The Australian market has effectively priced in both the prospect of recovery and the risks of it being derailed, with valuations for most asset classes rated “fair”, according to recent research.

The story behind medium-term asset valuation is quite positive, but not without challenges, according to David Stuart, head of the dynamic asset allocation team in Australia and New Zealand for Mercer, which conducted the research.

“The recent choppiness in markets could continue for some time, but we’re not expecting a repeat of 2008,” said Stuart.

“While there is talk of a double dip recession, as we are hearing from some bearish commentators, Mercer believes market valuations have priced in big picture risks.”

This has not changed substantially since early 2010, and Stuart felt at that time that the road to recovery would be rocky: “that has proved to be case, particularly for equities, however it continues to trend upwards,” he noted.

“There are still the macro risks, such as developed countries’ government debts, but companies have been reporting positive earnings, and this is reflected in equity prices.

“Overall, we believe things will be volatile for some time, but still heading in the direction of recovery – even if it is at a grinding pace” said Stuart.

Mercer’s Dynamic Asset Allocation report provides guidance for medium-term (two-year) asset allocation, and summarises Mercer’s view on the market outlook and valuations for that period.

Stuart is optimistic about local economic conditions, and said the risk of a sharp slump in Australian GDP growth in late 2010 and early 2011 are low.

“Rather, the rapid withdrawal of stimulus money and the emergence of a more subdued short-term global growth outlook have only curtailed the potential for above-trend growth,” he said.

One of the few standout asset classes in the report is emerging market equities.

“We moved up our rating for emerging market equities because we like the structural story behind them,” said Stuart.

“There’s going to be strong growth in the longer term because these countries don’t share the same problems as developed economies, such as more mature consumer markets and heavy government debt.”

While Stuart was previously concerned about inflows coming in too fast and pushing valuations too high, he said this has eased off since the beginning of the year, as investors generally have reduced exposures to risky assets.