MARKETS SPECTATOR: Fat equities retain the edge

UBS says excessive valuations in the Australian equity market will be more than offset by dour bond yields and cash rates.

In its latest Australian equity strategy note, UBS has made the point that valuations are beginning to look a little stretched on an absolute basis, but when compared against cash and bonds they are still attractive. Nonetheless, the broker has upped its end of year target to 5250 from 5000 previously.

“With the market price-earnings multiple back at more 'normal' levels, valuation is now in the 'debateable' zone. Australia’s premium to global and regional equities is somewhat cautionary, as is the P/E of the Australian market excluding resources," the investment bank said.

"However, the relative valuation appeal of equities versus government and corporate bond yields and cash rates provides the upside case for valuations. Overall we see the backdrop of low competing yields in addition to an improving cyclical earnings backdrop as supportive for equities for the rest of the year."

When compared against global peers, Australia’s outperformance and P/E re-rating has been led by the banks and telecoms, suggesting Australia’s yield attraction has been a dominant factor. These high-yielding sectors are looking expensive versus global peers, although real estate investment trusts still look reasonable value relative to their global counterparts.

Looking ahead, given continued low real rates, easing global tail-risks, continued improvement in the global – namely, US – economic backdrop and better domestic earnings trends, UBS upgraded its end of year target.

“The upgraded price target is based upon a year-end target P/E multiple of 14.25 times (previously 13.5 times), which is not a demanding absolute P/E based on history and still looks excellent value versus prevailing competing interest rates, although we do acknowledge that economic and earnings growth prospects are likely to be lower than the past 10 or 20 years,” UBS wrote.

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