Offshore earners struggle despite A$ weakness

Since September, the Australian dollar has remained broadly steady at a little above 70 US cents.  In the past five years, the local currency has been resilient, depreciating by 35% against the US dollar at the same time as global commodity prices have declined by 60%.  But the longer sweep shows that the A$ and commodity prices do not necessarily move lock in step; the lift in commodity prices during China's boom of the mid-2000s far outstripped the A$ appreciation at the time (see chart).  At its current level of 71 US cents, the A$ is 8% below its level that prevailed the last time the RBA commodity price index was at these levels in mid-2005.

Evidente's econometric model of the currency shows that at current levels, the A$ is broadly in line with fair value (see chart). 

After what had been strong out-performance for a little over three years, ASX listed US dollar earners have struggled in the past year, despite renewed A$ depreciation (see chart).  During this time, the overweight bet in offshore earners has remained a crowded trade.

The large cap US dollar earners have been de-rated in recent months, in line with the broader market.  The basket is trading on a median prospective earnings multiple of 18x, but continues to trade at a premium to the market (16.5x).  The premium reflects stronger long-term growth prospects and a lower beta (see chart).  Despite this, the percentage of buy recommendations from analysts is comparable across US$ earners and the top 100.  Despite the lofty multiple for Cochlear, the stock has continued its strong performance, jumping by 15% on its interim result.

From a longer term perspective, the Big Mac index suggests that the A$ is under-valued against the US$ by 25%, which represents the biggest under-valuation since 2003 (see chart).  Deviations from purchasing power parity can extend for long periods.  But short-sellers of the local currency should be cognisant that the US$ at present, is over-valued against all but three currencies based on the Big Mac index, notably the Swiss franc, Swedish krona and Norwegian krone.