The Australian equity market continues to hit new highs, aided by a powerful global equity upswing and the pivotal US market continuing to scale fresh heights.

Almost all global equity markets have performed above expectations over the past year, with even the much-maligned Chinese equity market joining the upswing over the past month, on expectations of a significant step-up in policy stimulus. 

As we have been discussing for some time, the global macro backdrop of moderate but positive economic growth, moderating inflation and an unfolding central bank easing cycle is proving to be a powerful support to the global equity market.

While Australia has been strong in an absolute sense, it has lagged the US-driven global rally on a 12 month basis, although the local market has performed in-line with the global equity market over the last three to sixth months. Despite Australia lagging the global equity market over the past year, its strong absolute performance is interesting in the context of the country’s lacklustre earnings growth backdrop.

The Australian equity market looks set to record zero earnings growth in CY24. CY25 earnings growth is expected to improve, but only to a still-moderate 5%. This compares to an index price gain over the past 12 months of 18%.

Closer inspection of the market’s PE re-rating reveals that it’s been driven by the “ex resources” portion of the market (All Industrials). The All Industrials multiple has expanded from 16.7x to 20.7x over the past 12 months. 

This compares to a 10-year average of 16.9x. In contrast, apart from the uptick in the past few weeks on China stimulus hopes, we have not seen any significant re-rating in the resource sector, with the sector’s multiple quite close to average at around 13x. 

Sentiment toward the resource sector could be on the cusp of a more sustainable improvement if China policy impetus proves to be a genuine pivot. However, China’s exact policy measures are still a source of uncertainty, alongside the looming US election. Investors should gain more certainty on the outlook for Chinese growth and resource sector prospects over the next few weeks. Valuations nonetheless do appear to be undemanding at present, and we remain moderately overweight.

From a stock specific perspective, all the big four banks stand out as looking stretched, given their high multiples but low expected growth. Commonwealth Bank in particular appears expensive.

Macquarie Bank also looks expensive at a headline level - however, it does appear to have a promising earnings growth outlook. 

Similarly, Goodman Group is on a high PE versus its historical level, but has a good growth outlook. In contrast, Wesfarmers looks expensive relative to its moderate growth outlook. CSL looks to offer a reasonable valuation with strong growth. Finally, energy play Santos offers reasonable growth at an undemanding cheap valuation. 

While there are reasonably priced options within the market, it is hard to escape the conclusion that the large cap end of the Australian market is, on average, fully priced. In our view, this suggests that an active approach to the Australian market is required.