation for the S&P/ASX 200's strong growth is explained in the next section:

Based on the historical performance of both the asset classes the S&P/ASX20 have outperformed the Australian 10-year government bond which can be confirmed after analyzing the data from April 30^th 2019 to April 30^th 2020. During the mentioned period the S&P/ASX 20 returned a loss of 10.56 percent whereas the Australian 10-year bond had a return of -3.19 percent (Dimitrov, 2019). When compared with the performance of the last year, the asset classes performed poorly this year due to the negative impacts of covid-19 pandemic in the year 2020 which was the reason behind the sharp fall in value of assets all around the world. The index despite putting a poor show in the year of 2020 and 2021 have outperformed the returns from the government bonds which increases our confidence in the index that it will continue to do so in the future periods to come (Alam, Wei and Wahid, 2021). Compared to the financial crisis of 2008 and eurozone crisis in 2011 the index outperformed the bond with a return of -37.51% and -18.65% compared to a return of -2.94% and -1.20% of the bond in the respective mentioned crisis periods. The bond issued by the government of Australia can be considered as one of the least risky investment which can be suitable for an investor looking to avoid high risk but earn a stable source of return in the form of coupon payment. The risk inherent in the equity has been historically higher also providing super normal returns compared to the bond. The stocks in the past have yielded a return of around 6 percent year; more than 7 times higher than that of the bonds. This has been the reason for many investors to pin their hopes on equity to outperform the bond markets in the future periods to come.

The performance of the index can be attributed to the performance of the stocks listed in the index. The risen in corporate earnings and a rise in demand for the stock in the country and worldwide drives the value of the index upwards. The three major stocks of the index which includes the Commonwealth Bank, BHP, and Westpac banking corp are the biggest constituents of the index and has the potential to influence the return of the index in a significant way. The financial performance of the financial sector accounted for around 1/3^rd of the total performance of the index whereas the sector of materials and energy have a little more contribution than 1/3^rd to the total performance of the index. The stock of the Commonwealth Bank of Australia fell down by around 16 percent in the year 2019 because of the company facing allegations of money laundering and a drop in the margin of net interest of the company. The materials sector witnessed a fall in value in the year 2018 but it went on to rebound in the year 2019 posting a significant performance. On the back of rising prices of iron ore around the world specially after the impact of the covid-19 pandemic, the stock of BHP also witnessed superior performance. Iron ore prices helped the company offset losses caused by lower metallurgical coal prices and a 7% strengthening of the Australian dollar.

Corporate earnings fluctuations can alter the growth rate of the country’s economy, inflation rate and the interest rate environment. The performance of the companies listed in the index does not depend on the factors that are firm specific, but it depends upon various factors which the government of the country can directly influence like the policy making structure, business cycle fluctuations and the exchange rate regime. The government bonds are instruments governed and issued by governments and are majorly influenced by the volatility in the interest rate structure. With a rise in the interest rate, the value of the bond would fall. There may be several reasons behind raising the interest rate in the economy which includes, to counter rising inflation or fighting a booming economy. As due to excessive quantitative easing process adopted by governments all around the world, inflation is expected to rise significantly which the government would be tackling by raising the interest rates in the near future which would negatively impact the performance of the bond. Hence, this further confirms our assessment of the S&P/ASX 20 index outperforming the government bonds.

The Australian economy is standing upon the performance of various commodities like iron ore and coal which have provided significant returns over the last one year. The iron ore prices have had witnessed a significant jump of around 51 percent in the past one year. China accounts for around 34 percent of all the imports and exports of the country and it is the biggest trading partner of Australia. The iron shipments that went to China from Australia was around 84 percent of the total export value of the country. The demand from China and the price of commodities in China have a significant role to play in determining the movement in the stock prices of Australia because of the exposure of Australia to the commodity demand of China. The Australian economy also places greater importance on the foreign investment coming into the country and as a result the country is amongst one of the most highly leveraged country compared with all the other developed economies in the world (Wang, 2016).

The period commencing April 30^th 2022, and ending on December 31^st 2022, the index is predicted to exceed the returns provided by the Australian 10-year government bond. It is expected that the economy of the Australia would be performing supremely well in the periods to come with the GDP of the country rising to over USD 1.3 trillion. The country is on the path of being the most successful countries in the Asian continent. The economy of the country can be regarded as one of the most diverse in the world and the county has been increasing its linkages with developing and emerging nations like China, India and Japan. The index of S&P/ASX20 has been representative of the best companies in the country and they are all exposed to the economic health of the country with economic growth which is superior in nature and vice versa.

