Australian stocks now offer better value than the US, says JPMorgan

Both Australian and US sharemarkets hit record highs this week but it’s the Aussie stocks which represent the best value, says JPMorgan’s Jason Steed.

JPMorgan’s head of equity research Australia, Jason Steed.

JPMorgan thinks Australian stocks now offer better value than those in the US.

Both markets hit record highs this week amid heightened speculation of interest rate cuts after faster than expected falls in inflation. However, they retreated as Federal Reserve chairman Jerome Powell pushed back on expectations that the Fed could cut rates in March, some US tech ­giants dived after reporting, and New York Community Bancorp plunged on jitters about a sudden increase in its provision for commercial real estate exposure.

Despite Australia’s lower than expected inflation data this week, the RBA is expected to cut rates much later than the Fed, because disinflation is more advanced in the US.

JPMorgan sees the RBA staying on hold this year, even as it expects the Fed to cut rates by 125 basis points. While the money market now implies the RBA will deliver two interest rate cuts this year, JPMorgan economists think the RBA will hold fire until 2025, when they see 100 basis points of rate cuts.

However, while the S&P 500 is tipped to end the year at 4200 points, about 13 per cent below Wednesday’s closing level, Australia’s ASX 200 index is only expected to fall slightly to 7500 points. The forecasts imply that the Australian market will outperform the US’s by about 12 per cent.

“For equities, the US looks stretched, with our strategists pointing to overly optimistic earnings expectations, persistent cost pressures and still-tight monetary conditions as headwinds,” said JPMorgan’s head of equity research for Australia, Jason Steed.

The strong upswing in the US tech sector, especially the “Magnificent Seven” stocks, over the past year has boosted the price-to-earnings valuation of the Nasdaq to 20 per cent above its 10-year average.

As a region, the US sharemarket’s valuation expanded the most over the past year. It is now trading at the largest premium to long-term averages of any region.

“Our global view on equities remains downbeat, with our global markets strategists running a deep underweight in their cross-asset portfolio,” Mr Steed said.

“The negativity is sharpest in the US, where our team is concerned that earnings will fall well short of market expectations.”

But Australia’s sharemarket valuation is trading right on its 10-year average of 16 times. Recent trends in earnings forecasts have been more encouraging than in the US.

“In Australia, the backdrop is less foreboding – the market’s 12-month forward price-to-earnings ratio is in line with its 15-year average, nominal economic growth is set to be above 5 per cent, and aggregate earnings per share growth is reasonable,” Mr Steed said.

“As a result, unlike the US, we see domestic equities at fair value.”

While relatively optimistic about Australia’s macroeconomic outlook, Mr Steed cautions that much of the expected resilience in the domestic economy has already been priced in to the shares of cyclical companies, including the banks, retailers and some of the industrial companies.

“Australian cyclicals – banks, consumer discretionary retail, some industrials – are trading at fair value, in our view, with positive macro dynamics fully priced in,” he said.

Sectors that face regulatory headwinds, such as the consumer staples sector where an ACCC inquiry into alleged price gouging by supermarkets is under way, and stocks that look to have “overshot” on an “overly enthusiastic cyclical view”, including banks, consumer discretionary retailers and industrials, are rated as underweight by JPMorgan.

Mr Steed’s preference is for so-called “defensive growth” stocks in the healthcare and information technology sectors. He is also positive on stocks and sectors that he expects to benefit from a further decline in the US 10-year bond yield, such as Telstra and Australian real estate investment trusts.

Australia’s bulk mining companies including BHP, Rio Tinto and South32 are also in favour, where he expects analysts to mark-to-market their earnings forecasts to account for stronger commodity prices, driving a further leg of share price outperformance.

Notwithstanding the apparent overvaluation of some stocks and sectors, he notes that there has been a positive start to the year for Australian corporate earnings ­estimates.

Trends in earnings estimates feed into quantitative and fundamental investment strategies.

The aggregate earnings per share estimate for the ASX 200 has been revised up by 1 per cent in January. With the exception of utilities and energy, all sectors have seen earnings upgrades.

The leaders have been healthcare and materials, where earnings per share estimates have been revised up by 2.5 per cent and 2.3 per cent on average.

Mr Steed says the risk that the earnings of banks, consumer discretionary retailers and other seemingly expensive stocks could end up being much better than expected is “one that I’m spending most of my time thinking about”.

His “earnings revision breadth analysis”, which outlines the three-month rolling change in earnings revisions by sector, is “very strong” compared to previous years.

Almost 68 per cent of ASX 200 companies have seen net upgrades in January.

“I think what’s happening here is, for the past few years we’ve all been waiting for the earnings cliff,” Mr Steed said. “That the much feared earnings cliff hasn’t materialised and certainly at the beginning of 2024 there’ve been very few companies to provide negative updates to the markets.

“It suggests that the past six months has been reasonably good across corporate Australia. The companies don’t have to come out and refresh guidance or set the market on the right path, and so you’re seeing analysts unwind some of that earnings cliff for certain sectors.

“What I’m trying to unpeel here is: is this indicative of a stronger earning cycle than most in the market are assuming? At this stage we’re saying it’s just a bit of enthusiasm in the market.

“But I would say this measure, historically, has been one of the stronger indicators.

“This is one measure I look at and say ‘this is quite strong’.”

CBA this week hit a record high of $118.24. On Thursday, CBA fell 2.9 per cent to $114.10.