Political events create uncertainty: active investing favoured
In April we have moved from an underweight position in Australian equities to a neutral holding. The Australian equity market appears relatively inexpensive compared with historical averages on some metrics, such as dividend yield and price-to-book ratio. On other measures, such as price-to-earnings ratios, the local market looks to be fairly valued.
The divergence between the different valuation measures can be partly explained by the composition of the local index, which includes a high weighting to banks that appear relatively cheap, relative to their book value and given their high dividend payouts. The index composition also makes the price-to-earnings ratio appear fairly valued, given negative earnings growth from the major miners and energy companies and low growth from the banks.
When we consider these factors in aggregate, it is difficult to have a negative view on the local market. At the current index level, the market is paying a 5% dividend yield franked to a level of about 70%, taking the gross absolute yield to around 6.5% per annum. If we assume that companies can grow earnings over the next few years in the low single digits, then the total return (dividends plus earnings per share growth) on the local market looks attractive, particularly when we consider that the official RBA cash rate is now just 1.75% per annum and possibly heading lower.
There are several risks on the horizon that temper an overly bullish view: a long and closely-fought election campaign in Australia’ the US presidential election; possible US interest rate rises; and a UK vote on an exit from the European Union. These risks create investor and business uncertainty that is unfavourable for markets. So while we have upgraded our Australian equities view from underweight to neutral, we suggest that investors remain conservatively positioned over the next six months and use a more active rather than passive approach to investing in the domestic equity market.
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