Is the ASX “priced for perfection?”

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From the SMH:

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The sharemarket is the most expensive it has ever been outside of the worst excesses of the dot-com bubble, as global investors in recent weeks have joined Australian in a headlong chase for yield.

After barely limping 1 per cent higher in 2014, the S&P/ASX 200 index has surged closer to 9 per cent in less than two months, despite a flat week amid a volatile earnings season. That has pushed valuations in the industrials component of the benchmark index to “pretty scary” levels, CBA equity strategist Tim Rocks said.

Mr Rocks calculated that listed industrial companies, which excludes resources and financial stocks, as a group trade at an estimated price/earnings ratio of more than 18, against a peak of about 19.5 early this century. That was during the tech boom – a stockmarket bubble that burst in March 2002 and sparked a 23 per cent plunge in prices over the following 12 months.

But as valuations have continued to be pushed higher, it is becoming harder to see how the recent strength can be maintained through the rest of the year, particularly with a number of high-profile global risks on the horizon.

“This is the whole point of this phase of the global cycle,” Mr Rocks said. “There are so many potential event risks, all of which have very ugly consequences, and there is a very good chance at least one of them does.”

Too true but the share market is not “priced for perfection”, it’s priced for rate cuts and the collapse of Australian yield, meaning the main risk ahead is the RBA sitting on its hands. Goldman chimes in, from The Australian:

While positive earnings surprises have dominated the Australian earning season so far, with 43% of companies beating earnings estimates versus 28% that missed estimates, the quality of earnings beats has been low, according to Goldman Sachs.

The number of companies experiencing downgrades to their earnings forecasts has exceeded the number of upgrades by 50%, with most of the downgrades occurring in cyclicals and small caps, Goldman Sachs analyst Matthew Ross says.

Consensus for fiscal 2015 Industrial EPS growth has fallen 80 basis points to 6.2%, with the revenue estimate falling 60 basis points to 2.9%, and margins down 15 basis points, Mr Ross notes.

Capital management has remained a strong theme, with a 73% rise in the Industrials pay-out ratio up 73%, driving dividend growth of 9.5%, well in excess of earnings growth.

But despite a raft of capital management initiatives, 25% of firms have missed dividend expectations versus only 14% at the FY14 results in August, Mr Ross says.

He notes that companies remain focused on executing cost-cutting strategies, with little in the way of new program announcements, and more firms are surprising with higher operating expenses, primarily staff costs.

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Yep, and it doesn’t matter. Price is the new driver of value, not earnings. Over to you, RBA.

About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.