Financial Analysis Assignment: Impact Of USA Trading War With China On Australian Share Market (ASX)

Question

Task: Assignment Task
Assume the role of a financial analyst and prepare a report
a) Explain how the companies’ future/expected profits impact the shares index? Do you think current or future profit is more important for value?
b) Explain how and why the escalation in the US-China trade war is making changes to the Australian share market? Do you think the information about political and economic events around the global are impacting the Australian shares market? Why?
c) Presents an argument as to whether or not the Australian share market has information efficiency.

To illustrate and support each element of the report you are required to use no less than 4 scholarly articles PLUS numbers of books beside any other type of references. You are also required to explore a range of other formats, such as online news broadcasts, newspapers, financial magazines and various financial market websites to enhance the quality and richness of your arguments, descriptions and explanations.

Answer

Introduction
The study of Financial analysis assignment states that the value of stock/ shares revolves around the return and risk characteristics of the stock. In order to analyze the risk and return, the investor performs various forms of analyzes which are categorized basically under two primary heads such as fundamental and technical. Further, there are various economic, social and political factors both at the country level and international level that play a vital role in the analysis (Jordan, Miller, & Dolvin, 2015). Taking these various factors into account, the investor conducts analysis to find out the value of stock and develops expectations for the future value. Thus, in this manner, the investor seeks to find out undervalued stocks which have potential to provide handsome returns in future. This is called beating market. There are various examples in practical world which has been successful in beating the market such as Warren Buffet. Warren Buffet is counted as one of the most successful investors of all times in the world (Bloch, 2016).

Though, practically it is possible to beat the market and the same has been proved too but there exists a theory called theory of market hypothesis which states that beating the market and earning superior returns by investing in stocks is not possible (Urquhart & McGroarty, 2016). In this context, this financial analysis assignment focuses on analyzing the impact on Australian capital market and associated changes in various economic and political factors.

Impact of Future/Expected Profits on the Share Index
The fundamental analysis of the stock is conducted based on the information produced by the financial statements of the entity. The analysts tend to take various types of information from the financial statements which may relate to profitability, liquidity, or solvency of the business. The most crucial among these is the information pertaining to profitability of the business. The profitability is the base information which investors look when analyzing any stock. It helps in determining the intrinsic value of the stock. Basically, the information on the future/expected profits helps in calculating the return that the investor would get by investing in a particular stock. Thus, this information is important and basic to the investor’s decision to invest in the capital market (Oino & Ukaegbu, 2015).

The intrinsic value of the stock is calculated with reference to dividend which is the one of the components of actual return on the invested money. Apart from the dividends, the investors also get capital appreciation and earn capital gains on the investment which is also crucial component of the return. There are various fundamental models that help in calculating the intrinsic value based on the profits or rather say dividends such as Dividend Discount Model and Earning Multiply Model. The dividend discount model is based on the simple concept that the value of stock is the present value of expected future dividends to be received by the investor from the company. However, this model can not be applied in each and every situation because there are many companies that concentrate on building value of the stock rather than paying dividend constantly. These are called growth stocks (Jordan, Miller, & Dolvin, 2015).

Thus, the information pertaining to future or expected profits is essential for the investor and it impacts their investment decisions. Since, the investor’s decisions are affected by information on future profits hence it obvious that the value of share index would also be affected as the share index (ASX) is made up of a blend of stocks only. However, it may be noted that only future profits are not responsible for change in the value of stocks. The future profits provide indication of the profitability only but the investor’s are also concerned by the risk. Thus, other information such as information on the liquidity and solvency also comes into play along with other information on macro-economic level (Jordan, Miller, & Dolvin, 2015).

An example of Rio Tinto mentioned in this financial analysis assignment can be studied in the context of impact on share value of future profitability. Rio Tinto is a mining company listed on Australia Stock Exchange and operating in Australia and other parts of the world. The stocks in mining sector in Australia are on decline since past few years due to sluggish demand of coal and iron ore. China has reduced imports of coal and iron ore from Australia. Thus, the reduction in demand means lesser profits in future and this affects the investor’s sentiments resulting in withdrawing invested money. The share value slopes down due to withdrawal of money. The same has been happening in the case of Rio Tinto. Rio Tinto announced the interim financial results which could not meet the investor expectations resulting in 4.30% decline in the share value on August 02, 2019. However, it may further be noted in this financial analysis assignment that this decline in share value of Rio Tinto is not only attributable to reduced profits but also to the announcement made by the US president of 10% additional tariff imports from China (Walton, 2019).

