The Australian Share Market is now almost “off the scale” and the Australian Share Market is representing outstanding value in all but the most pessimistic of scenarios.”  says Shaw Stockbroking Research.
On any rational measure of valuation, the Australian Share Market is pricing  in a very pessimistic outlook for earnings growth coupled with grave fears about credit worthiness.
All Ords 1 Year Trend
 asx 1 Year Graph

All Ords 5 Year Trend
asx 5 year graph.JPGd

Shaw’s research  analyse a “typical” downgrade cycle assuming that the Australian and global economies dip into recession and suggest there may be 10% downgrades to earnings estimates based on previous cycles should this scenario eventuate.
Global bond markets have been driven to “bubble” proportions due to a flight to safety amongst investors, a reluctance to borrow amongst the private sector and ongoing liquidity injections from central banks. Investors should avoid long term government bonds.
Whilst difficult trading conditions are likely to persist for the remainder of calendar 2011 in Australia and industrial earnings per share growth is likely to continue to be revised down, there remains a very robust capital expenditure cycle and strong export markets to buoy the economic outlook.
Unlike many central banks, the Reserve Bank of Australia has plenty of dry powder in terms of lower interest rates to help offset any demand driven weakness in the domestic economy .   
Valuations are now almost “off the scale” and the Australian Share Market is representing outstanding value in all but the most pessimistic of scenarios.
Australian Shares look attractive in both an absolute and relative sense. Long-term returns from our dividend discount model using a 5% terminal growth rate suggest returns in excess of 14% per annum total return. This compares favourably to both short-term interest rates of 4.75% and 10 Year Government Bond rates of 4.1%.
Analysis on Australian Bank Shares
All Big-4 banks provide investors with yields well above historic averages.  Yields have been rising strongly as concerns over the global financial system and the realisation of a benign domestic outlook has led to bank underperformance relative to industrial peers.
Historically high yields
All four banks provide yields well above their historic 10 year averages, see charts to left. ANZ  is trading at a yield of 7.9% compared to its 10 year average of 5.7%, CBA is 7.8% vs 5.8%, NAB 8.8% vs 6.0% and WBC 8.5% vs 5.8%.
Shaw Research believe current yields provide investors with unusually attractive risk/reward as we see little threat to the quantum of dividend payments over the medium term.  We believe the market has already factored-in benign revenue and cost outlook and this is reflected in earnings and thus dividend expectations.
Further, the Australian majors remain among the most conservatively capitalised banks in the world, a situation that has strengthened since the GFC.  Bank balance sheets have more Tier  capital than required under APRA’s   interpretation of the new Basel III capital regulations. Indeed, all four banks already materially exceed current requirements and in fact meet  increased requirements to be introduced in 2016.  This excess capital provides a buffer which could maintain dividend payments in the event of an unforseen occurrence (say a Eurozone default or bank collapse).  Indeed, as we flagged in a note dated 8 September, we believe there is the possibility of capital returns if the global banking environment stabilises and confidence returns to the Australian consumer and Boards.
Another reason Shaw believe the Australian banks are relatively immune from offshore concerns is that they are basically self-funding their lending requirements from domestic deposits. Cash deposits have increased materially as consumers have become ncreasingly risk averse; savings rates are at 30 year highs.  This implies that the Big-4 are much less exposed to offshore wholesale funding requirements in the medium term than they were during the GFC.
All four major banks provide particularly attractive yields at favourable risk/reward.  We maintain our preference for NAB and ANZ over CBA and WBC.
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