Table of contents 1. Introduction..2 2. Overview of Australian economy.2 3. Fundamental analysis3 4. Conclusion8 5. References..

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Introduction Investment involves a trade-off between risks assumed and the rewards expected. It is a tricky business and needs strong foundation and understanding of fundamentals to come up with the right choice. Investing in different geographies is a diversification strategy that is widely adapted to hedge the risks by multinationals today. The most important factor is to understand the macro as well as micro economic environment before proceeding to make rational investment decisions. The fundamental analysis is nothing but an understanding of factors that affect the investment in, say, stock market. Here we keep the fundamental analysis broad-based by looking at the economy as a whole. Now that we decided to start with the big picture, we take the top down

approach. This approach is about taking the larger idea first and then breaking it down to study finer details. We present in this paper the top down analysis of the Australian economy. Overview of Australian Economy The Australian economy has shown to have a robust outlook in the past. It is primarily dominated by the services sector. But its main strength lies in its richness in natural minerals and abundance of agricultural resources. It has a strong domestic financial market and also makes up an important part of the global financial system. The

countrys natural resources attract a lot of foreign investments and are a major export segment as well. The global financial crisis that hit in 2009, did not leave Australia unaffected. Its economy was impacted and is saw a dip in growth during that period. However, strong policy framework and continued demand from China helped the

economy rebound quickly. The country continues to keep its economic productivity high by leveraging its strengths. In fact, among all the developed countries, Australia was the least shaken by economic crisis because of it strong structural, political and economic design. It has well-managed to keep both unemployment and inflation rates on the lower side. Fundamental analysis To begin with the fundamental analysis, we begin with the single most important macroeconomic indicator of a country, which is its GDP. The graphs below present GDP growth for both the global economy and the Australian economy in particular.

The Gross Domestic Product of a country is the sum total of its economic output. It assigns a monetary value to all the goods and services produced in a country within a given period of time. The global GDP is the reflection of output of total economic activity in the world. As we can see from the chart, the global economy saw a major dip in 2009
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when the slowdown was at its peak. Triggered by the US housing bubble and inappropriate credit policies, it escalated into a far-reaching issue, that spiraled out of control in 2009. All the major economies were grappling with plummeting in stock prices, crunch in liquidity situation and financial crisis situation. In an era of globalization, all countries took a hit from this situation. The situation was controlled in following years but again started tapering thereafter. As for the Australian economy, after the drop in 2009, the gross domestic product rose in the next year. This growth was supported by increase in Chinas demand for iron ore and coal. Besides, manufacturing in China, the largest trade partner for Australia, grew at a faster pace in mid of 2010, indicating a limitation in the economys slowdown. The relationship between world GDP growth and Australian stock market is complicated. There are a lot of other factors which are interwoven with GDP that affect the stock market performance. The underlying premise of studying the economy is that economic situations and variables impact the earnings of a company and affect both their revenues as well as costs. Investors expectations of these earnings are reflected in the stock price of the company. When the GDP falls, the output decreases, this causes sluggishness in industrial activity as well impacting the companies performance which is reflected in their stock prices. This calls for a sound judgment of economic factors so as to make rational investment decisions. Since 2012, the global equity markets have seen a rise. Improvement in the momentum of US economy is the driver of this growth along with steps taken by governments to deal with sovereign debt problem and the banking crisis. Australian stock market has

approximately 40% of offshore investors. As the global economy begins to tumble, these investors start withdrawing their funds. They start selling their shares in the respective markets. Besides, industries do not operate in isolation. For example, the Australian mining sector is directly linked to the growth of Chinese economy. A

slowdown in China is bound to have an impact on Australian stock market, 25% of which is represented by mining companies.

Many studies conducted have revealed that Australian GDP does not have a very high correlation with stock market returns in the country. This can be attributed to two main reasons. One is that GDP is calculated with a long lag and that statistics are backwardlooking. The stock market on the other hand is a reflection of future expectations of earnings based on the companies performance and anticipated macroeconomic conditions. Secondly, the structure and composition of the Australian stock market differs from its countrys GDP. The stock market is made up of 40% of financial companies and 25% mining companies, whereas the composition of the same in GDP is 20% and 10% respectively. Therefore, we can see that more than the local GDP it is the global GDP or that of specific countries such as China, is what affects the stock markets performance in Australia.

Although GDP itself might not be correlated well for stock market returns it can be gauged for assessment of inflation in the economy and thus understand the movement of interest rates.

