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Why Australia stocks will extend their rally despite commodity slump

Leslie Shaffer | CNBC

The Australian market has rallied nearly 10 percent off its bear-market low in February, but the gains are just getting started, Credit Suisse said.

The market down under is seeing its traditional "gummy bear" rally, which generally follows its dips into benign bear markets, the bank said in a note Tuesday, referring to a popular sticky candy. That type of rally typically sees the index climb an average of 24 percent over the following 12 months, Credit Suisse said.

But historical comparisons aren't the only reason the bank is staying positive on the market despite few expectations for a strong recovery in the long-downtrodden prices of Australia's key commodity exports.

For one, Australia's stocks still look cheap based on dividend yields, with the trailing ASX 200 yield at just under 5 percent, compared with the long-term average of around 4 percent, Credit Suisse said.

"Supporting the rise in stock indices is a growing income seeking investor base—both domestically and from abroad," it said.

Indeed, in an email accompanying the research note, the bank highlighted how the extraordinary global appetite for yield allowed serial bond-defaulter Argentina to tap the global debt market for the first time in 15 years. The deal was four times oversubscribed and saw five-year bonds priced to effectively yield only around 6 percent, the bank said.

Australian bank Westpac is yielding a gross of 8.9 percent, it noted.

"The events in Argentina this week give us more confidence that we will see yield compression in Australia," it said, noting that at the bank's target of 6,000 for the ASX 200, the dividend yield would fall to around 4 percent.

The ASX 200 index is up around 0.3 percent at 5204.60 at Wednesday midday.

To be sure, Credit Suisse noted that forward dividend estimates have been cut.

"The cuts to DPS [dividend per share] have been focused amongst the commodity stocks and many are beginning to fear cuts in banks' DPS. We are more sanguine here," the bank's analysts said. "To get a meaningful rise in non-performing loans and a cut in Bank DPS, we need to see rising unemployment. But the unemployment has been falling in Australia for a year now."

Additionally, the bank is relatively positive on the outlook for the commodity sector, at least in the short term, as China has pulled forward some of its infrastructure spending this year.

"Our analysts have increased their Chinese steel output forecasts and in combination with tighter supply, should bode well for near-term iron-ore prices," it said, raising its forecast for the key steel-making ingredient to $40 a ton for the end of 2016 from $35 previously.

The price of iron ore dropped nearly 40 percent in 2015 on the back of an enormous supply glut, but it's recovered by around 40 percent year-to-date as China's imports of the metal rose 6.5 percent on-year in the first quarter. "We believe there will be further good news coming out of China, at least in the near term, which keeps us positive on commodity exposed stocks," Credit Suisse said, keeping plays such as BHP Billiton and Rio Tinto on its buy list. It also added Syrah Resources, a graphite producer, as that's one of the key ingredients in batteries used in electric cars.

Separately, iron-ore prices might find some support after both Rio Tinto and BHP Billiton this week cut their production targets, partly due to weather-related disruptions.

—Nyshka Chandran contributed to this article.

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—By CNBC.Com's Leslie Shaffer; Follow her on Twitter @LeslieShaffer1