There has been an increasingly optimistic outlook for the Australian equity market over the last two months on the back of an expansionary Federal Budget, dovish Reserve Bank and easing of restrictions in Victoria as the second wave of COVID19 cases was brought under control. This has been reflected in an improved earnings outlook, with upgrades in the Australian market ahead of all key developed markets since the beginning of September.
Chart 5: Forward EPS Revisions: September/October
The full year earnings season for three of the major banks is getting underway, with the focus likely to be on bad debts, capital levels, net interest margins and volumes. There will also been keen interest on asset quality as a large number of borrowers transition from a loan repayment holiday through the COVID crisis, although the full extent of losses is unlikely to be revealed until 2021. Currently, three of the four majors trade at a discount to book value, although as the chart illustrates, this is reflective of the lower return on equity across the sector.
Chart 6: Major Banks: Change in Price to Book and ROE
As is typical in a correction, domestic small cap stocks fell more than their large cap counterparts through the sell off in markets in February/March this year. In the recovery phase, however, small caps have outperformed significantly, reflecting the greater leverage to an improvement in economic conditions. We have a constructive view on small caps as the domestic economy reopens, combined with ongoing supportive fiscal and monetary conditions.
Chart 7: Australian Equities: Large and Small Cap Performance