From a world-beater to an also-ran, the Australian share market has lagged overseas rivals in recent years. What went wrong and how long until the "Lucky Country" gets its groove back?

Despite a recent rally, the ASX's 10 per cent gain over the past year pales in comparison to many overseas markets. As of close of trade on 26 October, the US Dow Jones Industrial Average was up by 28 per cent, while the tech-heavy Nasdaq Composite Index was showing a 25 per cent gain.

In Asia, Japan's Nikkei Stock Average was showing a one-year gain of 25 per cent, with South Korea's Kospi index up 23 per cent, Hong Kong's Hang Seng Index nearly 21 per cent higher, and Singapore's Straits Times index up by 19 per cent. Across the Tasman, New Zealand's S&P NZX All Index has risen by nearly 13 per cent over the past year, despite the nation's recent election volatility.

From the end of 2012 to the end of September 2017, the S&P ASX 200 has produced annualised gains of 4.3 per cent compared to the MSCI All-Country World Index's 10.1 per cent, on a local currency basis. Even accounting for dividends, the local market has still underperformed, returning 9.1 per cent a year compared to 12.3 per cent for the global benchmark.

Analysts point to the decline in Australia's terms of trade (a ratio of export prices to import prices) due to lower commodity prices following the end of the mining boom.

During the boom, higher prices for commodities such as coal and iron ore boosted the profits of major miners such as BHP Billiton (ASX: BHP) and Rio Tinto (ASX: RIO), helping lift corporate earnings and dividend payments.

Similarly, the Australian dollar tends to reflect movements in the terms of trade, as seen in recent years with its decline from over US$1 to around US$0.76 currently. A declining Aussie dollar reduces the attractiveness of Australian stocks to overseas investors, and the currency is widely predicted to fall further.

Another factor cited is the local bourse's domination by financial and mining stocks, which collectively account for around half the S&P ASX 200. Information technology (IT) has been one of the hottest sectors on Wall Street recently, yet IT comprises only 1.3 per cent of the local market, compared to around 23 per cent of the US S&P 500.

Morningstar's head of equities research, Peter Warnes, also points to a sluggish local economy, along with the Reserve Bank of Australia's less expansionary monetary policy compared to central banks overseas.

"In Australia, GDP growth has been below trend, while inflation and wages growth are also low, so the economic factors here are not robust at all," he says.

"The bigger economies of the Northern Hemisphere, led by the US and now the European Union, are exhibiting signs of much stronger growth than here. So why would foreign investors come here when they can get better returns at home?"

Warnes also suggests government intervention such as the big bank levy and energy sector regulation have sent "negative signals" to offshore investors.

A September survey of 568 offshore fund managers by Bank of America-Merrill Lynch found they were the most underweight on ASX stocks compared to other Asia-Pacific markets, excluding Japan. Australia's lack of technology stocks was cited, as well as risks attached to the financial sector due to an inflated housing market and increased regulation.

Locally, Warnes suggests investors have switched from equities into residential property as their "risk asset of choice," with US investors taking the opposite approach.

In Australia, margin loans for share investments peaked at nearly $42 billion in December 2007, but have since shrunk to around $12 billion as of June 2017. In contrast, investor loans for housing have doubled over the same period to around $580 billion.

SMSFs have also increased their exposure to residential property over the past five years, rising to around $27 billion as of December 2016, although still representing only 4.5 per cent of total investor housing loans in Australia.

"Had all that money have been channelled into equities, the local market would have been significantly higher," Warnes says.

In contrast, US investors are currently holding a record level of margin debt for shares of around US$580 billion, reflecting a similar surge in Australia prior to the GFC.

"The record levels of funds in US equity ETFs [exchange-traded funds] and margin debt could suggest US investors are overexposed to the equities risk asset class, just as many commentators suggest Australian investors are overexposed to residential property," Warnes says.

Can the Australian market bounce back? Analysts argue a weakening currency, sluggish business investment and a likely slowing of the housing market point to sustained underperformance, particularly as overseas markets continue to rise.

However, improving global growth should benefit Australia's miners and other companies with overseas earnings, such as biotech Cochlear (ASX: COH) and blood products maker CSL (ASX: CSL).

For now, Warnes suggests local investors retain "a reasonable amount of cash" amid the risk of an overseas market correction as major central banks unwind their inflated balance sheets.

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Anthony Fensom is a Morningstar contributor. The author holds shares in CSL. This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind. Opinions expressed herein are subject to change without notice and may differ or be contrary to the opinions or recommendations of Morningstar as a result of using different assumptions and criteria. The author does not have an interest in the securities disclosed in this report.

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