New data released by Northcape Capital has revealed that the Australian equities market generated an 11 per cent return over the first 10 months of 2024, outperforming the 8 per cent average of the past two decades.
The major contributors included banks, insurers, and Macquarie Group, which delivered 30 to 50 per cent returns to their shareholders.
However, the fund manager described the rally in major banks as “intriguing”, considering that companies in this sector reported lower profits in 2024 and have a “flattish” earnings outlook for the coming years.
Northcape attributed the share price increases to a re-rating to new all-time record price-to-earnings (PE) multiples.
With the market expected to start 2025 at relatively high valuations compared to historical levels, the fund manager warned that certain sectors could be especially vulnerable.
“The most vulnerable sectors, in our view, are those which have seen a major stock price rally which has not been fully supported by fundamentals,” the firm noted in its Australian Equities: Market Outlook 2025.
Northcape highlighted that the banking sector comprises nearly a quarter of the domestic market. This means that today’s passive investors allocate one-fourth of their portfolio into a sector trading “at a historically extreme valuation on virtually any metric”.
The firm noted that Australian banks posted underwhelming profit results in 2024, with little prospect for a significant improvement in profitability or returns ahead.
Consensus forecasts suggest that earnings per share (EPS) growth for the sector will remain at 1 to 2 per cent annually over the next five years, while return on assets has stabilised at much lower levels compared to their 2015 peak.
Additionally, traditional banks face growing competition in the retail banking space from competitors, such as Macquarie Group, which are not hampered by legacy IT systems.
“The momentum behind the banks may continue for a while, but we would expect some mean reversion over the next 12–18 months,” the firm said.
Aussie tech stocks
Another sector trading at elevated levels is Australian technology, which experienced a strong rebound over the last two years, Northcape noted.
Tech stocks have been driven by solid organic sales growth, high margins and opportunities for re-investment.
However, the firm warned that current valuations leave little room for error.
“The outlook remains buoyant but current valuations have been pushed to elevated levels, with no margin of safety,” the firm observed.
Investors should be aware that any external shock, such as a correction in US technology stocks due to concerns over future returns from AI capex or a sharp global economic slowdown, could trigger a sell-off in the Australian tech sector.
On a more positive note, Northcape identified opportunities in the healthcare and infrastructure sectors as well as individual stocks such as Brambles, Qantas, and James Hardie. Also, it noted opportunities can be found at select industries undergoing structural change.
“Our portfolio has a meaningful infrastructure exposure via our holdings in Transurban and Auckland International Airport.
“These stocks have lagged the market in 2024 and now offer excellent value given reasonable valuations and an outlook for defensive long-term dividend growth,” it said.
The firm also pointed to the airline sector, which has recently seen a “better capital discipline and pricing”.
Overall, Northcape anticipates a mixed outlook for the Australian equity market in 2025.
While some economic pressures are expected to ease, lower commodity prices and a weak outlook for bank earnings are likely to weigh overall profit growth.
Additionally, delayed interest rate cuts further add to the uncertainty.
“In today’s environment, it is critical to select stocks which will be resilient over the business cycle,” it said.
“Going into 2025, we remain focused on companies which have been neglected in 2024 but still generate a solid return on capital with further opportunities for growth.”
