Rudi's View | Feb 09 2007
By Rudi Filapek-Vandyck
It has become a regular feature during the first two weeks of the interim results season: securities analysts commenting they like the company’s improved growth prospects but the high valuation of the shares stops them from recommending investors should Buy.
It happened this week (Monday and Tuesday) to Crane Group (CRG), Talent 2 (TWO) and Stockland Group (SGP).
Is the Australian share market becoming too expensive?
Strategists at leading equity brokerages have looked into the matter over the past ten days. With the Australian share market breaking record after record, and, while doing so, outperforming most other leading share market indices across the globe it only seems logical to ask the question.
At FNArena we started to look into this matter last week when we noticed how most Australian banks were either trading beyond or near their average twelve month price targets. At a time when resources stocks are suffering from a significant lack of momentum, we would regard the banks as the barometer of the local share market. History has shown repeatedly that most stocks don’t usually trade above their average price targets – not for long anyway.
Our analysis in the past has shown it is no different for the banks. The conclusion we drew from this is that unless price targets move up the prospects of further share price appreciation for most banks would seem rather limited. This usually requires the market starting to price in higher earnings prospects.
As it happens, a similar theme seems to apply to industrial stocks in general, with several strategists arguing that if reported earnings don’t surprise over the next two weeks, share prices will have to retreat from current levels.
Depending on who’s insights one relies upon, or which valuation matrix is being used, Australian stocks in general would seem to be “expensive”, but not excessively so. Opinions about the valuations of the various sectors of the market differ, as can be expected, with the exception of two sectors for which overall opinions are in accordance: property trusts are very expensive and resources stocks are dirt cheap.
The FNArena Market Sentiment Indicator seems to paint a similar picture with overall underlying market sentiment, as defined by the relative amount of Neutral recommendations by ten leading experts, currently firmly bullish, but far from the levels seen over the past few years.
So far, the initial signals of the interim reporting season have been encouraging with companies delivering more upward surprises than disappointments. This seems to have tipped the overall trend for EPS estimates upwards again, although on relatively few reports only.
There is, of course, an alternative way to increase the upward potential for Australian shares and that is by increasing price/earnings (PE) multiples for the market. The suggestion was put forward by market strategists at Credit Suisse this week.
On the broker’s analysis, demand for Australian shares will outstrip supply significantly this year. Credit Suisse even uses the term “unprecedented”. The broker believes last year demand already outweighed supply, despite the large T3 offer, and this has pushed up the share market’s performance into double digits again. This year the gap should be much, much wider.
If Credit Suisse’s calculations prove correct circa 4% of the total market capitalisation of Australian equities will be looking for reinvestment in the market this year. All these funds come from excess cash (paid out through dividends or share buybacks), mandatory superannuation (with changes in legislation adding more to the basket this year), corporate mergers and acquisitions, private equity deals and -not to forget- the government’s Super Fund.
Last year, the strategists argue, the overall PE for the Australian share market rose by 10%. Credit Suisse sees a direct relationship with the demand/supply balance. Considering the broker believes the imbalance for 2007 will be four times larger as in 2006, it would be easy to see the market PE to expand further this year.
The fact that the bond market has now priced out any rate hike in the near term will no doubt contribute to such a scenario.
There is, of course, a third scenario whereby share prices retreat to create room to move further upwards again.
At a time when several commentators are pointing out that underlying momentum in the US equity markets appears to be waning, and the market is starting to look “heavy”, investors can possibly draw confidence from Credit Suisse’s analysis that any possible weakness will make the overall market simply more attractive.
