Asia Stocks to Watch: Australian currency, policy may limit stock gains

Reuters The Australian Stock Exchange in Sydney.

SYDNEY (MarketWatch) � The Australian share market�s gains since the start of the year have lagged those of its Asian peers, and that underperformance is likely to continue as long as monetary policy remains tight.

So far, the S&P/ASX 200 index AU:XJO �is up 5% year-to-date, trailing the Hang Seng Index�s HK:HSI �13.3% jump and a 6.1% gain for Japan�s Nikkei Stock Average JP:100000018 �.

Broad gains across global equity markets so far in 2012 have been made in the wake of improving investor sentiment, with Europe�s debt troubles addressed to some extent by policy action, and with a pick-up in economic data, notably in the U.S.

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Recognizing the brighter general-market mood, Goldman Sachs� Australian equity strategist Chris Pidcock recently made a modest upgrade to his targets for the Australian share market.

�We have reviewed the key assumptions driving our market targets for 2012, in particular prospective multiples, which had assumed little change to investor sentiment for the first half of 2012,� wrote Pidcock.

He�s expecting the market to advance to 4,340 by June, an upgrade to an earlier target of 4,100, with the Australian index trading at 4,256.60 midday Monday.

Pidcock also raised his year-end target for the benchmark to 4,600, up from 4,500.

Deutsche Bank strategist Tim Baker is targeting 4,700 by the end of 2012, again due to an improvement in broad sentiment toward riskier assets.

�Going back six months, there was more uncertainty in Europe, China has rising inflation, and the U.S. was in a soft patch. We�ve already moved on a lot from that,� he said.

Baker pointed out that price-to-earnings (PE) ratios for Australian companies are at very low levels, with the ratio � calculated by dividing the price of a stock by its annual earnings per share � currently at 12.56 times for Sydney-traded shares, according to IBES data

However, Deutsche Bank�s Baker said that, while there may be some support from a general improvement in sentiment toward shares, he�s not expecting the earnings side of the PE ratio to suddenly recover for Australian companies.

�Getting to 4,700, we�ve got the PE re-rate doing more of the work than earnings growth,� he said.

Profit hurdles

Earnings aren�t likely to pick up for Australian companies without some fundamental changes to the Australian investing environment, where relatively high interest rates and a strong currency have kept financial conditions on the tight side, analysts say.

The high Australian dollar AUDUSD �is a key impediment to the equity markets, said Baker, who sees an intense structural change currently underway in the economy.

Retailers, exporters and companies operating offshore have been notable sufferers in the market, and these firms weren�t given any relief this week, when the Reserve Bank of Australia kept its key cash rate on hold at 4.25%.

The decision surprised markets which had widely been factoring in an interest-rate cut, and pushed the Australian dollar to a level not seen since early August. See report on Australian interest-rate decision.

�The market was quite disappointed� when the Reserve Bank didn�t cut,� said Mark Rider, head of investment strategy for Australia at UBS Global Asset Management.

Australian companies are at a relative disadvantage in terms of monetary policy compared to offshore rivals, he said.

�Hong Kong imports U.S. close-to-zero interest rates, Japan basically has zero interest rates. They have got more accommodative [monetary] conditions than we do,� Rider said.

He believes the Australian equity market is now severely undervalued � �in some respects on par with the undervaluation we�re seeing in Europe. � Our valuation signals are showing that it is cheap.�

The average PE ratio for the Australian market is historically somewhere around 14 to 15 times, said Rider.

But that hasn�t tempted Rider to put more cash to work in the Australian equity market. UBS� multi-asset portfolio is invested in the Australian market but is underweight compared to other benchmarks.

�I think at the moment, [the market] is undervalued, but that�s for a reason � tightish monetary conditions and disappointing economic growth for a period of time. To see that turn around, I think we need to see a let up in that,� he said.