Australian Allure: Stocks Down Under Look Inexpensive

February 6th at 11:13am by Todd Shriber

The iShares MSCI Australia ETF (NYSEArca: EWA) lagged the S&P 500, the iShares MSCI New Zealand Capped ETF (NYSEArca: ENZL) and scores of other developed markets ETFs last year.

That despite the best efforts of the Reserve Bank of Australia, which has slashed borrowing rates by 225 basis points since late 2011. After an extended period of under-performance, Australian stocks may ready to bounce back, benefiting EWA and the WisdomTree Australia Dividend Fund (NYSEArca: AUSE) along the way. [Down Under Disappointment]

“Following the underperformance of Australia relative to global markets and its continued growth in dividends, Australia has now moved back to a position where it no longer looks overvalued on the basis of yield,” according to a Goldman Sachs note obtained by CNBC.

As global bond yields sank last year amid ongoing monetary easing by developed world central banks, investors flocked to markets with robust yields.

Although Australia’s benchmark rate of 2.5% is a record low for the country, it is among the highest in the developed world. That sent some Australian dividend stocks to lofty valuations, prompting concerns about the sustainability of dividends down under. AUSE has lost almost 11% over the past year.

In third quarter of 2013, Australia’s average payout ratio was 70%, more than double that of the S&P 500, prompting some analysts to remind investors that when Australia’s payout ratio tops 65%, slack equity performance usually follows. [Dangerous Dividends Down Under]

“Goldman believes the dividends can be sustained even though it expects this year’s earnings forecasts may slip and even if economic conditions don’t improve,” according to CNBC.

The bank may be right about the sustainability of Australian dividends. The previously strong Australian dollar made it difficult for Australian firms to reinvest in their businesses, but the CurrencyShares Australian Dollar Trust (NYSEArca: FXA) is down 6.1% in the past three months, providing some relief to Australian exporters and perhaps some assurance to skittish income investors eying Australia.

And there is still dividend opportunity left in the world’s 12th-largest economy. Goldman previously forecast dividend hikes from Australia’s largest financial services firms. That sector accounts for 50.1% of EWA and almost 20% of AUSE.

Goldman said the downtrodden mining sector could surprise with dividend hikes this year due to payout ratios that are well below the national average. AUSE and EWA have materials sector allocations of 14.2% and 18.9%, respectively.

WisdomTree Australia Dividend Fund