The stock exchange of Australia was established in the year 1987 and was a result of merger of six distinct state-based stock exchanges after a legislation was developed by the parliament of Australia. All the states had their own stock exchanges before the establishment of the ASX in the year 1987.The six exchanges that the ASX is made up of comprises of all the state capitals like Melbourne, Sydney, Hobart, Brisbane, Adelaide and Perth. The ASX is ranked on the 12^th position in the list of world’s biggest exchanges. Stockbrokers and stockbroking firms are the individuals or institutions which are involved in the conduct of trading activities in the ASX (Mathews, 2019). The exchange trading system on which the trades are carried are is called the Stock Exchange Automated Trading System or SEATS. The system which is used to settle and transfer the trades to appropriate systems is called the CHESS which stands for Clearing House Electronic Sub-Register System). To be able to get listed on the Australian Stock Exchange, all the companies must have the limited amount of market cap and have the minimum number of shares outstanding which comes under the listing rules of the ASX authorities. The listing rules of the ASX are put in place to protect the interest of the participants of the stock market and protect the integrity of the stock exchange.

The S&P/ASX20 index constituents are those companies which represents the economy of the country as the companies listed in the index are with the highest market cap. The index is constructed using the market cap weighted and the float adjusted methodologies. The following section would be focused towards selecting an appropriate balance between the stocks which are a part of the S&P/ASX 20 index and the bond issued by the Australian government (SPGlobal.com, 2022). An effective investment strategy can be established using the view on the markets and the long and short-term investment strategy. The following section highlights the steps and rationales behind the investment policy statement and the asset allocation based on the stocks that are the part of the index.

The Australian government issues bonds with distinct maturities and types which includes treasury bills, and notes. The government sells the bonds with different maturities to raise capital for different types of investment activities conducted by the government (ASX.com.au, 2022). The asset allocation process that was followed in determining a perfect balance between stocks and bond is based on the past one-year returns provided by the stocks that are a part of the index. The returns were filtered for selecting stocks that have provided returns in excess of 20 percent and those stocks were chosen for investment in the portfolio of assets. The total investment corpus for the purpose of creating a portfolio was equal to $1,000,000.

Corporate Earnings Fluctuation and Their Impact on the Economy

According to the discussion conducted in question 1, the stock markets are expected to outperform the bond markets because of the expectations of a tightening monetary policy stance adopted by the government which includes raising the interest rates to counter the inflation level in the economy (Mampatta, 2022). On the basis of this expectation, we have limited the total percentage investment in the bond market equal to 20 percent. This allocation was maintained to reduce the risk of the overall portfolio as bond have historically lower correlation with the returns provided by the stocks. The stocks that were chosen to be included in the portfolio takes up 80 percent of the total investment corpus. The stocks were chosen on the basis of the past year returns and a dividend yield of more than 1 percent. The companies chosen for investment also have a positive earning per shares. The following section gives an overview of the companies included in the portfolio along with the financial information supporting the decision:

