ASX set for strong recovery, Deutsche’s top stock picks include Harvey Norman

Deutsche says Harvey Norman and a string of other stocks are strong buys. Photo: Scott Barbour

History suggests the ASX 200 index is on track for gains of about 10 per cent over the next six to 12 months – as long as Australia avoids a recession, according to Deutsche Bank.

In addition to the big four banks, financial market plays and healthcare stocks, Harvey Norman, Echo Entertainment, Flight Centre, Boral, Fletcher Building, Stockland, REA Group, QBE and AMP were strong buys, Deutsche said, while resource stocks still looked too expensive.

Deutsche’s report, Corrections, Current Valuations and What to Buy, noted that the ASX200 had fallen 15 per cent over the past six months. Since 1960, there had been 13 such corrections.

“There are some 20 per cent-plus rebounds over the ensuing 6 to 12 months, but also some 20 per cent-plus falls,” Deutsche said. “The average is flat performance.”

However, the picture was rosier if corrections that preceded recessions were excluded.

“The market tends to rally following a 15 per cent fall provided no recession develops,” Deutsche said.

“Given our view that a recession is not imminent, we expect the market to rise in a similar fashion to historical precedents. Indeed, the market is already up 5 per cent since last Monday’s trough.” Resources expensive 

The ASX 200 was trading around 5202 at Monday noon, AEST, down more than 1 per cent for the day but 5.5 per cent higher than last Monday’s nadir of 4929.7.

Deutsche’s paper used a variety of price-earnings ratios to determine the value of the market: forward P/E ratio; trailing P/E ratio; modified trailing P/E ratio; cyclically adjusted P/E ratio; and Deutsche’s own “fair-value” model, which takes into account inflation, real interest rates, the Australian dollar and recent earnings per share revisions.

According to Deutsche’s analysis, both the forward and trailing P/E ratios were still 7 per cent above the historical average, suggesting the market was overvalued.

But other P/E ratios told a different story. The cyclically adjusted P/E ratio was 12 per cent below the historical average, the fair-value model was 2 per cent below the historical average and the modified trailing P/E ratio – considering return on equity minus cost of equity – was 17 per cent below the historical average, suggesting a cheap market.

Amid major sectors, “resources still look expensive, banks seem cheap and industrials are in the middle,” Deutsche said.

Among industrials, cyclicals are trading at a 5 per cent discount to defensives.

“This is not especially large, but does suggest that cyclicals offer marginally more value.” On path to 6000

Deutsche also slashed its ASX 200 predictions, tipping 5600 by the end of 2015 (previously 6200) and 5800 by mid-2016 (previously 6350).

It tipped 6000 by the end of 2016.

UBS, like Deutsche, was not enthusiastic about prospects for the market.

“Valuation does not appear overly compelling in absolute terms, but we believe relative values versus low interest rates is the key positive support.

“Given headwinds from banks and resources, as well as a subdued outlook for the domestic economy, medium-term market prospects beyond a short-term bounce appear constrained by mediocre earnings growth.

“We believe the positive earnings impact from further falls in the Australian dollar … remains the key potential positive in the earnings cycle,” UBS said.

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