DEUTSCHE BANK: Buy the dip in Australian stocks

SHEERNESS, ENGLAND – SEPTEMBER 05: A woman practices yoga on the beach on September 5, 2013 in Sheerness, England. Southern England is enjoying a couple of days of late summer sunshine with temperatures today expected to peak at 30C, before predicted rain and cooler temperatures are pushed in tonight. (Photo by Peter Macdiarmid/Getty Images)

The ASX 200 is up 0.44% today to 5,724. That’s the third day this week the Australian market has rallied after it made a low earlier this month at 5,602. – ASX200

It’s an emerging trend, likely to continue according to Deutsche Bank Australian equity strategists Tim Baker and Joseph Kim. In a note to clients yesterday Baker and Kim, having previously outlined a potential dip scenario, gave four reasons why they believe investors should buy the current dip in Australian stocks.

Here’s the run-down.

  • 1. A dip was due, so the fall likely reflects normal volatility rather than anything more sinister. It had been 94 days since the last dip, compared to the 6-year average of 50 days between falls. And the market had rallied 16% since the most recent trough, compared to an average 10% gain between market falls.
  • 2. Valuations are reasonable. Our model says the PE ratio of 16x is now only 4% above ‘fair value’, down from 10% above in January. This is quite a small deviation, and seems low given real bond yields are in uncharted territory. Further, Australia’s PE relative to global peers is back to average, after being a touch expensive.
  • 3. Earnings momentum looks okay. The earnings revision ratio is actually above average, and suggests the recent fall in forward EPS could soon be arrested.
  • 4. Poor analyst sentiment, while a risk near-term, is actually positively correlated to market performance on a medium-term view. It seems the lack of exuberance can lead to more orderly market conditions.

Perhaps the most compelling of their reasons is the bearish analyst sentiment, with Baker and Kim noting:

Poor analyst sentiment can be a risk in the near-term — a lack of buy ideas could drag on conviction levels and leave the market vulnerable. But in the longer term, bearish sentiment has actually led to rising markets.

That is one heck of a relationship.

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