MARKETS SPECTATOR: Equities uptick

Deutsche Bank expects investors' risk appetite to grow in 2013 as the effects of last year's rate cuts take hold, despite near-term risks from a recent rise in PEs.

After one of the worst periods of Australian equity performance in history, Deutsche Bank believes we will see a degree of mean reversion as equities garner support from a gradual rise in earnings from below-trend levels, cheap equity valuations in relation to bonds and a reduction in investors' underweight positioning.


Source: Iress, Wren Research, Deutsche Bank

Looking at the economic backdrop, the broker sees the economy as weaker than the Reserve Bank thinks and therefore believes there will be further rate cuts over the coming year. It sees GDP growth as fine but income growth, when adjusted for commodity prices, as quite poor, and this is weighing on the labour market.

"We don’t expect relief on the Australian dollar front, which puts a greater burden on rates. Our composite policy indicator (taking fiscal policy into account as well) is still far too tight relative to both global and local growth indicators,” Deutsche Bank noted.

The bank believes stimulus from last year’s interest rate cuts will begin to flow through in 2013, which should see the economy beginning to gain some traction. From a stock market perspective, given the recent strength in equities they look to have already priced in a rebound in global growth and a stop to earnings downgrades.

Deutsche Bank believes there are some near-term risks given how much PEs have risen and the near 1.5-year lows in the equity-bond yield gap. Hence, the broker believes it is prudent to wait for a pullback before adding further risk to the portfolio.

Deutsche Bank’s portfolio is currently overweight energy and underweight mining names on a valuation basis. It continues to hold several defensive stocks as its analysis suggests they are not expensive versus cyclicals. Its cyclical exposure is concentrated around housing stocks, which it is keen to add to if and when policy easing starts to support earnings.

It believes bank valuations look reasonable although notes that growth prospects have stepped down. The sector is also well-owned so it prefers to collect yield from insurers and real estate stocks.

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