The S&P/ASX 200 is set to reach 8,300 by the end of the year, new analysis from VanEck has shown, with Australian mid caps set to outperform the index.
While the S&P/ASX 200 has been range trading between 6,500 and 7,500 for the past two and a half years, feeling the brunt of recession concerns, rising interest rates, and stagnant earnings growth, recent months have seen it surge to 7,800.
Looking ahead, VanEck forecasts a 6.4 per cent to 8,300 by year end.
Moreover, surveying the current market environment, smaller companies would offer more upside potential through market share expansion and have historically outperformed in prolonged market recoveries, it noted.
As such, VanEck portfolio manager Cameron McCormack noted current valuations are appealing, with 12-month forward price-to-earnings ratios sitting below historical averages.
“Mid caps also reported the highest upside price target revisions during the February earnings season,” McCormack explained.
The environment bodes well for a potential mid-caps rally, he added, supported by overweight exposure to cyclical sectors like industrials, consumer discretionary and real estate that would benefit amid resilient consumer spending and moderate inflationary pressures.
“Australia’s banks are overvalued. Valuations are stretched and are the most expensive globally. Australia’s banking sector is vulnerable to a correction and investors should be wary if they are overexposed.”
Moreover, the market “seems to be pricing a dream scenario for the banks,” he observed, despite the lingering risks of a flare-up in mortgage stress in a sustained higher interest rate environment.
However, this environment bodes well for a potential mid-caps rally, supported by overweight exposure to cyclical sectors such as industrials, consumer discretionary and real estate.
VanEck highlighted that these sectors would be beneficiaries in a period characterised by resilient consumer spending and moderate inflationary pressures.
Namely, Australian real estate investment trusts (A-REITs) are “primed for a comeback”, according to McCormack.
Most notably, interest rate stabilisation and a positive economic outlook has improved confidence in the assessment of valuations, encouraging capital recycling. REIT leverage levels have also decreased and interest coverage levels have increased steadily since the global financial crisis.
“Office REITs offer attractive discounts to book value. The fall in occupancy rates has stabilised and net operating income has picked up. Retail REITs are fairly priced. Occupancy rates are strong and net operating income has accelerated,” McCormack outlined.
“Industrial REIT Goodman Group’s 12-month forward PE is trading at the upper bound of its historical average. It could be vulnerable to a correction if double-digit earnings growth is not maintained.”
He also pointed to the potential of a “paradoxical dynamic”, indicating that although Australia may achieve a soft economic landing, sustained high-interest rates could intensify mortgage stress, putting additional strain on household budgets.
“However, Australia’s migration surge will support retail spending and therefore consumer discretionary names such as Wesfarmers, JB HiFi and Super Retail Group. The sector reported strong net beats during the February earnings season and we anticipate this to continue,” McCormack concluded.
