Australian Equities

Overview
Over the quarter ending 31 March 2012 the ASX 200 Accumulation index rose by 8.40%.

The March quarter was dominated by a relatively lacklustre reporting season. Many companies had announced downgrades in the preceding six month period so while earnings were generally in line with expectations, expectations had already been lowered. Lower commodity prices resulted in a 7% fall in profits for the resources sector. Despite benign credit growth banks still managed to lift earnings by around 7%, mainly due to lower bad debts. Outlook statements remained cautious prompting a reduction in FY12 earnings estimates. Despite this, analyst earnings growth estimates for the ASX 200 in FY13 remain high at around 14% (versus FY12 estimates of around 1-2%), of which growth in industrials is expected to be around 10% (versus about 5% for FY12).

Outlook
The Australian sharemarket has drifted upwards in recent months, mainly in the slipstream of global markets that have been buoyed by US growth and an easing (albeit short term) in EZ risks. Yet the recovery very much remains in its formative stages. The sharemarket continues to trade on depressed multiples that are well below long term averages. To put this into perspective, the market is currently trading on a multiple of around 12 times FY12 earnings and around 10.5 times FY13 earnings. If the long term average is closer to 14 times earnings, then (assuming mean reversion) fair value for the ASX 200 as at 30 June 2012 would be around 5,000 points and fair value for 30 June 2013 would be around 5,700 points.

Conclusion
Although the performance of the Australian economy remains sub-par, it is impossible to ignore the valuation disconnect that has emerged on equity markets. Given the easing of risks (albeit temporary) in the EZ, we expect the rally to gain strength in coming quarters. For these reasons we recommend building from a mild to moderate overweight exposure to Australian equities.

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