Morningstar have released their Australia and New Zealand equity market outlook for the fourth quarter which envisages an imminent economic recovery that is already baked into valuations, however there are opportunities, they suggest.
The authors agree that the Australian equity market is overvalued but notes the market stalled during the third quarter. The Morningstar Australia index fell 1% over the quarter which will have improved the average price/fair value estimate ratio. Morningstar now has the Australian equities market to be around 8% overvalued on average.
Morningstar says, “We expect a strong economic recovery from the fourth quarter of 2021 following coronavirus lockdowns impacting the second and third quarters. However, we also expect mining company profits to fall over the next two years following the recent collapse in the iron ore price, which will significantly impact equity market earnings growth.”
The top 50 ASX-listed companies are tipped to record annual earnings growth of around 3% and dividend growth of 2% over the next five years with energy remaining the most undervalued and consumer cyclicals the most overvalued. Retailers stand to benefit from ad hoc tailwinds such as the redirection of travel spending.
Even though markets may be overvalued, there is still opportunity. Listed below are Morningstar’s best ideas, 30 stocks it considers are ‘more attractively priced than the market’, with the typical value-oriented approach:
Morningstar expects the Australian economy to recover quite fast post-Covid-19 and the forced lockdowns that were put in place during the second and third quarters 2021. Morningstar, “The mid-2021 coronavirus delta variant outbreak has been more severe than we initially expected but will result in over 80% of Australia’s adult population being vaccinated by the end of 2021.”
Australia will be in a robust position when it opens it borders at the start of 2022. Australian GDP has remained positive in the June 2021 quarter, mainly due to a record high iron ore price. This means avoiding a “double-dip” technical recession. Morningstar does however, “still expect a quarter-on-quarter decline of around 3% in the September 2021 quarter before economic recovery begins from the fourth quarter of 2021.”
Looking at the table above, the consumer cyclicals and financials sectors appear to have some of the highest ratings when comparing the current share price with the Morningstar fair value price.
Despite underperforming in the third quarter, the consumer cyclical sector should continue with elevated sales as the economy reopens. There are pockets of value in the services, leisure, and retail subsectors. Consumer numbers will start to return as the economy moves past the pandemic.
Financials outperformed in the last quarter along with the big banks on solid earnings. Morningstar says both Magellan and Challenger Group look attractive at current prices. Morningstar says “We expect improving earnings from the financials sector to partially offset materials sector earnings weakness. We expect bank profit growth to be relatively weak in the short term and driven by credit growth and cost-cutting. However, we expect rising interest rates to eventually increase net interest margins and profits for the major banks.”