Inflation in an economy reflects the increase in prices of goods and services. This results in consumers shelling out more money than presumed to meet their requirements. Inflation causes the businesses to become more costly to run as prices increase. This directly impacts the bottom-line. It affects every sector and thus impacts the stock markets performance. Generally, if inflation is high, the government will increase the interest rates as well to curb the increase in inflation. In such a situation, the people who seek borrow money will have to pay a higher rate of interest. This increase in cost of borrowing money leads to some inhibition of funds to be invested in stock markets. As the interest rates decrease, the borrowers enjoy lower costs of

funds, but the lenders opportunity to earn income from interest also decreases, lowering their willingness to buy securities such as bonds. If funds are not available for investing, the companies are unable to expand or capitalize on other opportunities for growth and innovation. Without this, the chances of businesses long-term survival become slim.

Generally, yield curve is upward sloping when investors look for higher interest returns for bonds with longer term maturity profile. There is a correlation that has been established between slope of yield curve and the expectations of economic activity and inflation in future. An upward sloping yield curve indicates an expectation of stronger economic performance and a higher inflation rate in future. On the other hand, the downward sloping yield curve as is present in the Australian economy signals a weaker economic activity and a lower inflation in future. As represented in case of Australia a downward trend in inflation and a resulting lowering in bond yields of the country, the returns of these instruments also become unattractive. As a consequence, the investors start looking for alternatives to channel their savings. Usually, these funds are channeled into stock markets which can potentially yield higher returns. Another important reflection of a countrys GDP is its currency. The economic

production of a country is given by total amount of money in the country. Thus, higher is the GDP, the stronger will be the currency and higher purchasing power. The higher the GDP, the stronger is the currency and its purchasing power.

As mentioned previously, the rise in flows of capital among the international financial markets causes the currency exchanges to have a greater impact on stock markets. Currency fluctuations have a direct impact on the revenues of multinationals, which operate in geographies all across the globe. For companies exporting or importing products again, this has a direct impact on their financials. The graph shows strengthening of US dollar and weakening of Euro and Yen against the Australian dollar. The main problem caused by Australian currency is that its exports are becoming less competitive because of a very high Australian dollar. The Australian companies have to grapple with the competing cheaper goods other markets have to offer. This puts a big impediment in the growth of Australian economy and makes the Australian share market less attractive to global investors. This lack of interest from international buyers for goods offered in the local Australian market holds back performance.

Conclusion As suggested by economic indicators, the Australian economy has proven to be highly robust and continues to be strong. It is also known for its high level of overall competitiveness. Australia has consistently outperformed expectations from OECD economies both in terms of its growth as well as resilience. The country has strong fundamentals and presents as a good opportunity for foreign investment in various sectors. Australias location advantage (close to Asian region) and its engagement with the Asian economies has made it attractive destination for companies looking to expand globally.

In terms of its economy, it was affected by the recessionary conditions that prevailed globally in 2008-09. All the indicators saw a sharp decline during that period. This was also marked by the dip in global stock indices. However, if we compare the other major indices like Dow Jones vs ASX, we can see the similarity in trend. In fact, the trend shows Australia has an upward trend unlike the European exchange index. Recession has had a relatively smaller impact on Australia as compared to other major global economies, and is expected to move to higher growth rate in a shorter span of time. Though the economic indicators have shown some decline in the recent past, the overall economy remains strong and with higher growth expectations in the future.

*( EURO STOXX 50 is a major index in Europe which captures the performance of 50 Blue-chip companies which are based in twelve Euro Area countries: Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal and Spain. The Dow Jones Industrial Average is a major index in U.S. It tracks the performance of 30 large U.S. companies)

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References: Interest rates, the Australian dollar and inflation, http://aust-investor.com/interest-rates-theaustralian-dollar-and-inflation/ Inflation And Stock Market, http://www.economywatch.com/inflation/economy/stockmarket.html Why GDP thinks globally, acts locally, http://www.theaustralian.com.au/business/opinion/why-gdp-thinks-globally-acts-locally/storye6frg9r6-1226427439314 Australia GDP growth rate, http://www.tradingeconomics.com/australia/gdp-growth Australian economic growth accelerates, http://www.tradingeconomics.com/articles/08312010230456.htm GDP (Gross Domestic Product) and Its Effect on the Market, http://www.etoro.com/education/gdp-gross-domestic-product-and-its-effect-market.aspx What does a cut in interest rates mean for the stock market?, http://www.investopedia.com/ask/answers/132.asp Recent developments in Australian bond yields, http://cprs.treasury.gov.au/documents/1042/PDF/09_low_bond_yields.pdf Graphs on the Australian Economy and Financial Markets, http://www.rba.gov.au/chart-pack/ Strong economic credentials, http://www.austrade.gov.au/invest/why-australia/strongeconomic-credentials/default.aspx Economic Overview, http://www.indexmundi.com/australia/economy_overview.html Inflation busters, http://www.asx.com.au/resources/investor-update-newsletter/201106inflation-busters.htm Euro area stock market, http://www.tradingeconomics.com/euro-area/stock-market Australia stock market, http://www.tradingeconomics.com/australia/stock-market United states stock market, http://www.tradingeconomics.com/united-states/stock-market

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