Overseas investors are back buying Australian stocks and that bodes well for the banks and miners

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Australian stocks have been rallying hard for several months, surging to fresh multi-year highs last week. And those gains have been sustained in recent days, leaving the benchmark ASX 200 index within touching distance of the 6,000 point level.

Part of that strength may have been due to a pick-up in foreign capital flows, says Tim Baker and Joseph Kim, equity strategists at Deutsche Bank.

“Newly released data show rising foreign flows into Australian equities, after earlier weakness,” the pair wrote in a note released on Thursday.

This chart shows that increase over the past year, comparing foreign capital flows to domestic flows on a three-quarter moving average basis.

Source: Deutsche Bank

Baker and Kim think there’s a simple explanation behind the renewed interest from foreigners — Australian stocks, even at these elevated levels, remain attractive.

Here are the five factors they say has assisted the recovery in foreign inflows after a prolonged period of weakness:

Earnings outperformance. Australia’s forward earnings and earnings revision ratio are stronger than DM and EM, after generally softer performance over the past six years.

Low policy uncertainty. Policy uncertainty is very high across most major countries, on the back of recent or upcoming elections. Australia stands in stark contrast, with uncertainty around average.

Cheap currency. The AUD is below the decade average (5% below on the TWI, 15% vs the USD). Foreign flows tend to pick up when the AUD falls, but this didn’t happen from 2013-15, so there’s now scope for catch-up.

Superior population growth. Australia’s population is growing at 1.5%, triple the rate of high-income countries. And population growth has picked up in the past year, after some previous slowing.

High dividend yield. Australia’s dividend yield remains well above global peers (4% vs 2½%). And this holds across most industries. While yield stocks themselves are not in favour, high yields are still likely to catch investors’ eyes given nominal global growth remains below average.

Given the acceleration in foreign inflows over the past year, something that appears to be strengthening even further, Baker and Kim believe that bodes well for the largest of Australia’s large cap stocks.

“Offshore investors tend to be attracted to larger stocks, given the greater liquidity,” they say.

“Consistent with this, we find that the ASX20 tends to outperform when foreign flows are relatively firm. The relationship suggests more relative upside for the ASX20.”

Given that historic relationship, Banker and Kim retain an overweight rating on the large banks and miners.

“(Our) top picks are Rio Tinto and Westpac. Our model portfolio also contains Suncorp and Woolworths, and Macquarie and QBE.”

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