JPMorgan’s Jason Steed is mostly positive about the outlook despite the likely fall by banks

JPMorgan expects aggregate earnings-per-share growth of about 4 per cent for the ASX 200 next year but that won’t be the case for the big banks.

JPMorgan head of equity research for Australia Jason Steed.

JPMorgan is mostly positive on its outlook for Australian stocks next year.

While the overall market is expected to be restrained by a fall in bank sector earnings, most sectors are expected to achieve decent earnings growth, assuming a relatively strong economy and still-high earnings from iron ore miners as long as China follows through on stimulus.

Two weeks ago, its head of equity research for Australia, Jason Steed, set a December 2024 target of 7500 points for the ASX 200. It has risen 3 per cent since then, hitting a three-month high of 7241.3 points as its rebound from a 12-month low of 6751.3 in late October continues.

Its rise of more than 7 per cent in the past six weeks has been driven by economic data and less hawkish central bank comments that have fuelled expectations of interest rate cuts next year.

The rise in the local stockmarket at the most positive time of the year has included banks, with Commonwealth Bank hitting a 10-month high of $107.64. But Mr Steed isn’t inclined to lift his target for the index.

“Inevitably when momentum is positive you’re inclined to feel that you need more room, but given our view on the banks, at a pure index level, I’m still comfortable at the 7500 points,” Mr Steed said.

No doubt if it wasn’t for the outlook for banks, which JPMorgan recently cut to underweight, from overweight, there would be a much higher target for the index, given his positive views on most other sectors.

But the major banks – which make up about 20 per cent of the index – are expected to be hit by pressure on their net interest margins from heightened competition in the mortgage market.

While JPMorgan sees aggregate earnings-per-share growth of about 4 per cent for the S&P/ASX 200 next year, its analysts expect earnings per share for the major banks to fall 8-10 per cent.

Excluding CBA, which tends to positively distort the average valuation of the banks due to its premium rating, the average price-to-earnings multiple of the major banks for the next 12 months, based on JPMorgan’s earnings forecasts, is about 12.5-13 times, versus a long-term average of 12.

It equates to a price-to-book value near 1.1-1.25 times, ex-CBA, which trades at about 2.5 times.

“The question on my mind is that for each incremental mortgage that you write, are you writing it at a level that’s above your cost of capital?” Mr Steed said.

“As we’ve heard some bank CEOs say, some mortgages have been written at the cost of capital, which means that effectively you should be trading at a price to book of no more than one.

“So the critical point here is their incremental flows of credit.

“It’s ensuring they lend levels that generate a return on equity above their cost of capital.

“I think it’s true in aggregate, but competition is at such an intense level still, that you’re not getting a particularly good return above your cost of capital, and that caps the upside potential for banks.”

It was the resilience of aggregate consumption – amid record immigration and savings buffers and a low unemployment rate – that led to banks surprising positively with their earnings this year. But JPMorgan’s recent downgrade of the banks was due to its view on the impact of heightened competition for mortgages rather than a negative view on consumption.

But the government’s recent decision to slow immigration is a negative factor in that regard.

Another factor to consider is that Australian bank stocks now trade on record premiums versus other developed markets in terms of price-to-earnings multiples.

Including CBA, the major banks on average trade on a forward PE multiple of about 14 times, versus 8.5 times for developed markets peers, whereas the historical premium is about 2.5 PE points.

However, positioning remains deeply underweight banks, which has recently provided support.

Elsewhere, JPMorgan sees a “hint of Australian exceptionalism permeating the economic landscape”. Not only do its economists see the “lucky country” generating near-potential GDP growth in 2024, they see enough deceleration in inflation for the RBA to hold the cash rate steady.

Several positive forces are spurring the Australian economy.

A near near-record terms of trade, high immigration, and ongoing strength in employment mean that it stands out against a range of other economies in terms of growth projections for 2024.

JPMorgan has an overweight recommendation on bulk miners BHP, Rio Tinto and Fortescue Metals, as steel demand looks set to be supported by China’s focus on stimulating housing.

The bank is also positive on the healthcare sector, property trusts and tech sectors, but recently switched from overweight to underweight on the consumer discretionary sector.

“Looking ahead, with most cyclical stocks – banks, consumer discretionary – approaching fair value, we look to some of the rate-sensitive sectors – REITs, healthcare – for outperformance, as well as tech, where we are overweight,” Mr Steed said.

JPMorgan’s slightly positive view on the local market is in contrast to its negative view on the US market, where it has a December 2024 target of 4200 points, versus the current level of 4622.

It does see 100 basis points of US rate cuts and a soft landing for the global economy in 2024, even if the US faces recession risk.

Geopolitics are also seen as a risk for the global stockmarket with two major wars still under way, important elections in some Asian countries and the US presidential election in 2024.