Thus, it may inferred that company’s future/ expected profits affects the stock’s value and thereby the share index but there are other macro-economic factors also that play crucial role in changing the market sentiments. However, ultimately all the factors whether political, social, economic at micro level or macro are directly or indirectly connected with the profitability of the company. Thus, the profitability is the important and base point in ascertaining share value.

Impact of Escalation in the US-China Trade War on Australian Share Market
The impact of escalations in the US-China trade war on the Australian share market could be referred as indirect macro-economic factor from the view point of analysis. There has been adverse impact on the Australian share market of this ongoing trade war between the US and China. The US president showed strict view on the imports from China and announced additional 10% tariff which will be applicable from September 2019. This news, as soon as came in the market domain, shocked the entire world. All the share indices around the world including Australian Stock Exchange (ASX) were adversely affected by this news. The shares listed on the Australian stock exchange lost $90 billion in total after the announcement made by the US president about additional tariff on imports from China (Chau, 2019).

Further analysis into the sector specific stocks reveals that almost all major sectors lost value with technology, healthcare and utilities being the biggest losers. A snap shot of the Australian financial market after the announcement by US president is given as below:

Figure 1: Australian Financial Market 3rd September (Chau, 2019)

It could be seen from the above that ASX SPI Futures index declined by 0.6% reaching from 6,573 points to 6,515 points. Further, Dow Jones of US fell down by 1.1%, S&P 500 by 0.7%, and Nasdaq was down by 1.1%. The European market could also be seen to be falling down after the announcement. Thus, the impact of US-China was is all on indices around the world. The Australian dollar has also slopped downward reaching to 67.56 (Chau, 2019). The reason for adverse impact on the financial market of this announcement is the change in investor sentiments. The investors are expecting reduced earning and thus, a negative perception is being created. The most affected business sectors are technology, utility, materials, and financial.

For the manufacturing sector in US, the raw material cost is expected to rise after imposing of 10% additional tariff on Chinese imports. It is discussed in this financial analysis assignment that the Chinese products would no more be cheaper causing manufactures to search for new suppliers. This additional cost burden of manufactures in US would be transferred to Australia and other parts of the world where US exports its goods. Australia is also a major importer of goods from US. Since, the exportable goods of the US based manufacturers would be costly leading to more costs to the Australian manufacturers who imports goods from the US. Therefore, effectively, the Australian manufacturers would bear high cost of manufacturing leading to lower profitability. Further, China has presented its counter attack on the US by devaluing its currency to keep Chinese experts competitive. The impact of falling value of Chinese currency is also going to affect Australian manufacturer adversely. Now, the revenues from goods exported to China would be down as the Chinese currency value is low. Thus, there is dual impact on the Australian exporters. On the one side, raw material cost imported from US is rising and on the other side, export revenues from China are declining leading to low profitability all around. This is the fundamental reason behind adverse impact on the Australian capital market of the US president’s announcement (Xiang, Kuang, & Li, 2017).

Figure 2: Australian Share Market (Chau, 2019)

The political and economic changes at the global level are affecting the Australian stock market. The market sentiment theory is playing its role here (Damodaran, 2016). There is a negative vibe among the investors about Australian companies specially the manufacturers. The future outlook seems adverse amid the US and China trade war because Australia is a major importer to US and major exporter to China. The negative vibes due to US and China have caused the investors to withdraw money from the Australian stocks. However, in the views of Stephen Anthony, the economist, this phenomenon is for short term only. In his views, the market is going to stabilize in the long run and the things would be good and back on track (Butler, 2019).

