New data released by Northcape Capital has revealed that the Australian stock market has returned 11% in the first 10 months of 2024, outperforming the 8% average over the past two decades.
The main contributors were banks, insurers and the Macquarie Group, which generated a 30 to 50 percent return to its shareholders.
The fund manager, however, called the recovery of the big banks “intriguing”, given that companies in this sector reported lower profits in 2024 and have “stable” profit prospects for the years to come.
Northcape attributed the share price rise to a revaluation to new all-time high price-to-earnings (PE) ratios.
With the market expected to start 2025 at relatively high valuations compared to historical levels, the fund manager warned that some sectors could be particularly vulnerable.
“The most vulnerable sectors, in our view, are those that have experienced a sharp rise in share prices that has not been fully supported by fundamentals,” the company noted in its Australian Equities: Market Outlook 2025 report.
Northcape highlighted that the banking sector represents almost a quarter of the domestic market. This means that today’s passive investors are allocating a quarter of their portfolio to a sector trading “at a historically extreme valuation on virtually any metric.”
The company noted that Australian banks posted disappointing profit results in 2024, with little prospect of significant improvement in profitability or returns going forward.
Consensus forecasts suggest that the industry’s earnings per share (EPS) growth will remain between 1 and 2 percent per year over the next five years, while asset returns will stabilize at levels well below their peak of 2015.
In addition, traditional banks face increasing competition in retail banking from rivals, such as Macquarie Group, who are unencumbered by existing IT systems.
“The momentum behind the banks could continue for some time, but we expect a reversion to the mean over the next 12 to 18 months,” the company said.
Australian tech stocks
Another sector trading at high levels is Australian technology, which has seen a strong rebound over the past two years, Northcape noted.
Tech stocks were driven by strong organic sales growth, high margins and reinvestment opportunities.
However, the company warned that current valuations leave little room for error.
“The outlook remains optimistic but current valuations have been pushed to high levels, with no margin of safety,” the company observed.
Investors should be aware that any external shock, such as a correction in US technology stocks due to concerns about future returns on AI investments or a sharp global economic slowdown, could trigger a sell-off in the Australian technology sector.
On a more positive note, Northcape has identified opportunities in the healthcare and infrastructure sectors as well as individual stocks such as Brambles, Qantas and James Hardie. Additionally, he noted that opportunities can be found in certain industries undergoing structural change.
“Our portfolio has significant exposure to infrastructure through our holdings in Transurban and Auckland International Airport.
“These stocks have lagged the market in 2024 and now offer excellent value given reasonable valuations and long-term defensive dividend growth prospects,” he said.
The company also highlighted the airline industry, which has recently seen “improved capital and pricing discipline.”
Overall, Northcape anticipates a mixed outlook for the Australian stock market in 2025.
Although some economic pressures are expected to ease, falling commodity prices and weak bank earnings prospects are expected to weigh on overall earnings growth.
Additionally, late interest rate cuts further add to the uncertainty.
“In the current environment, it is critical to select stocks that will be resilient throughout the economic cycle,” he said.
“As we approach 2025, we remain focused on companies that were overlooked in 2024 but nonetheless generate strong return on capital with new growth opportunities. »
