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CEO AllenWargent Property Buyers, & WargentAdvisory (institutional). 6 x finance author.

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Sunday, 26 April 2015

Are Aussie stocks in a bubble?


Stimulus and easy monetary policy has led to stock market exuberance in a number of developed economies.

In the US, the NASDAQ has risen to record highs, while the Dow Jones (DJIA) has roared from just around 6500 in 2009 to above 18,000 today.

In the Old Dart, the FTSE 100 has finally breached 7000 and hit new record highs.

Today, a short look at the Australian market, and, in particular, a consideration of whether we are in or are approaching bubble territory.

Australian stock market

On Friday the S&P/ASX 200 jumped by 88.5 points or 1.51 percent to 5933, once again taking the index tantalisingly close to the assumed "psychological barrier" at 6000.

Denoted by the stock code "XJO" this particular index was created at the end of March 2000 and commenced with an index value of 3133, which was equal to the value of the All Ordinaries index at that time.

In the 15 years since we have enjoyed the XJO experiencing a very sharp run-up prior to the financial crisis, running as high as 6828.7 on my birthday in the year 2007 - as indeed it is every year - 1 November.

By early March 2009 the index had slumped as low as 3145.5, an alarming crash of well over 50 per cent.

The story since that time has been one of a long but strong recovery, with a few blips and international debt crises along the way (just for good meaure).

Accumulated returns

When measuring average returns for investors, it is not enough to look at the index and note a "7 year high" or the market being "below where it was in 2007", because this is to overlook the income component of investment returns.

Since the financial crisis low of March 2009, the XJO has rebounded by 88 per cent, and on an "accumulation" basis (i.e. inclusive of dividends) returns are considerably stronger at an imperious 147 per cent.

Impressive stuff, and this has helped aggregate household wealth in Australia to hit record highs in 2014.


Concluding whether an index is fairly valued or overvalued simply by looking at its quoted numerical value is not a valid exercise, since the index is capitalization adjusted and float adjusted.

One measure we can look at is average price/earnings ratios, which divides market prices by annual earnings per share.

On a forward P/E measure valuations are threatening to move from the mid-teens to the high teens, a level which might be considered expensive on a historical basis, although valuations have previously run some way higher around the turn of the century.

Westpac (WBC), Commonwealth Bank (CBA), and ANZ Banking Group (ANZ) are all trading at PE ratios of above 15. 

So too is resources giant BHP Billiton (BHP). 

A diversified company such as Wesfarmers (WES) is trading at a PE of more than 20. 

AMP also has a PE ratio of above 20, while the successful Telstra (TLS) turnaround story has now justified a PE of above 18.

Not exactly cheap, one might say.

The wrap

The outlook for the economy remains somewhat subdued.

Futures markets are expecting to see another interest rate cut before the end of the financial year and there is every chance that the Reserve Bank will revise down its previously optimistic growth forecasts on May 8.

Low interest rates have helped to push share market valuations higher that might otherwise be warranted by the outlook for the economy.

This is one of the ways in which low interest rates can create a "wealth effect" and stimulate investor and consumer confidence.

Whether or not the market is in a "bubble", however, is a different question.

The expansion in valuations has not been particularly rapid, and nor are PE ratios wildly higher than historical averages.   

To some extent, however, the answer must be based upon and make reference to the underlying quality and sustainability of the earnings (E), and so in Australia the conundrum must be inextricably linked to the outlook for China, commodity prices and the demand for resources.

Others look to the outlook for our property markets given the exposure of the major banks to residential real estate, yet mortgage arrears are at their lowest level in 7 years, and indicators of financial stress are presently very low, with significant mortgage buffers having been acknowledged by the Reserve Bank.

What we can say is that value is now very difficult to find in the current stock market and the risk of a material correction is necessarily higher than it was. Not a concern for those averaging into the index, of course.