Information Efficiency in Australian Share Market Within Financial analysis assignment
Information efficiency plays a crucial role in the capital market. It is argued that higher the information efficiency lower will be market volatility resulting in better output for the investor. There are three market efficiency forms such as weak form, semi strong and strong form. The premise of the weak form of market is based on the phenomenon that all available historical information is reflected in the stock’s price (Naseer & bin Tariq, 2015). Thus, the investor can take advantage by exploiting the available historical information. The semi strong form of market is based on the concept that stock’s price is already adjusted for historic information available in the public domain. Further, the strong form of market is based on the premise that all private as well as pubic information is reflected in the stock’s price leaving no room for the investor to beat the market. Thus, the strong form of market is the most desirable form for the investors. However, it rarely happens in the practical world because no market can observe and reflect all information in the stock’s price (Naseer & bin Tariq, 2015).

In regards to Australian financial market, it is argued in this financial analysis assignment that it used to be one of the world’s most stable markets. However, the phenomenon has changed over the past few decades. This may be due to internalization of the business and several other factors relating to investment norms. In the empirical study conducted by Groenewold, it has been revealed that the Australian Stock Exchange (ASX) conducts affairs with weak or semi strong form of market (Gan et al., 2005). It has been found out that the returns on stock listed on the ASX are predictable and hence the investor could exploit the information to make superior gains. Though, with the increase in technology over the period of time, the information efficiency of the stock markets all over the world has improved and the same has been the case with Australia too.

Conclusion
It can be concluded from the above analysis done in Financial analysis assignment that determination of the share price is based on several factors however all factors are connected with the profitability. Hence, the base to determine the stock’s value lies in company’s profitability. Further, the macro-economic factors and political moves at the international level also have bearing on the stock’s value and overall stock market in Australia. The US and China trace war is affecting the Australian stock market adversely. The Australian stock market is getting affected more severely than other market due to its cross trade relationships US and China. Further, the discussion on market efficiency in the context of Australian Stock Exchange reveals that it operates with weak or semi strong form of market. However, the situation is improving with the increased technology.

Reference List
Bloch, R. L. (2016). My Warren Buffett Bible: A Short and Simple Guide to Rational Investing: 284 Quotes from the World's Most Successful Investor. Hachette UK.

Butler, B. 2019. Australian stock market down 2.4% as US-China trade war hits home. Retrieved from https://www.theguardian.com/australia-news/2019/aug/06/us-china-trade-war-hits-australian-stock-market

Chau, D. 2019. ASX drops as US-China trade war hits manufacturers. Retrieved from https://www.abc.net.au/news/2019-09-04/wall-street-sinks-us-china-trade-war-manufacturing/11476720

Chau, D. 2019. ASX sheds $26b with volatility to persevere until US 2020 elections: analyst. Retrieved from https://www.abc.net.au/news/2019-08-26/asx-tumbles-after-us-china-trade-war escalates/11447342

Damodaran, A. (2016). Damodaran on valuation: security analysis for investment and corporate finance (Vol. 324). John Wiley & Sons.

Gan et al. (2005). Revisiting Share Market Efficiency: Evidence from the New Zealand Australia, US and Japan Stock Indices. American Journal of Applied Sciences 2 (5), 996-1002.

Jordan, B. D., Miller, T. W., & Dolvin, S. D. (2015). Fundamentals of investments: valuation and management. McGraw-Hill Education.

Naseer, M., & bin Tariq, Y. (2015). The efficient market hypothesis: A critical review of the literature. IUP Journal of Financial Risk Management, 12(4), 48-63.

Oino, I., & Ukaegbu, B. (2015). Financial analysis assignment The impact of profitability on capital structure and speed of adjustment: An empirical examination of selected firms in Nigerian Stock Exchange. Research in International Business and Finance, 35, 111-121.

Urquhart, A., & McGroarty, F. (2016). Are stock markets really efficient? Evidence of the adaptive market hypothesis. International Review of Financial Analysis, 47, 39-49.

Walton, S. 2019. Rio Tinto shares drop 4.3% as a $1 billion special dividend is revealed. Retrieved from https://www.ig.com/au/news-and-trade-ideas/rio-tinto-shares-drop-as--1-billion-special-dividend-is-revealed-190802

Xiang, H., Kuang, Y., & Li, C. (2017). Impact of the China–Australia FTA on global coal production and trade. Journal of Policy Modeling, 39(1), 65-78.