Does the Australian equity market look cheap? This is not necessarily the conclusion you would reach if looking at the premium that investors are currently receiving for investing in domestic equities over government bonds. The yield premium has averaged around 4% since 2010 and the chart illustrates that, at the current premium, the market is close to fair value. The PE de-rate in the market through this year has therefore matched what one would expect given the sharp rise in bond yields we have witnessed.
Chart 1: Forward equity risk premium stable
With earnings holding up relatively well so far in 2022, weaker equity returns have been explained almost entirely by a decline in valuations. The decline in valuations continues to be far from uniform across the various sectors of the market, with high growth sectors affected disproportionally as yields have risen. The domestic information technology sector has suffered much more than most, with the forward PE dropping almost 40 points since the beginning of the year.
Chart 2: High growth sectors continue to bear the greatest valuation adjustment (Change in forward PE ratio in 2022)
Which stocks and sectors have been driving the ASX 200 so far in 2022? The top 10 contributors to the index’s performance (which have added nearly 5% overall to the market) tell a story, which include three of the four major banks and then a mix of resources stocks. Managers with little exposure to these sectors of the market would have thus struggled for performance – the rest of the market combined has lost more than 6%, leaving the benchmark slightly lower year to date.
Chart 3: Market driven by resources and banks: attribution in 2022