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Why a domestic bias could prove troublesome in 2024

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By Rhea Nath
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4 minute read

As Australian investors hunt for familiar domestic names among their allocations this year, a number of investment managers suggest there could be more promise in looking overseas.

Portfolios with high allocations towards Australia this year could find themselves on the back foot against more appealing opportunities in other parts of the world, according to professionals.

In its latest outlook, Zenith’s head of asset allocation, Damien Hennessy, noted underwhelming earnings in Australia year-to-date as the earnings season resumes.

“For equities, the market has run very hard for the last eight weeks and that’s primarily been just P/E expansion or valuations expanding, as earnings have been quite weak here in Australia. I think the 12-month forward expectations are about 2 per cent growth,” he said.

He highlighted Australia’s banking sector as an example, which is currently trading at a P/E multiple of around 15.5 times, a near-record high for the sector, despite unfavourable economic conditions.

“And earnings growth looks quite subdued, but that valuation of banks basically puts it in line with the rest of the market. Typically, it trades at about a 15 per cent discount to the broader market, so there are pockets of the Australian market that look quite expensive, a big part of the market, and our earnings outlook is not great,” Mr Hennessy said.

“So when we look at the various regions and how they stack up against each other on a range of different [factors] – valuation, policy, macro settings – Australia ranks towards the lower end of that, while parts of Europe, emerging markets, Japan, tend to rate a bit more highly.”

VanEck observed that Australian banks, on a global basis, could be the most expensive in the developed world on a 12-month forward P/E and price-to-book basis.

“Despite some grim economic forecasts, the share prices of Australian banks have performed well over the past three months; CBA for example, recently hit an all-time high of $115.98 per share,” it stated.

Additionally, the rest of the big four have also continued to witness growth year-to-date with Westpac’s shares rising over 12 per cent to $25.90, NAB’s adding 9.69 per cent to $33.85, and ANZ’s 8.58 per cent to $28.22, as at 21 February 2024.

“This has been surprising, given banks typically underperform as the economy starts to slow and future rate-hike expectations fall. Valuations have now come to the fore,” VanEck said.

According to the investment manager, should valuations move to be in line with global valuations and thus better reflect the economic outlook, it could disproportionately impact many Australian portfolios.

“Especially those that track or are benchmarked to the S&P/ASX 200 which we have noted before is concentrated to banks which make up over 20 per cent of the Australian benchmark index,” VanEck explained.

“Such sector bias makes sense if you are bullish on the sector but given the well-noted pressures on banks remain: margins are under pressure, the economic outlook is not conducive to growth and defaults are expected to rise, we think a more balanced approach to Australian equities may be prudent into 2024.”

VanEck also noted that while the prospects of a soft landing have improved, the market is pricing a “dream scenario” for the banks despite the risks of increased mortgage stress in a prolonged higher interest rate environment.

Last month, Vanguard research highlighted that a home bias may have proved costly for Australian investors in 2023.

“The Australian share market went into overdrive over the last few weeks of 2023, gaining more than 7 per cent as signs of a soft landing and improving economic conditions fuelled global markets,” said Tony Kaye, senior personal finance writer at Vanguard.

“It was a strong end to what, until then, had been a fairly lacklustre year for the Australian market. In fact, at the start of December, the Australian market had gained little ground over the previous year.”

Looking more broadly, however, the double-digit total return lagged the much stronger returns by international markets, Mr Kaye observed.

The US share market, measured by the S&P 500 Total Return Index, returned 26.29 per cent last year after including company dividends, more than double the return of the Australian share market.

Similarly, while not as strong as the US, the UK’s FTSE All-World Total Return Index rose a commendable 21.25 per cent in 2023.

“In general terms, it can be said that investors with broad exposures to the US and international share markets did much better last year than those highly exposed to the Australian share market,” Mr Kaye said.