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ASX overvalued by 15 per cent says Morningstar

•2-Tech

In its latest report, Morningstar has revealed its analysts’ economic outlook as well as top stock picks across 11 industry sectors. Published as part of the Quarterly Morningstar Australia and New Zealand Equity Market Outlook Q3 2021 report, the research firm has a number of strong positions.

To sum it up, analysts found the broader Australian equities market to be about 15 per cent overvalued, led by the tech sector, while the energy sector remains the most undervalued.

Morningstar’s equity research strategist, Gareth James, says the 10-year Australian government bond yield has fallen significantly and that’s led to rise in risk tolerance by equity market investors. High-risk, high-growth sectors such as the technology sector saw a huge rebound in the second quarter. Other sectors also saw similar rebounds, which overall has pushed the market higher. And so, from a price to valuation perspective, James concludes the market as being overvalued by traditional measures

By and far, the most overvalued sector was Technology, trading on an average price/fair value of 1.6, up from 1.4 at the start of the quarter. Morningstar says “High price/fair value estimate ratios mean opportunities are scant in the technology sector.” That said, it has labelled three interesting opportunities as its top picks:

  • Technology One (ASX:TNE)
  • Computershare (ASX:CPU)
  • Link Group (Australia) (ASX:LNK)

Iron ore and copper remain overvalued, Morningstar suggests, on average trading at a 16% premium to its fair value estimates. But analysts say there are ‘select’ undervalued opportunities.

As a sector, though, metals and mining stocks are generally overvalued. Morningstar says this is due to “elevated commodity prices, particularly iron ore and copper. We note the major base metals, led by copper, have come off their recent peaks but overall remain at very favourable levels. Current levels of commodity prices underpin very strong returns on assets for the miners.”

The research house has picked three stocks in the mining sector:

  • Orica (ASX:ORI)
  • Nufarm (ASX:NUF)
  • Newcrest Mining (ASX:NCM)

And finally, Energy remains the only undervalued sector trading on an average price/fair value estimate ratio of 0.77 as the higher spot oil price has yet to be factored in to share prices.

Morningstar says it “expect a full recovery in oil demand to pre-COVID-19 levels by 2022, and supply remains constrained adding to upward pressure on pricing. We forecast global supply will fall short of demand this year, allowing inventories to revert to normal levels. We expect a substantial supply expansion from OPEC+ producers and growth from US producers in 2022.”

The research house believes there is “upside short-term price risk” as oil producers limit supply knowing the energy transition will cap future demand growth.

  • Woodside Petroleum (WPL)
  • Beach Energy (BPT)
  • Whitehaven Coal (WHC)

Despite the recent lockdowns, real GDP growth forecasts of 2.5% per year over the next two years shouldn’t be affected. James says “second-quarter market strength reflected increased investor risk tolerance as interest rate concerns abated despite further economic improvement. We think the latest June 2021 lockdowns are unlikely to materially derail Australia’s strong economic recovery.”

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