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Why It May Be Time to Exit Australian Stocks

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Australian stocks have enjoyed solid gains amid the party in global equities, rising around 20 percent over the past six months, however, one strategist fears the rally could be short-lived.

The rally in Aussie equities is threatened by high valuations and the unwinding of defensive plays like banks and telcos, which have in the first place fueled this bull run, said this analyst.

"The real problem will likely be in the banks, not miners, over the coming quarters. The major Australian banks have been a popular trade due to the scramble for yield, but valuations are very stretched and price itself has gone parabolic," Nicholas Ferres, investment director at Eastspring Investments, told CNBC.

(Read More: Australia the Next Euro Zone? Maybe)

For example, the country's biggest lender Commonwealth Bank of Australia (CBA), shares of which have risen 27 percent year to date, is currently trading at 3.5 times price-to-tangible book and 16.3 times earnings - compared to a low of 13 times earnings seen in the past year.

Australia's big four lenders, which are expected to post record profits in the first half, according to Reuters, are luring investors in search of yield as they offer attractive dividends. CBA, for example, has a dividend yield of 5 percent.

(Read More: NAB Profit Drives Australia's 'Big Four' Bank Earnings to Record)

"Valuations of Australian banks would even make some of the much loved ASEAN banks blush," he said, adding that they are very expensive on a global basis given high household leverage and weak credit growth in the country. Australian financials are trading at a 12-month forward price to earnings ratio of 14.2, higher than a historical average of around 11.5, according to Eastspring Investments.

Alongside banks, high yielding defensive stocks, including telecoms have also done exceptionally well with shares of Telstra and Hutchison Telecommunications, for example, rising 16 percent since the start of the year.

But, the telecom sector - which faces "declining trend earnings" - is trading at almost 5 times book value - a 131 percent premium to the global average, Ferres said.

(Read More: Day of Reckoning - Australia's Budget to Show Dire Deficit)

"The common push back to this observation is that it [stocks] has a 5 percent dividend yield, and there is no alternative, 'Tina,' given the low returns on cash. It is time to fade 'Tina' and sell Australian equities," he said.

Lucky Country No More?

In addition, the macro environment in Australia is deteriorating with the commodities boom showing signs of fading as growth momentum in major trading partner China slows.

Falling commodity prices equate to a slowdown in national income, the "virtuous cycle" of profits, investment, employment and spending that has supported the economy and stock market over the past 10 years, he said.

(Read More: Why Shorting the Aussie Is 'Trade of the Century')

"We ought to consider hedging our exposure to Australia," added Ferres.

— By CNBC's Ansuya Harjani.

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