Australian equities have pushed higher through much of August, shrugging off the weak start to the month as US recession fears and Japanese carry trade selling subsided relatively quickly.
The domestic reporting season has been mixed, but perhaps a touch better than feared. FY25 earnings estimates have in aggregate edged lower, although this is relatively normal heading into a new financial year.
The Australian market is still battling against relatively sluggish aggregate corporate earnings growth. From this starting point of constrained earnings growth, the market has arguably overachieved in the last six to 12 months, courtesy of a significant aggregate PE expansion.
Big Cap PE Expansion Lifting the Index
The overall market PE has risen from 15.4 to just above 17x over the last 12 months. This valuation stretch leaves us expecting relatively moderate (low single-digit) index price returns over the coming 12 months.
This expectation of further moderate gains is heavily premised on (Fed-driven) global equity tailwinds on a three to six months view, combined with the prospect of easing domestic policy helping the market on a six-to-12-month view.
From the more fundamental perspective of valuation versus earnings growth potential, there looks to be better opportunities in global equities relative to Australian large caps.
PE expansion concentrated in the All Industrials
A key dynamic driving the Australian market’s solid push higher this year has been the strong outperformance of the market ex-resources (the All Industrials). The All Industrials index is up 15% year-to-date, while the All Resources index is down 15%. This has seen All Industrials PE lift from 17.4 to 20.2, while the resource sector PE has marginally declined to just under 12x.
Banks have received a fair amount of attention in respect of this theme with the bank sector PE looking stretched. Results were solid, but did not deliver upgrades sufficient to justify current valuations, particularly market heavyweight CBA.
Some of the structural re-rate in the All Industrials is attributable to the shifting composition of the index toward high quality global growers. It is hard to escape the conclusion, however, that on average industrials are expensive - particularly the banks.
Resources look comparatively cheap and (mostly) unloved but are lacking a catalyst. The sector appears to be waiting for more positive sentiment around the global, and the Chinese economy in particular, but the performance gap to All Industrials suggest opportunity for the patient.
The iron ore outlook remains a headwind for the sector in aggregate, but the outlook for many other commodities is brighter e.g. copper, gold, oil/gas, met coal.
Sticky Domestic Inflation Pushing Local Rate Cuts into 2025
Apart from being beneficiary of the weak resource backdrop, the All Industrials seem to be buoyed by actual and prospective interest rate declines. Some of this has already played out in terms of the big shift down in the long bond yield since last October, but part of the story is the expectation that the RBA, while behind the Fed, will ease relatively soon. The interest rate markets still have a rate cut priced for later this year. In our view, however, this appears optimistic.
From this perspective, last week’s domestic release did not bring much joy. While the July CPI reading did fall (from 3.8% to 3.5%), this was mostly attributable to state and federal government electricity rebates. Excluding this impact, the CPI was little changed.
There is likely to be more downward pressure on the CPI in August from the impact of electricity rebates, although the more complete September quarter CPI data (due late October) will be the key to views around any potential RBA easing.
In any event, we will likely need two good quarters of inflation news in a row to encourage the RBA off the sidelines. In our view, this makes the February meeting the earliest the RBA could conceivably cut.
However, the inflation stickiness once apparent in July suggests the risk on rate cuts is later rather sooner.
There were some signs in the reporting season (particularly retail) that the economy improved in July, which makes some sense in the context of July 1 tax cuts. However, the quid pro quo for this is that the RBA will be in no hurry to ease, particularly with the recent upbeat news on the labour market.
One area that hasn’t seemingly benefitted from rate cuts from a broad rotational standpoint is the domestic small cap sector. The firming of expectations for an imminent rate cut in the US has been the catalyst for rotation to US small caps over the last six weeks or so. However, as discussed, the catalyst seems a bit of a way off for Australia. With large caps looking stretched, the local small cap sector looks attractive on a two to three year view for the patient investor.
Written by
David Cassidy, Head of Investment Strategy
David is one of Australia’s leading investment strategists.
About Wilsons Advisory: Wilsons Advisory is a financial advisory firm focused on delivering strategic and investment advice for people with ambition – whether they be a private investor, corporate, fund manager or global institution. Its client-first, whole of firm approach allows Wilsons Advisory to partner with clients for the long-term and provide the wide range of financial and advisory services they may require throughout their financial future. Wilsons Advisory is staff-owned and has offices across Australia.
Disclaimer: This communication has been prepared by Wilsons Advisory and Stockbroking Limited (ACN 010 529 665; AFSL 238375) and/or Wilsons Corporate Finance Limited (ACN 057 547 323; AFSL 238383) (collectively “Wilsons Advisory”). It is being supplied to you solely for your information and no action should be taken on the basis of or in reliance on this communication. To the extent that any information prepared by Wilsons Advisory contains a financial product advice, it is general advice only and has been prepared by Wilsons Advisory without reference to your objectives, financial situation or needs. You should consider the appropriateness of the advice in light of your own objectives, financial situation and needs before following or relying on the advice. You should also obtain a copy of, and consider, any relevant disclosure document before making any decision to acquire or dispose of a financial product. Wilsons Advisory's Financial Services Guide is available at wilsonsadvisory.com.au/disclosures.
All investments carry risk. Different investment strategies can carry different levels of risk, depending on the assets that make up that strategy. The value of investments and the level of returns will vary. Future returns may differ from past returns and past performance is not a reliable guide to future performance. On that basis, any advice should not be relied on to make any investment decisions without first consulting with your financial adviser. If you do not currently have an adviser, please contact us and we would be happy to connect you with a Wilsons Advisory representative.
To the extent that any specific documents or products are referred to, please also ensure that you obtain the relevant disclosure documents such as Product Disclosure Statement(s), Prospectus(es) and Investment Program(s) before considering any related investments.
Wilsons Advisory and their associates may have received and may continue to receive fees from any company or companies referred to in this communication (the “Companies”) in relation to corporate advisory, underwriting or other professional investment services. Please see relevant Wilsons Advisory disclosures at www.wilsonsadvisory.com.au/disclosures.