Goldman Sachs' outlook for the S&P/ASX 200 remains cautious in the short term, and it's chosen Australian banks as its 'high-yield defensives' of choice.

In a portfolio strategy note from Goldman Sachs that looks back on the recent rally and reporting season, it has upgraded its year-end target for the S&P/ASX 200 to 5300 from 5000, which implies a 4 per cent price return and an 8 per cent total return.

Having said that, its outlook is a bit cautious in the short-term given the extent of the recent rally and becomes more positive towards the back end of the year. Given the more cautious short-term outlook, Goldman is looking to increase its exposure to the ‘defensive high-yield’ theme by upgrading the bank sector to overweight.

“Banks continue to be our preferred play in this space. They trade at similar yields to other defensives, but on much lower payout ratios, with lower political/regulatory uncertainty (versus telcos, utilities) and less valuation risk if bond rates rise”. Its preferred exposure in the sector is ANZ and National Australia Bank.

Elsewhere, the broker has downgraded the resources sector to neutral as it believes the market is looking through the strength in iron ore prices and worrying about the inventory cycle and measures aimed at slowing the Chinese property market. Goldman is also concerned about the cost out story and worries about margins as revenues fall. BHP Billiton remains its preferred exposure in the sector.

On a stock specific level, it is maintaining its overweight position in materials names like Orica, Incitec Pivot and Amcor; transport stock Asciano, Brambles and Toll Holdings; and building materials names Fletcher Building and Boral. Elsewhere, it is switching its overweight in non-bank financials into steel names like BlueScope Steel, given the deep valuation support and a macro backdrop that looks to be bottoming out.

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