Australian stocks bask in China recovery As befits one of China's chief proxy trades, Australian stocks have suffered a turbulent nine months. Now, though, as the Chinese economy stabilises, the "return to Oz" is under way. Investors are flooding back. The country's main equity market, the S&P/ASX 200, on Tuesday closed at a fresh five-year high, having gained 13 per cent since the end of June. When dividends are factored in, the index has surpassed the record highs it reached in the heady days of late 2007, according to research from AMP Capital. The Australian dollar has bounced, too. Earlier this year it sank to $0.89 against its US counterpart, with many analysts predicting further falls. Instead, the currency has wrongfooted the China bears, rallying to trade at $0.93. Domestic and wider factors have helped change sentiment. Australia's resource-rich economy, and its markets, are tightly correlated to events in China. The slide in equities and the Aussie dollar earlier this year coincided with a faster-than-expected slowdown in the Chinese economy, a cash crunch in the country's banking system, and a rapid sell-off in Chinese equities. The ASX 200 and the Hang Seng China enterprises index simultaneously hit their year lows on June 25. "Australia is destined to become more and more tied to Asia as time goes by," says Paul Bloxham, economist at HSBC, adding that China and Japan will increasingly make up the bulk of demand for Australian resource shipments. The mining story isn't over yet. The investment stage appears to be passing, but the export stage is just beginning. So, as the economic news out of China has improved, investors have come back to Australia, boosting market heavyweights in the resources sector. Rio Tinto has jumped about 25 per cent since June 25, BHP Billiton is up 17 per cent, while iron ore producer Fortescue Metals has soared about 60 per cent. "Certainly the improvement of the economic backdrop in China has helped sentiment towards the Australian market in general," says David Cassidy, equity strategist at UBS. There's also some evidence of safe haven flows out of other parts of Asia. The election victory for Tony Abbott's Liberal-National coalition has given markets a lift, too. Mr Abbott has already moved to cement his pro-business credentials, announcing a rollback of policies like the resources super tax, another positive for the mining sector. The new government has also vowed to scrap carbon pricing, helping lift Qantas Airways, which is up 20 per cent since the start of August, and utilities such as Origin Energy, which has added 16 per cent. Recent rises in house prices and signs of stabilisation in the labour market have also fuelled economic optimism, aiding financial stocks. Commonwealth Bank of Australia is up 12 per cent since late June, and now trades just below its all-time high, while National Australia Bank has enjoyed an even better run, gaining 21 per cent. We've had a long period where domestically people have been pessimistic. But I think that's turning. It's not just a feeling, you can see it in the numbers," says Mr Bloxham. Yet, long-term doubts surrounding the Australian economy remain pertinent. As the mining-led investment boom of the past decade draws to a close, policy makers have sought to breathe life back into other areas of the economy, such as construction, service sectors, exports and the retail industry. That transition has not been as well-oiled as they would have hoped. It's been a bit of a more difficult period," says Martin Whetton, rates strategist at Nomura in Sydney. The Reserve Bank of Australia cut interest rates to a record low in August, partly to help exports and tourism through a weaker currency, and partly to encourage consumption. Although business confidence indicators have seen a post-election jump in the last few weeks, there are concerns over whether that pick-up will last. They need to see that consumers are going to spend again, and are happy to borrow again. They want to see businesses hiring again. There's a lot of dominoes that need to be lined up to get that right," says Mr Whetton. The RBA is also wary of letting house prices rise too far, too fast. With the ASX 200 trading at 14.4 times expected earnings, a premium to its 20-year average, valuation is an issue. The index looks "fair to fully valued," Mr Cassidy says, and investors have already priced in an as yet uncertain improvement in the domestic economy. "Markets are relying on that to hold current levels," he says. I think there is better value elsewhere in the world.