UBS anticipates the Australian stockmarket will improve in 2014 as the lower Australian dollar and interest rates begin to have a positive impact and business confidence lifts post the federal election.
The investment bank thinks the Australian market currently offers good value based on price-earnings multiples and forecasts earnings per share (EPS) growth in the next financial year to be between 6-7%, against the market estimate of 10%.
The bank listed four reasons as to why the Australian market has dropped by over 10% since May: it was looking expensive, it was too heavily overweight yield compared to other markets, the pullback from foreign investors amid the falling dollar and increased fears about the Australian economy.
However, the effects of interest rate reductions and lower $A are beginning to kick in, which will boost corporate earnings in the medium term.
The investment bank estimates the drop in the $A to 93 cents from $1.04 will boost Australian companies' aggregate market earnings by 4% in 2013-14, and by 2% excluding the resources sector.
"While the economy and earnings cycle will likely continue to work through the current soft patch, the foundations are likely being laid for a better CY14 rather than a slide into outright contraction," UBS said.
But UBS said the key risk to this is the domestic economy outside of negative shocks from China, with increased talks about a recession dampening sentiment.
"Sentiment towards the economy has clearly soured in recent months as the capital spending cycle has begun to weakn while the non-mining economy remains subdued," the bank said.