Treasure Chest | Apr 13 2015
By Rudi Filapek-Vandyck
Australian equities are not cheap. On that point, pretty much everyone seems to be in agreement. But try to put a number to it, and disagreements start opening up.
It was a wise man who once declared: there are lies, damned lies and then there are statistics. And data. And calculations. On Macquarie’s number crunching the Australian share market is trading on a FY15 Price-Earnings (PE) ratio in excess of 17, well above the long term average which is situated somewhere between 14 and 14.5. But given we are already in April, meaning there are but 2.5 months left for financial 2015, maybe we should look at FY16 forecasts? In that case, Macquarie puts the share market’s PE at 15, which seems a whole lot less scary compared to the long term average.
The weakness behind these numbers remains what analysts are putting through their models in terms of profit forecasts. Traditionally, these forecasts start off too high and then get downsized as the year progresses. This pushes up the PE without any need for further share price movement. It is probably a fair assumption to make at this stage that the pressure for Australian profits remains to the downside.
At Morgan Stanley, however, the number crunchers have arrived at a different outcome. They believe the FY16 market PE has currently surpassed 16 and that, history shows, may well turn out to be an ominous observation. As the chart below shows, the ASX200 has only traded above a market consensus PE (one year out) above 16 three times in total. On each occasion this proved the precursor to a market correction.
No surprise thus, Morgan Stanley market strategists ask the question whether this observation warrants repeating the old share market mantra: sell in May and go away, don’t return until St Leger’s Day. As indicated above, Macquarie’s numbers indicate the 12 months forward PE still sits at 15.6, which is above long term average, but still well below Morgan Stanley’s ominous market observation.
To complete this picture, FNArena’s own calculations, which omit extreme outliers (and there are quite a number of those given the high representation of resources and contractors) put the respective consensus market PEs on 18.8 for FY15 and on 16.2 for FY16, effectively supporting Morgan Stanley’s number crunching over Macquarie’s.
Market bulls will counter that extremely low interest rates by definition allow for higher equity valuations, thus today’s 16.2 should not be compared one-on-one with those in 2009, 2007 and 2001. The bears will counter-argue further downward adjustments to profit forecasts will automatically push up these numbers to even more dizzying heights.
In between sits the observation that ongoing anticipation for an RBA rate cut in May is providing natural support for local equities, while US equities seem caught between loss of profit growth and further delays to the anticipated first rate cut from the Fed.
It really is a smorgasbord of conflicting angles and observations, isn’t it?
Fun and games.
The above mentioned PE numbers suggest a glaring discrepancy between growth projections used in calculations by Macquarie, Morgan Stanley and FNArena. On this item, FNArena’s projected 10.9% growth in average earnings per share (EPS) is closer to Macquarie’s 13.2% for FY16. Morgan Stanley is working off 3% growth only, and declining.
The numbers at Macquarie and FNArena are supported by relatively buoyant expectations for industrial stocks and resources. The latter implies a bounce from the annus horribilis that is FY15 for the sector.
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