FYI | Oct 05 2007
By Chris Shaw
“It’s different this time” are among the scariest words an investor can hear but AMP head of investment strategy and chief economist Shane Oliver suggests there are a number of reasons why October 2007 won’t be a repeat of the stock market crash of October 1987.
Firstly, Oliver points out the share price gains and valuations are much more reasonable this time around than was the case 20 years ago, meaning the trend should remain positive.
The figures back up Oliver’s assertion as he notes in the year prior to the October 1987 crash share prices in the US rose 36.4% and in the four years prior enjoyed annual gains of 20.3%, whereas this time the respective gains are 15.8% and 11.3% annually.
The numbers for Australia show a similar story, with the one-year gain leading into October 1987 of 88.4% dwarfing the return this time of 29.6%, while for the four years leading up to the 1987 crash the market gained an average of 34% annually against 20.1% this time.
The higher gains in the years prior to the 1987 crash were achieved despite far stronger earnings growth this time around, Oliver noting US earnings actually fell by around 2% in the year to October 1987 but this time have risen almost 15%, with the comparison equally as attractive on a four year timeframe.
Australian earnings growth over the past year has been less impressive when compared to 1987 at 14.7% against 24.5% two decades ago, but on a four year comparison again comes out in front at 25% annually against 15.5%.
This means that over the past four years share price gains in the Australian market as a whole have actually lagged profit growth, which is a major factor in why the historical P/E (price to earnings ratio) for the Australian market is 16x now against 20x back in 1987.
If this is not enough, Oliver points to another major difference between now and the conditions of 20 years ago. Back then entrepreneurial stocks were a large part of the market (those with a long memory may recall the likes of Industrial Equity, Brierley Investments, Alan Bond and Christopher Skase) but their earnings were not real, whereas this time resource companies are actually generating real profits.
This has contributed to a significant lowering of corporate debt levels, which is a positive given a contributing factor in the 1987 crash was the rapid growth in corporate debt and gearing levels. As well, inflation is now far lower at around 2.7% in Australia against more than 8% in 1987 and the US Federal Reserve is now lowering interest rates rather than lifting them as was the case 20 years ago.
Oliver’s conclusion is while the market may be set for a correction a major pullback is unlikely and the uptrend should continue. It is a view not too different to that of UBS, though the broker too is a little more cautious now in terms of the chances of some sort of correction given the Australian market is once again at a P/E premium to the rest of the world.
Offsetting this and likely to continue providing support to valuations in the broker’s view is a tightening in the supply and demand balance as takeover activity has reduced the supply of available stocks yet money to invest continues to flow in via superannuation.
This inflow has been a major factor in the speed of the market’s recovery from the late July/early August correction in the broker’s view, as it was only once prices came down that much of the available funds for investment actually entered the market.
As with Oliver the UBS team of market strategists expects the medium-term trend to be stronger, as it sees continued share price gains on the back of a strong corporate profit cycle and ongoing inflows into superannuation.
