Bull market rages on despite record valuations as banks lead value charge

In the near term, banks may be vulnerable to profit-taking from traders since they have almost achieved the targets of recent technical patterns which are also near their 100-day moving ­averages. Picture; AAP

The fastest-ever bull market in Australian shares shows no sign of ending despite record valuations.

After falling as much as 39 per cent from a record high of 7197.2 points on February 20 to a seven-year low of 4402.5 on March 23, the S&P/ASX 200 has now risen 32 per cent on a daily close basis, driven by unprecedented central bank liquidity and faster-than-expected easing of coronavirus lockdowns.

While some profit-taking emerged on Thursday after the index regained 6000 points for the first time since early March, driven by another exceptionally strong rise in banks, the big four still managed solid gains despite having risen 20 per cent on average over the past two weeks.

Defensive growth stocks in the healthcare and consumer staples sectors made a comeback, but the market retained a substantial tilt to value, led by the banks, real estate and consumer discretionary stocks — helped by the federal government’s HomeBuilder stimulus plan — even as energy fell back.

One concern for the overall market may be its valuation, as the S&P/ASX now trades on a record 12-month forward price-to-earnings ratio of about 19.55 times and a record-low 12-month forward PE ratio of 3.4 per cent, based on Morgan Stanley’s estimates.

However, the PE multiple always leads earnings estimates and the higher-than-normal valuation is justified by near-zero or negative interest rates and unprecedented central bank liquidity.

The European Central Bank was widely expected to expand its Pandemic Emergency Purchase (quantitative easing) Program overnight. A 3.4 per cent dividend yield plus franking credits isn’t much compensation for risk, but dividends will also bounce, and volatility is falling for now.

Offshore investors who bought at the low will in theory have made a 52 per cent gain in US dollar terms, but offshore investors are renowned for being underweight Australian banks.

In the near term, banks may be vulnerable to profit-taking from traders since they have almost achieved the targets of recent technical patterns which are also near their 100-day moving ­averages.

But there is limited risk of widespread downgrades — only CBA is above its consensus price target.

In fact Morgan Stanley raised the banking sectors to “equalweight” from “underweight” in its model portfolio, while also adding some energy and consumer discretionary stocks in a rotation to value.

“Faster reopening of the economy and continued control of virus risks have reduced certain macro tail risks that were in focus at the height of the crisis,” said Morgan Stanley’s Chris Nicol.

“Taking a relative value tilt within the banks favours buying ANZ, NAB and WBC over CBA while maintaining an overall equalweight banks sector weight.”

He says the prospect of a V-shaped economic recovery will drive value stocks.

“Over the last two months value has shown a brief cameo of outperformance, and combined with the extreme gap relative to growth, is sending warning signals regarding the potential for a more sustained rotation event,” Mr Nicol noted.

“Our view was to initially risk-mitigate against this and we take this more formally by moving our model portfolio positioning away from consumer staples and healthcare and embracing a larger value bias through the additions of Ampol, Santos, Super Retail and Viva Energy in addition to our current active overweight positions in ANZ, BHP, NAB, QBE Insurance, Rio Tinto, Stockland and Tabcorp and equal-weight positions in Qantas, Telstra and Westpac.”

While the recovery path for the economy will “unlikely be linear”, Morgan Stanley’s Mr Nicol says “finding value within industrials makes sense … and finding companies that can more quickly return to positive year-on-year growth is one area of opportunity.