Morningstar says ASX shares ‘heavily discounted’ and will remain under pressure

Morningstar says the ASX will remain under pressure for the rest of the year, with real estate stocks offering the best opportunity.

Falls to the sharemarket sparked by a surge in bond yields on concerns that interest rates will remain higher for longer are seeing Australian shares trade at discounted levels not seen in more than a year.

Morningstar’s Australia and New Zealand Equity Market Outlook for the fourth quarter of 2023 reports that ASX 200 shares are trading at a 9 per cent discount to the fair value on average, the lowest in a year, and among the poorest readings since the recent low of 15 per cent in September 2020.

On average, Morningstar says Australian shares have traded at an average premium of 5 per cent in the past decade.

Real estate was the most undervalued sector after a sell-off in September triggered by fears of higher bond yields depressing distribution potential and hurting credit metrics. The ASX 200 fell 2.8 per cent in September.

While the sector was “significantly undervalued”, Morningstar said that further downside remained possible, particularly for highly geared REITs, but there were opportunities for investment in high-quality names such as Charter Hall with more favourable outlooks.

Morningstar head of equity research Peter Warnes said that shares would be at the mercy of bond yields in the months ahead, with the trajaectory dependent of key economic data including inflation, labour force and retail sales.

“Higher yields will put pressure on equity valuations that are yet to fully adjust to a return to a more normal yield environment,” he said. “We expect the market to remain under pressure and trade in a relatively narrow band between 6,800 and 7,200 through the December quarter.”

Mr Warnes said that the outlook for fiscal 2024 is for moderating growth in corporate profitability with higher interest rates and operating costs putting pressure on margins.

“Those exposed to discretionary spending will continue to see a deterioration in revenue while consumer staples should generally ride out the storm, though margins will likely contract with sales volumes easing and competitive forces increasing,” he said.

Progress of further stimulus by Chinese authorities to turnaround a slowing economy will be of far greater importance for the direction of the bourse as investors continue to hold hopes of a package to boost consumption of materials including iron ore. Morningstar notes that a turning point for the ASX is likely if bad economic news forces the central bank to start cutting rates.

Morningstar head of equity research Peter Warnes expects the ASX 200 to trade in a narrow range of between 6800 and 7200 for the rest of 2023. Picture: Morningstar

Mr Warnes said most meaningful share price movements determined during the August reporting season was the result of guidance commentary than results, with a key feature being high impairments and restructuring costs of over $20bn, led by consumer discretionary and utilities.

He added that the further updates to guidance was expected at annual meetings through late October and November. This period will also see full-year results for ANZ, NAB and Westpac, which Mr Warnes said would determine the near-term direction of the financial services sector.

“The spotlight will be on expense growth with wage inflation key. Bank impairment charges should remain benign, and provisions are adequate,” he said.

Materials, which makes nearly 30 per cent of the ASX 200, was modestly undervalued on average with gold miners including Newcrest the standout. Iron ore miners were broadly unchanged and remained elevated despite a weak property market in China.

Miners’ earnings are under pressure from increasing labour, fuel, logistics, and other expenses, though cost inflation looks to be moderating. Morningstar expects demand from China is likely to soften longer-term as consumption takes over as the key driver of economic growth rather than investment.

Originally published as Morningstar says ASX shares ‘heavily discounted’ and will remain under pressure