Australia's profits recession is at an end and earnings should turn positive into next year, levelling the playing field for unloved value stocks that have been long avoided in favour of growth stocks.
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"The defining feature of the Aussie equity market over the last two years has been the profits recession," Credit Suisse equity strategist Hasan Tevfik said, the fifth of its kind since 1980.
Much of the 13 per cent fall in earnings per share during the recession was due to resources stocks weathering the worst of the mining downturn and the nadir of commodity prices in January.
With commodity prices stabilising and these now leaner companies returning to profit, Credit Suisse is forecasting single-digit EPS growth over the next year, which should send the S&P/ASX 200 Index back to 6000 points by December 2017.
Yield search
This may also give rise to a shift in the market that has been marked by the valuations of high-growth stocks being pushed to extremes as investors search for yield and growth amid an uncertain macro backdrop.
"We think we are at an inflection point in the profits cycle," Mr Tevfik said in a quarterly outlook piece.
Not only are earnings likely to rise on higher commodity prices, but the outlook for economic growth is also improving for next year, Perpetual's multi-asset head of investment strategy, Matthew Sherwood, said.
"In the next year, the Australian economy is clearly going to strengthen because one of the big headwinds in the last few years is the mining investment unwind, and I think by this time next year that will largely have dissipated," Mr Sherwood said.
"I tend to think that GDP growth is going to be better in a year's time; it's already pretty robust."
Global forecast
Mr Tevfik said while the investment bank had upgraded its global growth forecast from 2.6 per cent in 2017 to 2.8 per cent, the growth was low relative to other turns in the profit-recession cycle.
"For these reasons we think the coming EPS recovery will be modest and are expecting mid-digit growth for the ASX 200 during the 12 months to June 2017," he said.
While the outlook for earnings is positive, Mr Sherwood said it would not be all smooth sailing, with financials coming under pressure as they passed the bottom of the bad and doubtful debt cycle and faced a squeeze in their margins.
"The key for which sectors outperform, growth versus value and defensive versus cyclical, is the performance of long-dated bond rates," Mr Sherwood said.
Bonds higher
If bond yields continue their march higher, value and cyclical stocks would outperform, but this would be more likely driven by global factors, particularly the global real interest rate, rather than local drivers. Australia's 10-year bond yield has risen from 1.819 per cent in August to 2.303 per cent.
"I'm of the view that we've seen the most of the bond yield rise to date. I don't expect there's going to be a further leg up," Mr Sherwood said.
Mr Tevfik said the end of the profit cycle will even the playing field for stocks, and rising EPS and bond yields would help reduce the premium associated with growth stocks.
According to Credit Suisse's research, Australia's defensive sectors are trading at a hefty premium to their global counterparts. The healthcare sector trades at a 60 per cent price-to-earnings premium over its global peers, despite weaker EPS growth. Infrastructure, meanwhile, trades at a 200 per cent premium on a P/E basis.
Credit Suisse has identified stocks set for a resurgence as those with low valuations but EPS growth momentum. These include Ansell, BlueScope Steel, Caltex, Computershare, Fortescue Metals Group, Lend Lease, Macquarie Group and Myer.
