ASX tipped to reach 5900 by year end amid low rates outlook

AUSTRALIAN shares are expected to generate robust returns for investors this year.

A man waves an European flag in front of a Greek flag in Athens yesterday.

AUSTRALIAN shares are still expected to generate robust returns for investors this year as a low interest rate outlook continues to offset concern about modest earnings growth and rising bond yields.

Investors continued to wade back into the market yesterday, pushing the S&P/ASX 200 up 1.3 per cent to 5684.3 points as European officials sounded more positive on the prospects for a new austerity and debt relief package that allows Greece to stay in the eurozone. Hopes of a resolution also spurred on a rally across Europe and on Wall Street.

Bourses in France, Germany and Britain were last night on track for a second consecutive session of robust gains as Greece’s creditors suggested for the first time that a deal to avert the country’s bankruptcy was in sight. This has helped ease a key uncertainty building into global financial markets.

Despite a hefty pullback in local shares over the past two months, the benchmark index is expected to end December around 5900 points, which would generate a 9 per cent annual gain for investors before dividend payments, according to a survey of 10 equity strategists by The Australian.

While the index hit a seven-year high near 6000 points in April, its recovery from 5122 points in October last year was primarily due to lower interest rates — consensus expectations for earnings per share have fallen consistently since October.

After falling almost 9 per cent from its April peak, the sharemarket has recovered more than 4 per cent in the past two weeks as bond yields have stabilised after soaring to levels prevailing late last year when the share index was trading around 5300.

Still, with the US Federal Reserve continuing to reassure investors that it expects US interest rates to rise slowly after it ends its zero interest rate policy, and interest rates elsewhere expected to remain low for the foreseeable future, strategists said a higher price-to-earnings multiple was appropriate for the S&P/ASX 200. “Normally when interest rates go down, price to earnings multiples go higher, unless of course you go into recession and it becomes more complicated,” said AMP Capital’s head of investment strategy and chief economist, Shane Oliver. His year-end target is 6000 points.

“With the Australian cash rate around 2 per cent and bond yields (10-year) around 3 per cent, interest rates can probably support a price-to-earnings ratio somewhat higher than the long-term average of 14 times. It’s quite conceivable that the price-to-earnings ratio can stay around 16 times.”

Citi analyst Tony Brennan also expects the index to end December near 6000 points, based on his view that a correction in banks is complete and lower commodity prices are generally factored into resources-sector valuations.

“The market seems to have adjusted to the prospect of more limited earnings growth,” he said. Iron ore prices were likely to fall back toward $US40 according to Citi: “but that seems reasonably reflected in earnings estimates and would mark a return to the average real price over the last century, unwinding the dramatic boom”.

Deutsche Bank strategist Tim Baker was even more bullish on the index, arguing that the current price-to-earnings ratio of 16 times forward earnings per share estimates was only about 4 per cent above “fair value” versus 10 per cent in January.

“Further, Australia’s price to earnings relative to global peers is back to average, after being a touch expensive.”

Earnings momentum in Australian companies looked reasonable, he said. “The earnings revision ratio is actually above average, and suggests the recent fall in forward EPS could soon be arrested,” he said.

Goldman Sachs strategist Malcolm Wood said the S&P/ASX 200’s price-to-earnings ratio was about 9 per cent below that of the MSCI World index, the biggest discount in almost a decade. “Looking across regions, Australia trades at a discount to the US, Europe, Japan, with only Asia-ex Japan still offering greater value,” Mr Wood said. He sees 5800 by year end.

Morgan Stanley’s Daniel Blake has an index target of 5650 because of weak domestic economic growth. “We think that will play into a more challenging environment for corporate earnings, particularly in fiscal 2016,” he said. “We are already seeing a few cyclical stocks putting out downgrades, and these are reflection of a downbeat economic environment.”