Offshore events likely to keep bourse in check

Investors will be looking for direction from the annual central bankers symposium hosted by the US Fed this week.

The world’s central bankers converge on Jackson Hole, Wyoming, this week. Photo: Bloomberg

With the Australian corporate earnings season about halfway through, the results so far have been reasonable though unspectacular, leaving the local bourse highly dependent on record low interest rates and risk-tolerant global markets to sustain its high price-to-earnings valuation.

After surging 11 per cent in the four weeks following the brief sell-off triggered by the Brexit vote, the S&P/ASX 200 has tracked sideways for three weeks as investors digest earnings reports, while awaiting decisive movement in global markets.

With Federal Reserve members talking up the potential for a September interest rate hike in the US — seen as only a 22 per cent chance by the market — upside might be held in check this week. The annual Economic Policy Symposium for central bankers held in Jackson Hole, Wyoming, later this week is another reason for investors to sit on their hands.

As for the domestic earnings picture, Bloomberg’s consensus estimate for fiscal 2017 has trickled down since earnings season began three weeks ago, leaving the one-year forward ratio for the market up around the decade-high it hit last April just before the market tanked.

UBS says aggregate earnings trends look set to improve after a weak fiscal 2016 year due to a revival in commodity prices. But of course commodities could tumble as China’s iron ore port inventory remains near a record high, and the seasonally weak period for steel demand is ahead.

Absolute PE multiples look demanding, particularly in industrials ex-financials, but the relative appeal of equities against low interest rates shouldn’t be ignored, say UBS strategists David Cassidy and Dean Dusanic.

“Setting aside some currency headwinds, the bottom-up aggregate earnings picture going into fiscal 2017 of market cap-weighted growth of 9 per cent and ­median growth of 6 per cent is reasonable with the domestic economy still defying the naysayers,” they say.

On UBS’s reckoning, fiscal 2016 earnings estimates are mostly unchanged, while fiscal 2017 estimates have been revised down about 1 per cent. Bank sector results have been fairly benign, although constrained on the growth outlook, with some pressure on margins and bad debts, and weaker fee income.

UBS says the banks will be forced to raise more capital in 2017, so don’t expect much upside. Domestic cyclicals have been the bright spark, but “the market continues to grapple with what multiple to pay for these seemingly late cycle earnings”. UBS sees best value in Lend Lease and Harvey Norman.

Foreign currency earners do face the risk of downgrades if the Australian dollar holds current levels, though UBS is betting on a fall to US70c by the year end.

UBS says there’s “still a pool of capital keen to buy defensive growth”, since the market was keen to buy back REA Group and Cochlear after their shares initially suffered from results that didn’t do enough to justify their very high PE multiples.

Overall, UBS says valuation is the market’s Achilles’ heel, yet they see potential upside from valuations relative to interest rates. “We believe it is prudent to assume single-digit total returns over the coming year ... but estimating market performance from here is complicated by estimating the appropriate P/E in a regime of very low rates and moderate earnings growth.”