Australians will have to delay party

We are in a world that is growing more slowly, and will be for years.

Pulling Greece and Europe's banks back from the brink has put a base under the New Year sharemarket rally, and the US Federal Reserve is laying foundations now, too.

Yesterday's 1.7 per cent Wall Street bounce and the buying around the world that accompanied it came after upbeat comments from the Fed about the US economy, and the release of a stress test for the biggest US banks that was not a perfect "10", but good enough to show that America's banking system is substantially repaired, and getting stronger.

There are two questions now. Is this, finally, the early stages of a convincing climb away from the global crisis and the collateral damage it caused? And if it is, to what extent can the Australian market participate?

The answer to the first question is there's not much unbought slack in global share prices given the rally that's already occurred. More good news is probably needed to push prices substantially higher. The answer to the second question is that Australia is handicapped - which its base valuation reveals.

Yesterday's 218-point rise for the Dow Jones Industrial Average of 30 blue-chip stocks more than compensated for last week's losses, including a 203-point fall on Tuesday, March 6, and took the market to levels last seen in late 2007 before the global crisis fully hit. The Dow average is also now just 7 per cent below the high it set in October 1997 in a brief, stupid rally out of its initial crisis downturn.

The US market is trading at about 12.9 times expected corporate earnings for the next 12 months. That's well below the fair value benchmark of about 15 times expected earnings that existed before the global crisis, but the relevance of that comparison is questionable. We are in a world that is growing more slowly, and will be for years. Earnings multiples need to be lower to reflect that, and it's quite possible that 13 times earnings is close to correct weight.

It's also worth noting that the market's mood now and current overseas sharemarket valuations are strikingly similar to what they were in the first half of last year. The first Greek bailout had occurred by then, and the cautious consensus, returned now, was that Europe's sovereign debt crisis was not over, but being brought under control. US economic growth also appeared to be consolidating, as it does again now, and investors were pricing US shares at about 13 times expected earnings, as they are today.

The story is similar for the global sharemarket. The MSCI global index was priced at an average of 12.2 times expected earnings in the first half of last year, and it is priced at 12.2 times expected earnings now.

The Australian market is different, and not in encouraging ways. The Australian portion of the MSCI global index, our top 100 stocks basically, is priced at about 11.3 times expected earnings in the next 12 months, down from an average of 12 times in the first half of last year. The multiple would be even lower if analysts had not downgraded the outlook for earnings, and the discount is evident in substantial under-performance.

The ASX 200 index is still only 10.9 per cent above the low it set on September 26 as Europe's sovereign debt crisis reignited. The Dow average has risen by 23.7 per cent since October 3, and the MSCI world index is up 21.8 per cent.

Can Australia catch up? Perhaps not for a while. All the markets remain sensitive to bad news, but growth is also cycling down here.

Commodity prices are still strong, but they are softening as China's economy slows, and the Reserve Bank is continuing to pummel our industrial and service sectors with an interest rate policy that aims at containing inflation in the resources sector, and encouraging the redirection of finite resources of capital, goods and labour to the boom.

High interest rates have driven the dollar to a point where it is an unprecedented weight on export competitiveness outside of the resources sector, a carbon tax that is pitched at twice the depressed international market price is just around the corner, the states are not spending to boost overall demand, and the federal budget in May will be sharply contractionary, assuming Labor maintains its target of a surplus next year.

The opposition, meanwhile, is making the same budget surplus promise, joining the Greens to block a tax cut for large companies because it is linked to Labor's mining tax, and threatening to impose a 1.5 per cent tax on the same companies to fund its parental leave plan.

You really couldn't make some of this stuff up, and announcements such as Julia Gillard's creation of a small business commissioner yesterday or elevation of the small business portfolio to cabinet will not change the market's mindset.

Overseas markets will continue to be defensively priced against expected earnings to reflect risks in Europe's sovereign debt rehabilitation program and the US recovery. Share prices could still rise, however, if corporate profits exceed expectations in the March and June quarters.

If that happens, shares here would probably trend upwards, too. But they would struggle to match the overseas pace, and are unlikely to close the gap that has opened up since the rally began: local investors aren't facing something as concussive as a perfect market storm. They are in a sub-tropical depression: a trough of policy-driven low pressure that brings with it profit-dampening rain, and a soggy sharemarket.

mmaiden@theage.com.au

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