Australian equities are not expensive by global standards. However, the key investment issue is earnings, not valuation: profits increased sharply through the resource boom, and remain high in domestic sectors. If profits normalise, Australian equities will likely under-perform.
The valuation of Australian equities is mid-range amongst global markets (although most markets do not appear cheap). Valuation is at, or a little above, the historical average (Exhibit 1).
However, if history repeats, Australian equities may under-perform global equities over the medium term. There is a long-standing correlation between relative equity performance and Australia’s terms of trade (export prices to import prices – Exhibit 2).