Rudi’s View: How Expensive Is Expensive?

Rudi's View | Jun 04 2025

How Expensive Is Expensive?

By Rudi Filapek-Vandyck, Editor

Equity markets look "expensive".

There's virtually nobody around who will fiercely dispute that statement, but does this by definition mean we should all worry about the next sell-off forthcoming?

Recent client conversations by analysts at Morgan Stanley appear to suggest investors have --sort off-- given up on the ongoing valuation/over-valuation debate.

On the analysts' observation, there is now a "genuine fatigue" among investors when conversations migrate towards things like average and historic PE levels and equity valuations versus inflation and bond yields.

As far as Morgan Stanley's experience goes, local investors are way more interested in identifying companies that source their earnings locally and offer quality and defendable earnings stories.

Clearly, this year's context has put tariffs and tariff risk on everyone's mind.

Banks Loom Large In Australia

This also tells us a lot about why Australian banks refuse to "come down to earth", so to speak, despite just about every sector analyst and his pet (dog/cat/parrot) calling the sector overvalued by double digits.

The world remains uncomfortable with what can possibly be decided at the White House tomorrow.

Australian banks might not offer the same excitement and growth potential as the likes of Nvidia and Microsoft in the US, or try defense companies in Europe, but viewed through this year's specific risk assessment, they are solid enough havens that don't keep investors awake at night.

At some point, one would assume, either underlying fundamentals will need to catch up, or today's share prices will revert back to much lower levels.

According to analysts at The Intelligent Investor, the sector in Australia awaits in all likelihood another lost decade, just like the first ten years after the GFC delivered no net gains for loyal shareholders.

Except it lasted more than ten years, and CommBank ((CBA)) has been the stand-out exception (as I have pointed out time and again).

Banks remain the largest index constituent in Australia, and with none of them still trading below consensus target (outside of Judo Bank ((JDO)) and Macquarie Group ((MQG)), it goes without saying today's key indices in Australia all look inflated, pricey and bloated.

One can see why so many investors and market commentators feel nervous and uncomfortable, also because May yet again delivered outsized returns for local investment portfolios.

Ord Minnett Is Bearish

Last week, Head of Asset Allocation at Ord Minnett, Malcolm Wood released a valuation update for the Australian market and made his conclusions clear from the get-go: valuations in Australia are "extreme" no matter the angle from which an assessment is made.

On Wood's sector comparisons between the US and Australia, five out of 11 sectors locally look "expensive" against a direct comparison with the US, where valuations equally look richly priced. Those five sectors are Financials (of course, and mostly the banks within), as well as Healthcare, Info Tech, Communication Services, and Utilities.

Underneath such generalised assessments, there's plenty of material for hours-long debate. Wood himself acknowledges even in an "extremely" overvalued market, there are parts in sectors and the share market generally that look "attractive", "compelling" or "undervalued", including inside the five sectors highlighted.

One additional observation to make is Wood's historical PE comparison is 14.6x. With the local PE now sitting around 18.5x, this suggests overvaluation by two standard deviations, which sounds very scary and no doubt is one reason why the term "bubble" is so commonly used these days.

But maybe a more accurate observation to make is that equity valuations have been higher over the decade past than in the decades prior and in Australia this means a more apposite comparison might be the ten year-average multiple of 16x. It still means today's valuations are well above average, but a whole lot less than suggested off the 14.6x multiple.

In simple terms: Wood's analysis is suggesting the local market looks overpriced by some 26.5%, but against the ten year benchmark this percentage shrinks to 15.5% -- admittedly, that still remains a sizeable distance from "cheap".

UBS Remains Positive

Strategists at UBS are significantly less worried than Ord Minnett. Following this year's sharp sell-off and equally steep recovery, markets look due a breather for the time being, also because economic momentum is likely to weaken globally and in the US, but UBS has its focus firmly pinned on more upside for equities by year-end.

This view mainly centres around plenty of supportive factors keeping investor sentiment net positive, including lower tariffs, more rate cuts from central banks, fiscal easing in Europe and China, and, eventually, lower bond yields. UBS is also positive on AI and how investments made will result in leaner businesses with increased margins, which justifies higher multiples.