• Goodman group – Goodman group is a commercial and industrial property development firm which has a specialization of managing warehouses, logistics facilities, business parks and other infrastructural assets. The group owned 392 properties which have a presence in over 17 countries. The company has a market cap of around 27.2 billion with an operating profit of around $1060.2 million on the basis of the data collected till the end of 2020. The total returns generated by the stock in the most recent year was equal to 24 percent (Yahoo finance/GMG.AX, 2022). The stock has a price to earnings ratio of 13.71 and has yielded a dividend of around 0.89%.
• National Australia Bank – Being one of the four biggest banks currently operating in Australia, the bank is of significant importance for the movement in the S&P/ASX20 index. The market cap, customer base and the earnings of the bank is one of the highest in the country. The bank had been ranked 52^nd in the world in terms of total assets that are owned by banks till the end of the year 2019. The total revenue generated by the bank till the end of 2020 was equal to AUD 172.61 billion and the market cap of the company was equal to AUD 10.55 trillion. The price to earnings ratio of the company was equal to 17.62 with a dividend yield which was equal to 3.83 percent (Yahoo finance/NAB.AX, 2022). The stock has returned around 26 percent returns since the past one year which was the major reason for including the stock into the portfolio.
• Macquarie Group Ltd – The company is a financial services company having operations all around the globe. The company is headquartered in Australia and is considered to be the world’s largest infrastructural asset manager. The total AUM that the company have is equal to AUD 737 billion and it operates under four distinct groups. The company has a asset management wing, offers banking and financial services, and operates in the commodities and global markets. The company has a market cap of AUD 7.76 billion with a price to earnings ratio of 18.96. The company regularly provides dividend with a yield of 2.92 percent (Yahoo finance/MGQ.AX 2022). During the past one year the company has yielded returns which were equal to 32.74 percent.
• Woodside petroleum Ltd – Woodside petroleum ltd is a petroleum exploration and distribution company having operations in several parts of the world including Australia, South Korea, New Zealand, United States, Senegal and many more. The company is a major operator in the sector of oil and gas with a market cap of AUD 32 billion. The price to earnings ratio of the company was equal to 11.57 and the stock has yielded dividends of around 1.87% (Yahoo finance/WPL.AX, 2022). The stock of the company has returned around 40.29 percent during the past one year.
• South32 Ltd – The company is a mining and metal company which has operations in different parts of the world including Australia, South America, North America and others. The market cap of the company was equal to around 23 billion with a price to earnings ratio which was equal to 21.42 (Yahoo finance/S32.AX, 2022). The company came into existence when it was spun out of the BHP Billiton company in the year of 2015. The stock has provided extraordinary returns in the past one year which was equal to 70.42 percent making it the most profitable stock listed in the S&P/ASX 20 index.

As represented by the graph above, the stock of SOUTH32 has been allocated the highest capital with a total capital investment of AUD24,000. The second highest investment has been made into the stock of Woodside Petroleum Ltd with a total capital invested equal to AUD 16000. The stock of Macquarie Ltd has been allocated a capital of AUD 16000 which represents 20 percent of the total capital allocated to equities. Goodman Group and National Australian bank were allocated equal capital on the basis of the past year returns and the total investment corpus was equal to AUD 24000. Based on the proposed allocation the equity portfolio would earn around 43.06 percent of returns as demonstrated in the table below:

The one stock that we expect would be outperforming the S&P/ASX 20 index for the period starting from 20^th April 2022 to 31^st December 2022 would be the stock of Charter Hall Group (CHC). The CHC is a infrastructural management company which is involved in owning and managing properties on the behalf of various clients including institutional and individuals. The group owns and manages more than 1500 properties across the globe and the total assets under management of the company is equal to $79.5 billion. With a history of efficient management of properties, the company is considered to be one of the largest integrated companies in the world. The company leverages on the expertise and exposure it enjoys in the sector to identify properties related to various domains.

The revenue of the company for the year 2021 was equal to AUD 608 million compared to a figure of AUD 493.4 million which the company earned in the previous year (Annual report, 2020). The book value of a company represents the intrinsic worth of the company and the company had a BVPS of around 5.09 in the year 2021 and it is expected that the figure would rise to 7.15 in the year based on the estimates collected by several analysts. The ROA measures the ability of a company to generate revenue by employing the company’s assets and it was equal to 9.40 percent for the year 2021 and is expected to rise to 13.4 percent in the year 2022 based on analyst’s estimate. Cash flow of a company refers to the amount of cash available to the company after adjusting for all non-cash expenses (Annual report, 2021.  The cash flow per share of a company was equal to 1 and according to the estimates of a number of analysts it is expected to fall down to 0.95 in the year 2022.

As depicted by the stock price chart of the company, it can be seen that the stock is on an upward trend for one month. The stock price of the company has risen from the levels of AUD 3 to a high of AUD 21 in a matter of a month. On the basis of the 20-day, 50-day and 100-day moving average of the stock, the stock is expected to rise in the future periods. Hence, it is safe to assume that the stock of the company would be outperforming the S&P/ASX20 index in the period starting from 20^th April to 31^st December 2022.

References

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Annual Reports (2020). Available at: https://www.charterhall.com.au/annualreports (Accessed: 25 April 2022).

Annual Reports (2021). Available at: https://www.charterhall.com.au/annualreports (Accessed: 25 April 2022).

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https://www.marketscreener.com/quote/stock/CHARTER-HALL-GROUP-6497850/charts/

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