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Chart of the week: AUSTRALIAN SHARES HAVE GREAT EXPECTATIONS IN THESE HARD TIMES

1 August 2019

Bob Cunneen, Senior Economist and Portfolio Specialist

 

Source: Datastream and Institutional Brokers' Estimate System (I/B/E/S).

 

Australia’s share market has reached new record highs (blue line), surpassing the previous peak of November 2007. A strong surge in global share markets, falling bond yields and the Reserve Bank of Australia cutting the cash interest rate to only 1%, have been the tailwinds behind this buoyant Australian share performance in 2019.

The key question is whether Australian shares have further upside potential for 2019 or are they overvalued? A simple share valuation measure is the Forward Price to Earnings (P/E) ratio. This compares the current share market price to the expected corporate earnings results in one year’s time. Essentially, how many dollars you are paying now for one dollar of earnings next year. The old adage ‘to buy low and sell high’ applies to the Forward P/E ratio. The Australian share market was expensive at the previous peak in November 2007 with a Forward P/E ratio of 16.5, and this proved a wise time to sell (red line).

Australian shares currently have a Forward P/E of 16.3, which is well above the past decade’s average of 14.4. This would suggest investors have great expectations already. Admittedly, future Australian corporate earnings results could come in even better than expected, allowing shares to make further strong gains over the next year. However this is a bold call given these great expectations are in sharp contrast to the current hard times in the Australian housing market and retail sector.

 

Important information

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